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Central banks are faced with a dangerous paradox. Economies at the state level have become de-linked and sectors within economies have become de-linked as well. At the top level, coordinating a policy response means both finding a mechanism to cool off China’s rapidly overheating economy and continuing to pump oxygen into the western system.
Even within the United States, as we are starting to see a healthy rebound in certain sectors, there are disturbing signs of a second possible real estate collapse – this time in the commercial sector. The Federal Reserve system will be forced to choose between averting an imminent disaster today and tolerating an overheated economy later OR letting the chips fall where they may, the market clearing brutally and efficiently, which brings the risk of entering a deflation spiral, but the possible benefit of a stable, less intervention prone future.
This chart is a proprietary index which I’ve found does a nice job of picking up on economic inflection points. It combines industrial factors and money supply, tracking the rhythms as economic cycles gain strength, then gradually lose steam. According to this metric, we ought to be shifting solidly into recovery mode and clearing out the debris of bad investment decisions from the last cycle. That supports the optimistic scenario.
(Note: This chart is sensitive to flows of activity in the real economy of manufacturing and large orders and changes in money supply around those orders, so it will show strong surges leading out of recessions as well as softenings in order flow leading into recessions.)
Non-financial economy index
However, the International Monetary Fund remains quite pessimistic about the financial condition of the US consumer, with the assumption that consumer loans will be charged off for an extensive period, and not reach 2007 levels until possibly 2013. This strongly suggests an extended period of workout with tightened credit conditions, more stringent collections activities, and a general loss of desire to take on yet more debt. This alone will probably keep the consumer bottled up through the next cycle.
If the picture on the consumer credit side is less than wildly energetic, the commercial real estate market appears to be downright implosive. Nobody seems to really know how bad it could get or how much direct intervention may be required in case a major player decides to pull a Lehman.
No doubt the Treasury and the Fed are wondering, should they have to go back to Congress, and ultimately the US taxpayer, how much sympathy would be left for another massive bailout program. The public may have become so disgusted by the last round of emergency measures that they’ll vote to let the chips fall where they may this time around.
Surely Geithner and Bernanke understand the political dimension, and will be working overtime, in advance, to stave off a commercial real estate collapse with every means at their disposal that can be kept reasonably hidden from public view. Which may mean that they are willing to stuff the goose in advance and pray that they can drain excesses from the system before a potential inflationary surge gets back into the public mentality.
This YouTube video (posted about a month ago) will help explain this leg of the predicament we find ourselves in.
Meanwhile, China appears to have used every tool and mechanism at its disposal to avert a global meltdown by a radical program of internal investment to create internal markets to buffer the loss of external market capacity. The result seem to have been to unleash an astounding amount of real estate development and speculation. How much is too much?
What happens if it breaks down? Who is left holding the bag? Does the Chinese Communist Party have the administrative smarts to structure a bailout program above and beyond furiously reflating their economy? Or was the Chinese approach to combating a potential worldwide deflationary spiral that of slamming their economy into the opposite gear of a potentially extreme inflation or bubble scenario?
January 8, 2010 at 5:22 pm
FWIW….. Paul Smalera writing in today’s Slate, January 7, had the following to say:
“Not every member of the Federal Reserve’s Open Market committee thinks the central bank’s job in handling the financial crisis is done, reports the New York Times. The Fed is taking steps to end some of the programs it had started to prop up the housing market through the collapse, but according to minutes from the committee’s mid-December session, the decision wasn’t universally viewed as the final action: “If [economists] are wrong, and the modest pace of economic growth slows or mortgage markets significantly deteriorate, ‘a few members’ of the Federal Open Market Committee believe that ‘more policy stimulus’ may be desirable, the Fed minutes said.” James Bullard, the president of the St. Louis Federal Reserve Bank, has publicly said the Fed should keep its program of buying mortgage-backed assets—to the tune of $1.25 trillion—alive. But Bullard isn’t currently a member of the committee, which decides such matters, though he will become one later this year. It’s already been estimated that ending the program will push mortgage rates back up by half a point to a point, squeezing some potential buyers out of the housing market. The Fed is walking a “tightrope,” as one economist puts it, between weaning the private sector off of the Fed’s beneficence and sending the housing market off another cliff.”
Right…. but it wouldn’t be the housing market to take the big dive, it would be the commercial maket, which, of course WOULD knock the housing market down if IT did a swan dive into a deep ocean tranch…
January 8, 2010 at 8:26 pm
Housing will bottom when we get to about $70/sg ft. for residential. Now its bouncing between $100 and $85 which is still out of whack historically.
Yieldpig´s last blog ..You say you want a resolution…