The Downside of the Bubble Economy

Another signal that financial reflation has pumped up more than just the stock market flashed and beeped on Tuesday.  The housing market, following an epic bust and years of extraordinary monetary measures, is once again expanding at a specious rate.  Could it be the Fed has finally succeeded in engineering a new housing bubble?

We may not know for years.  However, at the moment, we’re beginning to catch a whiff of something with an uncanny scent.  In fact, when we breathe in deeply we feel it in our pulmonary alveoli.  Do you?

“The S&P/Case-Shiller index of property prices in 20 cities climbed 13.7 percent from November 2012, the biggest 12-month gain since February 2006, after a 13.6 percent increase in the year ended in October,” reported Bloomberg.

“All 20 cities in the index showed a year-over-year gain, led by a 27.3 percent advance in Las Vegas.  Values climbed 23.2 percent in San Francisco.”

Not bad, if you’re a home owner.  Just for living in your home you experienced the added joy of ballooning wealth.  The experts say this will give the economy an added boost too…

The Effects of Cheap Credit

“Higher home prices bode well for consumer spending, because it helps to boost household net worth.  Economists at Bank of America led by Ethan Harris estimate that between 1980 and the third quarter of 2013, every additional earned dollar of housing wealth translated to 9 cents of consumer spending, compared with 5 cents for every additional dollar of financial asset wealth.”

Compared to the 13.7 percent rise in the Case-Shiller index of property prices, consumer prices, as measured by the consumer price index, increased just 1.2 percent during the 12-month period ending November 2013.  Just what is it that would cause housing prices to rise 11.4 times faster than consumer prices?

If you recall, during the peak of the housing bubble there were all sorts of reasons for rising prices.  “There not making more land.”  “Housing prices always go up.”

Perhaps housing prices are rising so much faster than other prices because they fell so much…and are now catching back up.  Who knows?  But we have an inkling cheap credit and accommodative Fed policies have a lot to do with it.

Nonetheless, it doesn’t seem likely house prices will fall again anytime soon.  At least not until credit tightens or the approaching wave of retiring baby boomers looking to downsize their homes floods the market.  In the meantime, we’ll keep an eye on things for you.

The Downside of the Bubble Economy

The point is, the reflation part of a bubble economy is the agreeable part.  It’s when everyone can feel good about their place in the world and the direction things are headed.  It doesn’t matter that the President’s a caricature or that MyRA’s a ploy to get low income earners to prop up government debt.  None of this matters when your house is going up at double digit rates.

Unfortunately, there’s also the deflation part of the bubble economy.  For those who forgot, January offered a nasty reminder that bubbles both expand and contract.  In particular, after going up all last year stocks are doing the exact opposite…they’re going down.

On Wednesday, following Fed Chairman Ben Bernanke’s final FOMC meeting, stocks got creamed…

“As expected,” reported the International Business Times, “the U.S. Federal Reserve on Wednesday voted unanimously to reduce asset purchases on Feb. 1 by another $10 billion a month to $65 billion.  The reduction was evenly split, with the Treasury purchases cut by $5 billion to $35 billion and the mortgage-backed securities purchases trimmed by $5 billion to $30 billion.”

Following the announcement, the DOW fell 189 points.  Moreover, even with yesterday’s gains, the DOW’s down 4.3 percent year-to-date.  By our back of the napkin estimation, the DOW’s got another 15 percent – or more – to fall.

But what do we know.  The big bull market could just be taking a slight breather before stocks rocket into the upper stratosphere.  On the other hand, they could be entering the downside of the bubble economy.

Ominously, Janet Yellen starts her new job as Fed Chair today.  If stocks fall too far too fast, she may be compelled to do something rash – like print lots of money – to stop it.


MN Gordon
for Economic Prism

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