Thursday, April 28, 2005

"Few Tools Beyond Language"

It is often said that as long as the Fed keeps liquidity available and rates low, the housing boom will continue. Those voices believe the central bank to have supernatural powers over market forces. For a check on the theory, lets look at Japan, which enjoyed a stock market and RE bubble.

"The Bank of Japan on Thursday officially abandoned hope that the economy would return to inflation before March 2006. Given the bank’s commitment to keep interest rates at zero until deflation is eradicated, it implies a one-year extension of the zero-interest rate policy."

"With interest rates at zero and markets flooded with liquidity, the bank had few tools beyond language to affect market expectations."

Perhaps the reason the Fed and congress are doing nothing about the housing bubble is there is nothing they can do, but talk.


At 10:38 AM, Blogger John Law said...

low interest rates only lets the malinvestments stay there, right? or is it different because there is actual real deflation, so adjusted for that interest rates are higher than 1%?

At 10:41 AM, Anonymous Anonymous said...

What about negative interest rates? The current real interest rate in Japan is about 1% I believe (0% interest rate, 1% deflation). Why not a -1 or -2% interest rate?

At 10:46 AM, Blogger Ben Jones said...

I believe they are in effect negative in Japan, and they are negative in the US as well, adjusted for inflation.

That's why every company will give you a no-interest period if you'll buy their stuff. Classic over-stimulus.

At 10:55 AM, Anonymous Anonymous said...

I don't know if anything the Fed *says* will do anything to stop the bubble. Housing speculators are strong headed and they think home prices will rise forever. As long as that continues, so will the bubble.

The one thing the Fed could do is raise interest rates, more than the 25 BP that is expected. Given the soft GDP numbers, I highly doubt they will do this.

However, given the increase in inflation, they might not have a choice.

At 11:18 AM, Blogger realist said...

stop with the japan b.s. already. the prices fell 80% there, and the houses are still out of reach for the average person. you can't get a loan on a house that's over 10 years old. you can only get a loan for the land value. their houses start to fall apart after 3 years. labor is too expensive. they don't have craftsman building houses. we've got all that cheap labor from south of the boarder. maybe they are not craftsmen, but they are teachable. the japan crash is not a good comparison.

raising rates will not be the answer. in 1978, rates were somewhere around 15% and real estate sales in colorado springs were booming (while they were starting to tank in n.y.c). most of the sales were for homes purchased with zero down v.a. loans and 3% down fha loans. by 1988, colorado springs was the reo capitol of the country. the way to stop the speculation is to have a minimum of 20% real funds down payment. although, high down payment requirements in china have not slowed the housing market there. of course,the chinese had money saved for down payments. the average american hasn't saved squat.

At 11:42 AM, Blogger John Law said...

for all those that believe hyperinflation could hit the US, this is sort of an example of maybe that not beig the case.

I think the CPI numbers are bogus, but people also have to look at the difference between the PPI and CPI. I think that companies are eating a lot of the inflation out there because of competition(no pricing power). Ford can't raise prices on cars and neither can GM. I think a little bit of rising inflation and a drop in consumer demand will kill the retail sector...then we'll find out when those companies sell their real estate that there is too much RE space per person in this country!

At 12:07 PM, Anonymous Anonymous said...

"the way to stop the speculation is to have a minimum of 20% real funds down payment."

I agree that this would definitely stop the bubble. However, what lender is going to implement this policy? The government certainly won't mandate this until after the crash. Then everybody will be talking about what went wrong.

Maybe the credit cycle has turned (as Nolan says) and credit tightening has begun. I just can't imagine any major lender puposely turning off the spigot unless they start collecting a lot of bad loans. And this won't happen until prices flatten/fall. Sort of a catch-22.

At 12:09 PM, Anonymous Anonymous said...

Speaking of China, I hear they're considering raising the down payment requirement to 30% and also imposing a capital gains tax on RE.

realist, where do you get your information on Japan? I'd be interested in learning more.

At 1:39 PM, Anonymous Anonymous said...

Japan and Germany are examples of what happens when liquidity preferences soar due to a bad scare. The Japanese and Germans tends to be highly disciplined savers. Whenever anything bad happens in those countries, the people tend to overreact and start worrying the sky is about to fall. They pull in their belts and save like mad and the result is a classic Keynesian liquidity trap. The classic Keynesian response is have the government compensate for the shortfall in demand, by running a budget deficit and lowering interest rates. This isn't working in Japan and may not work in Germany either, if the Germans go back into recession, because the Japanese and Germans populations have become so old and conservative at this point that the more the government tries to fight the demand gap with deficits and low interest rates, the more frightened the people get and so the more they save, and thus the liquidity trap never ends.

I don't think the US will have this problem, for many reasons. The US population is younger than that of Japan or Germany. The US culture is much more flexible than those of Japan and Germany. The US has always been tolerant of bankruptcy, total destruction of entire industries and massive layoffs, provided there are new jobs available elsewhere in the economy, whereas the Japanese and Germans value stability more. The US consumers are much more fearless than those of Japan and Germany, where people tend to worry about the future. Unless the Congress and Fed really blow it, CPI deflation seems highly unlikely in the US. But asset deflation, that's another story. In particular, I think real-estate is going to bear the brunt of the adjustments necessary to the unbalanced whole world economic system.

At 4:43 PM, Anonymous Anonymous said...

Maybe it is because they actually pay attention in history class in Japan and Germany. In my family, we have a few octogenarians with money stuffed in their mattresses who occasionally spew their great depression stories to great laughter and derision. I for one do not laugh at those stories.

At 4:50 PM, Blogger realist said...

this is for anon, who wanted to know where i got my info on japan.

one of my former students is one of less than 250 u.s. corporate lawyers working for a japanese corporation in japan. i get blow by blow descripitons of what's happening over there. he lives in an 800 sq.ft house on a postage stamp lot. he paid $700,000 for it last year. his parents gifted him $100,000 and his wife's parents gifted him the same amount. they have 3 children. he makes an excess of $250,000 a year, and after paying his mortgage and all the super high govt taxes, he has very little left to live on. everyone tells him he's lucky to own a house.

the interesting thing that japan and germany have in common is that they have the largest trade surpluses in the world. yet, their standards of living is very low. the u.s., england, and australia have the largest trade deficits in the industrial world, and they have some of the highest standards of living. go figure. japan has a shrinking population. one of the biggest boons to their construction industry is retrofitting elevators to existing apartment buildings. germany, on the other hand, is still suffering frome its unification. it has more non-working population than it can afford.

At 5:44 AM, Anonymous Anonymous said...


West Germany still has a higher standard of living than either UK or Australia, and West Germany is the biggest exporter in the world (East Germany produces nothing that Germans let alone foreigners would want to buy). So large trade surplus does not equate to low standard of living.

Aggregating statistics for East and West Germany makes about as much sense as aggregating statistics for US and Mexico - if you do that N. America standard-of-living is lower than Germany.


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