Markets Need Time, Not More Poison


A recent story from the front page of the Wall Street Journal illustrates the bankruptcy of mainstream macroeconomic thinking. The piece contains so much nonsense that the only appropriate critique is to go through the article step by step:

Shrugging off a flurry of grim economic news, stock investors pushed the Dow Jones Industrial Average up more than 10% as they anticipated new medicine from the Federal Reserve.

I realize the WSJ is in the business of selling newspapers, and that calling injections of Fed funny money "medicine" is a catchy opening. But if our present crisis it the result of prior injections of artificial credit, then the medicine is in fact arsenic. What is especially ironic is that this very article later on alludes to the possibility that the housing boom was fueled by Greenspan’s low rates. In any event, the most recent Fed cut was largely symbolic, since the actual fed funds rate (as opposed to the official "target" set by the Fed) had already been below 1 percent for some time:

Let’s return to the article:

The case for more rate cuts strengthened Tuesday, with new reports showing the economy deteriorating sharply. The Conference Board said its monthly measure of consumer confidence hit 38.0 in October, the lowest level since the New York-based business research group began keeping records in 1967….The housing market also took a turn for the worse. Earlier in the summer, some housing indicators suggested home-price declines might be slowing. But the S&P/Case-Shiller home-price index for 20 large cities was down 16.6% in August from a year earlier, a record decline. Falling home prices can feed a downward housing spiral, creating pressure for more foreclosures and resulting in mortgage losses among banks.

It is true that spiraling home prices are the ultimate driver of the immediate problems, but to repeat, we are in the present mess because of an unsustainable boom in housing. Everybody agrees that investors foolishly bought into a rising market, and that the incredible appreciation in house prices was not based on fundamentals. How else will the economy move on, if these admittedly overvalued properties do not shed some of the gains during the artificial boom? Government efforts to prop up house prices will waste billions of taxpayer dollars and will only serve to continue denying reality.

The article touches on this point — unintentionally — when it says:

[T]he last time the Fed pushed rates [to 1%], it helped to plant seeds for the current credit bust, some economists argue, by contributing to a frenzy of borrowing by households and on Wall Street. That doesn’t appear to be a concern for Fed officials now. Credit markets are so shaky and the economic outlook so unpromising, another speculative frenzy now looks remote.

Read the rest of the article