Sunday, September 30, 2007

Depression? Inflation?

I'd like to ask a simple question of those wiser than I in the ways of $$$.

This piece forecasts a housing depression. Apparently, new homes are not selling quickly and the median price fell 7.4% from a year ago. Expect the plummet to continue.

But plenty of other stories predict inflation. Here's one from Newsweek:
Catch that bit about "core inflation"? That's Fedspeak for: inflation is under control, unless you look at the costs of things that are going up. The core rate excludes the prices of food and energy, which can be volatile from month to month. Factor them in, and inflation is about as moderate as Newt Gingrich.
Okay, you can probably guess where I'm going with this: Won't a dive in housing prices compensate for elevated numbers elsewhere?

Of course, many poor bastards will have to make hideously overpriced house payments while also paying four or five bucks a gallon at the pump and a buck-fifty for a tomato. But: Traditionally, inflationary pressures drive up wages as well as prices. I don't know if that tradition will still hold true in the Age of Outsourcing -- but if it does, then those folks who bit off more than they could chew (mortgage-wise) will be better able to pay the banker his pound of flesh.

I've been predicting economic doom for a while now. I'd love to be wrong.

6 comments:

Anonymous said...

No expert here, but I have felt for a long time that falling home values would be at least partially masked by a falling dollar in the not-so-distant future, as the house of cards begins to collape.

As far as how this affects actual "inflation rate" I have started to believe that this is a question borne of the fantasy that published inflation rates are somehow grounded in reality.

I was recently informed by a service company that pegs their annual price increases to the overall CPI that the next increase will be 2.8%.

Having been living in something similar to the real world, this number struck me as being incredibly low, and I mean that in the literal sense of the word.

Hyperman said...

The value of houses on the market doesn't really influence inflation directly or on a short term. It's like the price of stock, if it goes down, the price of living is not directly influenced by it. Will your rent go down because the price of houses are going down this year ?

Inflation is calculated with the "Consumer Price Indexes" (CPI). It includes the price of housing (rent or the interest paid on the mortgage, not the capital reimbursement), but not the value of the house on the market.



"The Consumer Price Indexes (CPI) program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services. The CPI represents all goods and services purchased for consumption by the reference population (U or W) BLS has classified all expenditure items into more than 200 categories, arranged into eight major groups.

FOOD AND BEVERAGES (breakfast cereal, milk, coffee, chicken, wine, service meals and snacks)
HOUSING (rent of primary residence, owners' equivalent rent, fuel oil, bedroom furniture)
APPAREL (men's shirts and sweaters, women's dresses, jewelry)
TRANSPORTATION (new vehicles, airline fares, gasoline, motor vehicle insurance)
MEDICAL CARE (prescription drugs and medical supplies, physicians' services, eyeglasses and eye care, hospital services)
RECREATION (televisions, pets and pet products, sports equipment, admissions);
EDUCATION AND COMMUNICATION (college tuition, postage, telephone services, computer software and accessories);
OTHER GOODS AND SERVICES (tobacco and smoking products, haircuts and other personal services, funeral expenses).
"


http://www.bls.gov/cpi/

But there's a link between the current mid-high inflation and the housing bubble. A greater availability of money through credit will stimulate inflation by driving demand for goods. That's why the feds usually fight inflation by raising the interest rate. But since they are trying to fight the housing bubble crisis by lowering the interest rate, they will create more inflation by increasing the availability of credit. Oil price is also a big driver, since it's included in the price of everything in our "oil based economy" (plastic, fertilizer, transport, paint, you name it !), so you can expect to have to pay a little bit more for almost everything if it goes up.

Anonymous said...

Back in the double-digit inflation days of the '70s (Nixon, Ford, as well as Carter), housing price increases were improperly put into the inflation index. It was improper, because by far most people in those days had fixed mortgages at the 5% or lower rate, and thus were not out in the marketplace paying the 12-18% mortgage interest rates, to any great degree. This was eventually realized to be true, and not only were the inflation indices changed to reflect that, but the official inflation statistics were gone back over, and restated, to reflect this change.

It is a little different now, since the bubble effect in residential properties has pushed mortgage indebtedness by approximately double over the past decade or so, with much of those new mortgages tricked out with adjustable rates, interest only for some years with a balloon due, and etc.

Consumer spending, something like 2/3rds of the economy, has been driven by negative savings (drawing down savings to spend on consumption), backstopped by a vast paper increase in the value of the properties, and refinancing with cash out at the lower (although tricked out) rates, and second or third mortgages known as home equity loans.

There is the well-known 'wealth effect' of rapidly increasing home values, where the homeowner is willing to keep spending, perhaps beyond their means, because they think they've gotten a small fortune windfall in their house value. Or they've reduced their housing payments to allow greater cash availability for other consumption spending, along with those that just borrowed out some of their equity.

All of the above has now come to a screeching halt. There is a reverse wealth effect, where plummeting prices make the home owner feel poorer and less willing to spend on other things. And the re-financing splurge cannot occur with higher interest rates, while all the adjustable rate mortgages and balloon payments are coming due, further squeezing cash flow for homeowners.

This particular debt system we live in mounts up debt to the sky until it cannot be repaid, and then a rather painful retrenchment occurs, with much of this debt going bad, lenders forced to write off their loans as non-performing, and homeowners losing much of their wealth when they lose the equity they'd built up in the home value.

Inflationary recessions are nothing new (the whole '70s suffered from so-called stagflation), so perhaps there isn't a real choice between the situations, but now, the worst of both worlds?

sofla

Anonymous said...

The CPI is calculated using something called "owner's equivalent rent" -- which I don't pretend to understand, but the bottom line seems to be that rents were unusually low during the housing boom (because people were buying instead of renting) and are now going up (because fewer people can buy and there is more demand for rentals.)

So this ought to increase the official inflation rate, even if house prices are falling.

AitchD said...

No one talks about or has written about (to my knowledge) the hidden vigorish in all retail transactions, i.e., the 3-4 points the banks charge for credit/debit transactions plus the state/local sales taxes added. It's a factor too complex to write about here, so I'll abbreviate it with a simplified explanation. If you charge $100 at K-Mart, K-Mart gets $98 (tops) or $96 (bottom) from your (credit-card) bank at the close of that day's business; your bank gets your $100 if you pay before (more) interest (penalty) accrues (grace period). No one should think they haven't paid 3-4 points interest up front, at the point of sale. (Remember in the late 1970s, when gas stations had two prices, one for cash, another for credit? Now, without an option, the 3-4 point vigorish probably should be called 'inflationary', and added to the inflation rate.)

Incidentally, I live in Charlotte, NC (HQs for Bank of America and Wachovia), where there is still a housing boom market -- it's Silicon Valley here without the silicon: instead of software engineers, there are finance engineers.

Consider this: two years ago, when the gas prices spiked to $3/gal, consumers (including truckers) bought gas with credit cards; many consumers continued to pay only the minimum payment on their accounts, while the banks benefitted from the spike (windfall), since 3-4 percent of $3 is additional money for no additional cost, per se.

Consequently and subsequently, those gas consumers had less money to spend if their income didn't increase. Many of them refinanced on their home 'equity'. Now, that bill is coming due....

Another point: franchises and malls. Whenever you have your credit card swiped for a purchase at your local mall or franchise restaurant, the funds don't stay in your town. A few bucks stay there to pay a manager and 'assistant managers' plus 'associates' (sales clerks); most of your purchase money leaves your town or community.

Not incidentally, if you pay with cash, you're paying the (credit-card) premium price anyway, so you might as well use your credit card because you're losing money that your cash could earn theoretically. It's a devil's bargain.

Into this decades-old mix comes eBay and PayPal, which most consumers don't know about -- yet.

By the way, the Mellon family made its bones during the Great Depression, when it suddenly owned most of the (foreclosed) real estate in Western Pennsylvania. After that Mellon became one of the largest banks in the US.

We no longer live in a society; we live in an economy.

Anonymous said...

"We no longer live in a society; we live in an economy."
-> ... if it only WAS an economy..