Our Love, Hate Relation to Inflation

Listening to debates about housing, oil and commodity prices is surreal. Housing and medical costs are huge components of household spending. In the first 3 months of 2008 housing and medical costs represented 33% of personal consumption expenditures, or $3.3 trillion. Across the same three months sky high energy and food costs accounted for 18% of personal consumption expenditure, or $1.8trillion. Housing and medical costs suffered massive and sustained inflation for years. Housing prices- the single largest cost facing American families- went nuts from 1996-2007. Not only were there virtually no complaints, every imaginable policy action was taken to extend and increase run-away and unsustainable house price inflation. Speculators drove housing price inflation. Individuals bought more, larger and more expensive homes constantly. How? Why? They got larger and larger loans on easier and easier terms. Lenders could bundle and sell the home mortgages to speculators around the world. We see the downside now as these speculative investments have already gone bad into the hundreds of billions of dollars. Everyone caught up in the process is writhing in pain. Our response? Let's re-inflate the bubble and/or try to lock in our inflated house prices. We have been failing and trying that for the last year. These attempts to save run-away housing inflation are feeding energy and food costs.

Over the past several years oil/gas/energy prices have soared. Prior to that, oil prices were basically flat or declining for more than 10 years. Food prices performed similarly. More recently commodity prices in general have spiked. Energy, food and materials costs are significant. They represent a smaller portion of spending than housing and medical care. Food and energy combined account for about half as many household dollars as housing and medical costs- even now. Why then the vast disconnect in response to inflation? Why is speculator driven hyper inflation in housing the greatest thing ever? Why is speculation influenced inflation in food and energy prices the work of Satan?

US mortgages were sold in an international market place. Chinese, Japanese and other nation's economic growth created vast pools of trade surplus dollars. Trillions of these dollars were recycled back to US homeowners to allow America to keep borrowing and spending- including on foreign exports. Oil export surpluses were stockpiled and recycled into US mortgages as well, to keep America buying oil and to support the US dollar. The public neither heard about, nor seemed interested in this from 2001-2007. As of June 30, 2007 foreign holdings of US agency securities stood at $1.4trillion. Such securities are heavily comprised of bundled American home mortgages. Foreign, particularly Chinese and Middle Eastern, demand growth funded the inflation in housing. No one minded, no one said anything and few paid attention. Suddenly, Chinese demand growth and Middle Eastern policy is decried for causing energy inflation and aggravating food prices. There was no problem when international markets, speculators and financial flows inflated housing. The stories of housing, energy and food are similar and intertwined. The responses are vastly divergent.

The speed and transparency of food and energy cost increases may explain part of the difference. A newly enhanced interest in blaming foreign actors smoothes political and media discussion. The confluence of today's high prices with declining home prices, stagnant wages and dimming job market prospects helps explain radically different perception of the new inflations. In the end, none of this explains it all. We seem to have decided some hyper-inflations are good and some are bad. Ultimately, we like hyper inflation in what we already own and hate it in what we have to buy.

Comments

[cylindar]

I think inflation coupled with job losses and high energy prices are superb! I would like to see more of this.Hopefully the bad news is just starting. I hope it gets so bad that the Great Depression looks like a picnic. The reason is that we have been getting robbed by the plantation owners for many years. They could hide it by throwing a few crumbs at necessary moments to the dogs (citizens who work hard and often wonder what the F#@k) Now, however they have run out of crumbs (hopefully). and the Sh$t will hit the fan. I want everyone in the middle class to become as poor as sin so that they will take up pitchforks etc. and demonstrate in Washington.

[worldtraveller]

Yes freakin brilliant.. Of course we "we like hyper inflation in what we already own and hate it in what we have to buy."
One increases assets on the balance sheet over liabilities increasing wealth, the other raises expense lowering cash flow.

[cylindar]

The worse it gets the better it will become.

[AtheistAd]

> Ultimately, we like hyper inflation in what we already own and hate it in what we have to buy.

Exactly. Human greed knows no bounds.

Sincerely,

bugmenot.com

[dadw5boys]

Lets see they ship more food overseas and create shortages here and the prices go up.

They call this inflation because people want to buy food and will pay more for the limits supply.

The people who are buying it oversea, in mexico, or South America are not paying as much because there is competition there. But here BARRIER TO ENTRY laws block protect them from competition and they fool the public whith 3 or 4 brands all from the same company.

[Henry]

"Our response? Let's re-inflate the bubble and/or try to lock in our inflated house prices. "

This statement you make is not true. Put yourself in Paulson and Bernankes respective places. Estimate the hundreds of thousands of loans (millions?) that will reprice out of their initial teaser rate stages. If Bernanke had Fed Funds at 5.0% (300 bips up) then mortage rates for conventional loans would be around 8.0%. That 8.0% would extinguish any opportunity for those with "rate" adjustments coming. Also look at all the foreclosed properties that need to be sold. If mortage rates were 8.0% for takeout financing of millions of reo the increase in loss at the margin would be phenomenal at the nationwide level. So.... bump up rates and wipe the life out of mortage potential for the struggling or keep rates lower and suffer the consequence of a "liberal" monetary policy. Tough choce.
So Mr Arrogant.. if you were to put your thinking cap on a bit and imagine that the Fed may not be "trying to lock in our inflated prices", they may actually be trying to help out millions of Americans. Of course, the consequence would be keeping a sinking sector (real estate) higher than it otherwise would be.

[Bitsyann]

Judging from Max's many excellent blogs on this website, I think he is well aware of and sympathetic to the pain caused to the millions of Americans caught in the deflating housing bubble. The issue here is not whether or not something should be done to stave off complete collapse - that has already happened and is happening in spite of aggressive and unprecedented action on the part of the Fed to keep credit markets from freezing up. The issue is that the housing market collapse and easy money policy is linked to a possibly inflating bubble in commodities - not new jobs, higher wages, and clearing economic skies for those millions of Americans who recently joined the home-ownership club on questionable terms.
What Max points out here - the divergent responses to what are essentially similar and related inflationary episodes in housing, energy, and food prices - are right on the money, and unfortunately not more widely discussed in these terms.

[MFWolff]

Dear Henry,

Thank you for reading and responding.

You disagree with "Let's re-inflate the bubble and/or try to lock in our inflated house prices. "

You respond with :That 8.0% would extinguish any opportunity for those with "rate" adjustments coming. Also look at all the foreclosed properties that need to be sold. If mortage rates were 8.0% for takeout financing of millions of reo the increase in loss at the margin would be phenomenal at the nationwide level. So.... bump up rates and wipe the life out of mortage potential for the struggling or keep rates lower and suffer the consequence of a "liberal" monetary policy.

To paraphrase, lets cuts rates and reinflate the bubble.

This does not work! We just have learned- in the hardest of ways- that financing does not allow people to afford things. It allows them to get in over their heads and go under. Excess money devalues the dollar, reduces savings, creates inflation and impoverishes America in absolute and realitive terms. In short, what is going on now. The rate cuts and cheep money went to banks. They didn't lend. Repos did not stop and housing prices fell.

If we just tried something twice and failed, perhaps a new idea is worth considering?

The Fed is charged with price stability and economic growth. You might enjoy when I took up this very issue in September 2007 in the Asia Times :http://www.atimes.com/atimes/Global_Economy/II14Dj02.html

Max

[Henry]

Max,
You're right my response did essentially state what you write. With one exception and that is that Bernanke has little choice. To assert that he has done us wrong in policy matters is not correct. If you were in the shoes of Dispeptic Ben you'd probably swallow and do the same as he has. (he's not an idiot).
Maybe Ben knows something you are not privy to. You know the Fed has operated behing the front lines a lot of its history. Let me make up a for instance. Let's say the FHLB was technically insolvent and that to push up rates in this country would force them into a government bailout? Or if Ben ups rates, who wants to be holding Treasuries... all trillions of them? There is something bigger here than Ben being a bad student of economics. I think you will agree.

[Steve13133]

Wow, I see now that I am not alone in recognizing the culprit to our woes at the pump and the supermarkets. Now for some history to explain it all. Get real! Gas prices won't come down much at all. You people have it all wrong. Oil is an international commodity, just like gold, pork bellies, wheat and corn. Did you all fail to notice that all commodity prices went up? An ounce of gold will buy the same amount of any commodity that it did 100 years ago. The only change we had here in the USA is the change in value of the dollar. When Bush was elected the first time, the Euro traded at 88 cents, now it is $1.60 which is about double (same as gold). Gee, that's the same doubling that the price of oil did, with milk, bread, and nearly every other commodity catching up fast. The problem is the US Government and the private Federal Reserve. When the Gov bozos spend more than they take in, they just borrow from the Fed, who has the treasury print up the money to loan to us taxpayers to cover the deficit, which devalues our currency, and this is exactly what happened with the commodity prices. Stop blaming Enron, Exxon, BP, and the Saudis. Blame the guys who control the purse strings in this country. It is the fault of Congress and the fault of the private bankers organization, the Fed, for our woes.

[Dugan]

The value of the dollar has come down but don't forget that the dollar had appreciated significantly to unsustainable levels in the late 90s and 2000. The key reason for the depreciating dollar is not the budget deficit, but more so the trade imbalance. But even more than that, the weakening dollar has reflected a weakening economy in the United States relative to strong growth in the rest of the world. Don't forget, however, that the weak dollar has helped the country in many ways,particularly in exports, US agricultural commodities and coal, tourism, and has brought in foreign buyers of US real estate in our most depressed markets like Miami and NY City. Last, the high price of oil isn't all due to the weak dollar. A lot of it is due to the dwindling worldwide slack in oil capacity.

[worldtraveller]

Get your passport, get on a plane, and see how you feel about that weak dollar when you go to buy lunch in London and realize how poor Americans now are. That minimum wage that was fought for a few years back is now worth a lot less globally.