Approaching the Zero Bound

"An Attempted Hypodermic
Straight to the Economy’s Heart"

A fascinating, even feverish dialogue is taking place right now -- joined by some of the financial world's most influential thinkers -- concerning what will happen next week, and what economic consequences will flow from that outcome.

The elections next Tuesday?

Try, the Fed's much-signalled intention to initiate another round of quantitative easing (also called "printing money") when it meets next Wednesday.

Here is Bill Gross' take, from his perch at PIMCO, the nation's (world's?) largest investor in bonds:

Quantitative easing is temporarily, but not ultimately, a bondholder’s friend. It raises bond prices to create the illusion of high annual returns, but ultimately it reaches a dead-end where those prices can no longer go up. Having arrived at its destination, the market then offers near 0% returns and a picking of the creditor’s pocket via inflation and negative real interest rates.

--Bill Gross, "Run Turkey, Run"; PIMCO Investment Outlook (Nov., 2010)

So why do it?

Because the Fed, caught in a liquidity trap, is out of other options.

Gross again:

Ben Bernanke can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it (more quantitative easing) is all he can do.

--Bill Gross

Will "it" work?

Gross, whose credentials are as good as anyone's, thinks the jury's out.

Real Estate & Inflation -- Updated

A *Macroeconomic Overview

Back in April, I ran a post called "Real Estate & Inflation" that isolated wage growth as the key to whether any inflationary outbreak would help or hurt real estate (incidentally, that post is now ranked 18th in the world, according to Google).

Specifically, if inflation spilled over into workers' wages, it would drive up real estate; absent that, inflation would hurt real estate.

That's because static wages plus rising prices for everything else (food, gas, health care, etc.) would "crowd out" consumers' ability to spend on housing.

Six months later, how do things look?

Clearly, there is no inflationary pressure on wages. In fact, with unemployment at about 10% nationally and still rising, there is more downward pressure on wages than upward.

However . . . two other developments have come into clearer focus.

Coming Into Focus

The first is the Fed's apparently indefinite commitment to an easy (free?) money policy -- at least to banks that borrow from it.

Second, while wage inflation is nowhere to be found, asset and commodity inflation -- at least outside of housing -- appears to be rampant. (Hmmm . . . maybe the two are linked).

The Dow Jones is well over 10,000, gold smashed through 1,000 an ounce weeks ago, and oil appears to be poised for another run at $100 (and beyond). Meanwhile, the dollar is plumbing record lows against the Euro, yen, and other major currencies.

So, to return to the original question, what will an outbreak of inflation mean for real estate -- and specifically, the housing market?

Based on the foregoing, I've shifted into the camp that believes that rising inflation elsewhere in the economy will ultimately spill over into real estate, as well -- even if wage growth is flat (or negative).

If the economy can simultaneously experience recession and inflation -- a phenomenon dubbed "stagflation" in the '70's -- there's no reason why houses can't appreciate in a lousy economy, given what's happening to other asset prices.

P.S.: Peter Lynch has a famous line that if you spend 15 minutes a year trying to figure out macroeconomic factors . . . you've wasted 13 minutes.