As long as you don’t look down, it really is a lovely ride. But then, that is the stated goal of British Columbia’s PEAK 2 PEAK Gondola ride, the longest and highest lift in the world connecting Whistler and Blackcomb Mountains. Make no mistake, there’s no hype on that ‘world record’ claim. At nearly two miles, the ride crosses the longest unsupported (which one definitely senses) span that also boasts being the highest, some 1,427 feet above the valley floor. For suspended suspense of a different kind, I highly recommend taking this 11-minute journey in June. That way, you can see two seasons in one – elegant, be-downed skiers at the very top of the mountains and, if you dare peer below towards terra firma, mountain bikers in summer garb bounding down the mountain. Luckily, 56-millimeter-thick cables allowed me to live to tell the tale of the surreal sight of witnessing live performances of both winter and summer Olympic sports in tandem.
The occasion for my trip to the pristine northwest was a Vancouver speaking engagement hosted by an international group of foresters. Their one query, back in 2012: when would American homebuilders recapture the 2005 glory year pace of annual construction of over two million new homes? (Spoiler alert: they’re still waiting) In fact, there’s a solid chance the mill owners and loggers will be forced to play the waiting game for another generation. Such is the case when demand is pulled forward causing an unnatural rise in prices culminating in a burst bubble, which has to then be unwound in painstakingly slow order. Of course, I refer to home prices rising at an unsustainable rate due, in part, to loose monetary policy facilitating bad behavior, basically all around.
Today, policymakers find themselves staring down the barrel of another bubble that’s burst. This year’s International Monetary Fund’s annual meeting concluded with the world’s greatest minds in policy and economics agreeing that there will be no easy solutions to the problems facing emerging markets in coming years thanks to the bursting of the commodities bubble, which has also pulled forward demand on a global scale.
In an October 11 speech at the IMF confab, Fed Vice Chair and Reining Godfather of Central Bankers, Stanley Fischer, nodded to the dilemma facing U.S. monetary authorities. It is unwise to devise policy in a domestic vacuum given the, “increasing influence of foreign economic developments on the United States economy, both through imports and exports, and through capital account developments.” Beyond the slowdown in U.S. job growth, “the possibility that shifting expectations concerning U.S. interest rates could lead to more volatility in financial markets and the value of the dollar, intensifying spillovers to other economies, including the emerging markets.” At a mere word count of four, Fischer’s speech was relatively judicious in citing the ‘dollar’ by name as a concern. Contrast that to the September Fed meeting minutes wherein references to the strength of the ‘dollar’ made a record 19 appearances.
The bursting of the housing bubble, which to this day remains a thorn in the lumber industry’s side, and today’s commodities bubble, currently plaguing the global economy, are two bubbles bound by a troubling ‘flation’ paradox. The reaction to the PEAKing in home price inflation led to the PEAKing in commodities inflation. Meanwhile, boom/bust cycles, which stretch back in history as far as black tulip mania and characterize the current era of policymaking will inevitably usher in deflation scares that emanate from bursting bubbles. The debt Band-Aids applied provide an easier path than the restructuring of economies that would make them more productive over the long haul. The absence of such structural reforms leaves countries reliant on re-igniting their sputtering export engines. The only catch is, not everyone can play the same game at once.
Where in today’s boom/bust cycle does the U.S. find itself? According to the latest WSJ headlines, “Worry Over Low Inflation Kept Fed at Bay.” And yet, eight days earlier, another headline, this one from the Dallas Morning News angsted over, “Area Apartment Rents Rising at a Record Rate.” Well, which is it? According to two of the brightest minds in investing, Van Hoisington and Jim Grant, the answer is BOTH.
At a recent conference, fixed income investing legend Van Hoisington explained why the Fed cannot technically “print” money, at least when gauged by true M2, which is cash, checking and savings deposits and money market mutual funds. Recall that at its simplest, inflation is too much money chasing too few goods. Buying up all manner of debt with the hopes of inducing inflation only works if what the Fed spends circulates back into the economy in the form of M2 chasing goods. But that hasn’t happened. Rather, Fed purchases have been deposited right back at the Fed where they now sit fallow generating a pittance of income that sadly beats the negative rates they’d get otherwise. In Hoisington’s words, these reserves are simply not ‘transactable.” Hence the conundrum: M2 was growing at about six percent in 2008 where the rate remains today despite $2.5 trillion in Fed purchases. When money growth stagnates, the economy won’t slip into gear, which is just what we’ve seen for over six years now. (True money printing involves depositing money directly into checking accounts and happens to be illegal for those of you wondering.)
Jim Grant of Interest Rate Observer fame concedes that while we have seen little in the way of inflation of goods in recent years, we remain real time witnesses to the effect of the extraordinary amount of credit chasing asset prices from stocks, bonds and commercial real estate to the mountain PEAKs and beyond. Rising asset prices have no place in traditional inflation metrics as they are viewed as misleading economic growth signals. Or, as Grant “The distortion of prices puts us in a Hall of Mirrors.” It is thus an illusion of prosperity via the prism of asset bubbles that deludes us into believing anything of economic value has been produced.
But back to those paradoxical inflation/deflation headlines. The two gentlemen above, along with some acknowledged defects within the Fed’s preferred inflation measure, help solve the riddle. The creation of debt in debt-laden economies accomplishes a whole lot of economic nothing, hence incomes grow at no faster pace than the rest of the economy. That’s what happens when debt levels cross a line in the sand of the whole of a given country’s economic output. (Look no further than Japan’s debt to GDP of 670 percent to understand why that country is flirting with recession yet again.)
At the same time, credit has been chasing high-end apartment construction and prices to what is hoped are PEAK levels. Dallas, with its influx of jobs, may be the economic exception given the ease with which companies can actually conduct business there, but seven percent over the past few years will quickly extinguish a defining attraction of the area – that of reasonable housing costs. At a national level, apartment data miners find that rents are rising at something more along the lines of a five-plus percent pace. The core consumer price index (CPI), which excludes food and energy, meanwhile, reports a more subdued 3.6-percent pace in rental inflation.
But that still isn’t the number that poisons the ‘flation’ worry well. The Fed’s “preferred measure,” the core personal consumption expenditures (PCE) gauge, most recently crawled in at a worrisomely low 1.3-percent rate, a level sufficiently shy of the Fed’s formal 2 percent target. When numbers are this low, four-tenths of a percent is material. That’s exactly the size of the difference between core PCE and CPI, the latter of which last clocked in at 1.7 percent. The main difference between the two comes down to their shelter weightings. In the CPI, shelter has a 31-percent weight, which reflects an ideal but modern-day unrealistically low proportion of a household budget. The PCE’s 15-percent weighting insults households struggling to keep a roof over their family’s heads.
Tellingly, the core PCE also came under scrutiny during the PEAK years of the housing boom because it failed then, as it fails today, to capture the immense drag housing puts on household budgets. Harvard’s Joint Center for Housing Studies most recent data find that almost half of all renters spend more than 30 percent of their income on rent; they call this cohort ‘burdened’ and I’d have to agree. More than a quarter of all renters are ‘severely cost burdened,’ and spend more than half their income, half, on rent. The Harvard data reveal that lower income individuals are even more disproportionately burdened, which distressingly stands to reason.
In a recent report titled, “The Burden of Shelter,” Michelle Meyer, Bank of America economist and renowned housing expert, nodded to policymaker’s dilemma: “If renters have to allocate more of their disposable income on shelter, there is less money to spend elsewhere, contributing to the disinflationary pressure for consumer goods.”
And that’s just what we’ve seen. The Liscio Report’s latest survey of sales tax receipts picked up a distress signal being emitted from household budgets crimped by the factors discussed here and others: Only 30 percent of states met their forecasted sales tax collections in September, down from 68 percent in August.
Impeding policymakers’ future efforts are further downward pressures building in the pricing pipeline for goods. Though exporters to the U.S. don’t see it this way; the silver lining of a strong dollar is that it makes the goods we import cheaper. Indeed, import prices overall are down 10.7 percent over the last year, which largely reflects the bloodletting in the energy complex. Zero in on nonpetroleum import prices, though, and they have slid 3.3 percent from year ago levels. Even the supposedly Teflon services sector has failed to generate the level of inflation associated with economic recoveries. At last glance, services inflation was running at a 2.6-percent rate, far shy of the pre-crisis highs that exceeded 3.5 percent.
As for the prospects for truly normalizing interest rates one day, demographic trends only promise to increase the ranks of severely cost burdened renters in the coming years. Harvard’s data project that due to the rise in minorities and elderly as Baby Boomers age, those who spend more than half on rent will increase by 11 percent over the next decade and that’s IF rental inflation slows to that of income growth.
Of course, the opposite scenario unfolding would be ideal – that income growth begins to outpace that of rent inflation. Such an economic miracle, though, will only be possible with a radical change of thinking among policymakers. Policymakers are either blind, or worse, willfully blind to the financial asset price inflation that flashes red today, just as it did during the dotcom and housing bubble eras. If that is the case, the bust to come will be followed by yet another boom in asset prices, one that will require firehoses to douse the flames of impending deflation.
At the core of policymakers’ Catch 22 is the fact that there is no easy way out. To borrow from Hoisington’s philosophy – developed countries such as the U.S. are simply too large to devalue their way out of debt by using a depreciating currency to reduce debt loads. That leaves belt tightening which generations of central bankers have been trying to avoid at all costs.
Can the same brands of debilitating debt loads that leveled the global economy during the Great Depression be sustained indefinitely? That’s surely the hope as the frequent application of additional debt-creation bandages over the open wounds of high debt levels seem to be the only solution politicians find palatable. Perhaps the privileged skiers atop the world’s financial markets will be nimble enough to avoid sliding on the ice as one season of asset bubble glides into the next creating the illusion of a powdery permanent winter wonderland for a chosen few. Perhaps they can be magically transported from PEAK to PEAK with little in the way of collateral damage.
But what of the hard landing on the fully-thawed bare earth at the bottom of the mountain that must be endured by the millions of workers who cannot choose a more accommodating trail to escape their budgetary shackles? Will central bankers always be seemingly divinely endowed with soothing words to calm and assure the masses? After all, inflation in the wise words of central bankers, is only an illusion and does not exist. Except it does exist in a very real way for the masses far below the rarified air of the lofty PEAKS.