Drum-Roll Economics

May 17, 2001

Monday's hypnotic oscillations reinforced the nagging feeling that, Fed-wise, investors may no longer know what to hope for. (There's that pathetic, economically futile word "hope" again -- a word that encapsulates the navel-obsessed meditation that these days passes for point and counterpoint on Wall Street.) With the rally that began a few weeks ago starting to gasp for air, should shareholders hope the Fed continues to ease aggressively with yet another 50-basis-point announcement? Or should they instead pray for the health of the economy itself, invoking the sort of robust recovery that would render further easing unnecessary?

The dilemma over the Fed's next move undoubtedly caused the stock market to dither on Monday, filling investors with a mixture of angst and dread that is almost certain to persist for over the summer months. In the past, as all investors know, easing by the central bank has never failed to work. This time, however, the ratcheting down of short-term rates has been accompanied by such a loud and persistent drum roll that Americans are understandably nervous about, if not to say self-consciously obsessed with, the hows, whys and wherefores of credit stimulus. I could argue that because it now requires more than $3 of additional borrowing to induce a single dollar's worth of GDP growth at the margin, lower interest rates will achieve little or nothing -- save, perhaps, a brief flurry of activity in the financial markets. But that would be just another damned statistic, one which may or may not apply to such an inherently irrational and unstable economic model as one based on consumer psychology. As such, talk related to money velocity is as ill-suited to describing the current economy as Newtonian physics is to describing the interaction between anti-matter and black holes.

Mortgages Tightening

Speaking as someone who has waited in vain for an opportunity to refinance a mortgage loan, however, I am only too acutely aware of possible reasons why "Easy Al" Greenspan's current efforts to stimulate the economy are beginning to falter, perhaps fatally. For it is quite a stretch to think that housing can remain an untroubled bright spot in an economy that has been hovering precariously above a statistical magnetic storm. Even the know-nothing bulls must be starting to sense that something is dreadfully wrong, since they hear the same anecdotes that I hear -- anecdotes of creeping recession that flatly contradict our by-now egregiously lagging unemployment data. As such, Greenspan's nostrums are seeming more and more metaphysical, even as the leap of faith required to believe they will work continues to widen, fissure-like, in the consumer psyche. Retail sales, housing and autos are still showing signs of health and even vigor, as the pundits keep reminding us. But as Schumpeter famously said of investors and consumers following the Great Crash, they stood their ground until "the ground gave way beneath them."

And give way it has -- with a noticeable lurch in Northern California, epicenter of the late, great technology boom. In San Francisco, to take the scariest example, "for rent" signs have been springing up all over the place, even in the yuppified Marina District where rentals were all but impossible to find less than a year ago. A friend of mine in the commercial real estate business there says the overhang of vacant office space on the Peninsula has gone from zero square feet to three million during that time. His firm has survived by doing business only with established companies that are looking to expand, not to pitch a tent. But many smaller firms have already come and gone, creating a diaspora of underemployed techies who have begun to migrate back to places where studio apartments rent for far less than $2,000 a month: Cincinnati, Dayton, Louisville, Stamford, Pittsburgh -- and, of course, Mom & Dad's.

Today's Bargains, Tomorrow's Liquidations?

For the hardiest of survivors, there are bargains to be had at the high end: re-po'd low-mileage Porsches, ski packages to Bariloches, theater-quality home entertainment systems, marina space for sloops -- even luxury houses in some Silicon Valley neighborhoods are going for 30-40% less than a year ago. It must be tempting for those with surplus cash to scoop up such "deals." Similar thoughts must have occurred to those who bought Cisco shares last December for $40, half of what the stock had sold for just eight months earlier. More recently, though, one could have bought Cisco stock for under $14 a share. Can those who did be absolutely confident they got a bargain?

Meanwhile, the financial markets continue to cast a pall on predictions of an imminent upswing in the economy. The pundits have been saying that rising long-term yields are discounting the potentially inflationary effects of easing by the Fed, but I think it's worse than that. What could be more fearsome to investors than a return of inflation? Perhaps a wholesale collapse in the dollar, which would have far greater consequences globally over the long-term than any threatened uptick in domestic inflation.

"Inflation" Is Deflationary

Anyway, I have written here before that what everyone is still calling "inflation" has by now become a catalyst of deflation, with higher fuel prices the most obvious example. $2.00-a-gallon gas would be inflationary if the marginal increase could be passed easily through the economy. In fact it cannot, and nearly every fuel-consuming business these days can only reckon with higher fuel costs by subtracting them from profits. If that is the road to inflation, then I-95 leads to Finland.

Whatever the reason for the spike in long-term yields, it is about to throttle the only sector of the economy that has at least maintained the appearance of robustness, namely housing. I say "appearance" because, as I've noted before, strength in residential real estate this late in the economic cycle is a lot of smoke but no fire, with the least-qualified buyers being lured in at the margin. Wait till they find out how much bankruptcy laws have changed over the last few months.

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