America on the Verge?

Could a housing collapse drag the economy from recession into... something far worse?

(Source: Getty Images)

Bill Bonner, reckoning today from Poitou, France...

Here’s the Daily Mail with the latest lurid headline:

Is America on the verge of a house price collapse? Prices could crash by up to 20% and homes are overvalued by as much as 72%, expert warns

• Boise, Idaho; Charlotte, North Carolina and Austin, Texas were the three most overvalued areas in the United States, according to Moody's Analytics

• Moody's found that found that 183 of the nation's 413 largest regional housing markets are 'overvalued' by more than 25 percent

• If a recession hits, house prices in those 183 regions could plummet by as much as 20 percent, Moody's predicted

• If there is not a recession, they will still fall 10-15 percent, the analysts believe - echoing other experts 

• The housing inventory is at its highest level since April 2009, as sellers struggle to get rid of their property because mortgages have become more expensive

Last week, investors were surprised by the forthright and clear-headed tone of Jerome Powell’s remarks from Jackson Hole. It almost seemed as though the Fed jefe had come to his senses:

The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years. A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now..  

Powell is telling us – loud and clear – that he intends to ‘pull a Volcker.’

That is what we expected him to say. And we still don’t believe it.
  

Buckle Down

When push comes to shove, we predict, the Fed will buckle under demands to ‘pivot’ towards a looser monetary policy. But that is still somewhere in the future; today, we look at where ‘shove’ might be.

Remember, it’s ‘inflate or die.’ Since the 1990s, the markets – and the economy – have been under the spell of the Fed’s voodoo economics. It inflated everything – with its ultra-low interest rates for ultra-long periods. Now, with consumer prices rising uncomfortably, the Fed is forced to position itself as a steadfast, almost heroic, inflation fighter.  

That is a fairly easy role for Powell et al; for now, they can fight inflation without taking casualties. Employment is still high. Stocks are still high. Interest rates are still low, with the 10-year Treasury bond yielding only 3.2% (more than 5% below the CPI). And houses are still selling near their peak prices.  

So far… so good.  

But there’s $90 trillion in debt to reckon with. Raise the average carrying cost (interest rate) by a single percentage point and the cost to debtors is an extra $900 billion a year.  

As we mentioned on Monday, while the Fed’s balance sheet is coming down (the Fed is buying fewer bonds… aka QT, quantitative tightening), it is still lending to member banks at rates far below consumer price inflation. This is essentially ‘inflationary,’ since it encourages people to borrow. It is only by getting lending rates above the level of consumer price hikes that the Fed can control inflation.  

At today’s 8.5% CPI that would mean interest rates around 10%. And if applied to all the debt outstanding that would cost the economy $9 trillion per year – or more than a third of total GDP. Not going to happen.  

But what can happen is that the Fed’s gradually increasing interest rates will put the economy into a deeper recession. Then, people stop buying; businesses fail; jobs are lost; and prices fall.  

Most likely, we’ll see the two converge – rising rates from the Fed coming up to meet falling consumer prices – leaving us with positive (above zero after inflation) interest rates.  

But wait… there’s more.  

Ropes in Their Hands

The Fed is also stepping up its QT program, re-absorbing much of the liquidity it put out into the economy. It will be extinguishing nearly $100 billion per month, beginning this month. Instead of buying bonds, in other words, the Fed will be selling them (or letting existing bond holding expire).

And here is where the battle against inflation becomes a fight for survival. It’s where the pain really begins… and where the Fed begins to fear for its own safety. Because, if the Fed isn’t buying US bonds, who will? And if fewer buyers appear at the Treasury bond auctions, bond prices will fall… and bond yields will rise.  And as Treasury yields go up, mortgage rates will go up too. And soon, there will be mobs forming – on line, or on Pennsylvania Avenue, of homeowners, stockholders, politicians, the media – with ropes in their hands and Jay Powell in their sights.    

Without the Fed there to buy up bonds (providing more cash and credit… more ‘liquidity’) borrowers will have to depend on real savers. But the savings rate has been going down since the Covid panic and now stands around 5% – or less than $1 trillion per year.  The US government is still running deficits and expects to borrow more than $1 trillion in FY 2022.  

You can do the math as well as we can. If all of the available savings are gobbled up by the federal government, private corporations, local governments, and mortgage lenders will be starved for credit.

What we are going to see is something we haven’t seen for many years – a bidding war, not for houses… not for meme stocks… not for gas… but for scarce credit. In effect, the Fed is doing to the US credit market what the Russians are doing to the European gas market – cutting off supplies. The price is going to go up. Mortgage rates will go up. Housing prices will go down… and the whole economy will tip into a deeper recession.

Then we will see what stuff Jay Powell is really made of.

Regards,

Bill Bonner

Joel’s Note: If you didn’t catch Jerome Powell’s speech at Jackson Hole last week, you can watch the whole thing in under ten minutes right here. Words like “slow,” “soft” and “pain” suggest the Fed is serious about fighting inflation with higher rates. But for how long… and at what cost? There’s a lot of “hot air” in the system, built up over decades of EZ money and loose credit markets.

The bear market rally, which saw the S&P 500 bounce almost exactly 20% off its June lows (the classic definition of a bear market rally) looks like it is already fizzling. What else might be “on the verge” of breaking under pressure from higher borrowing costs?

Here’s how Tom Dyson, Bonner Private Research’s investment director, put it to members in his weekly research note yesterday…

Since 1994, the Federal Reserve has insured the stock market, underwritten corporate borrowers, backstopped the banks and encouraged leveraged speculation. For twenty-eight years, the assumption has been that the Fed would backstop the market with cheap and abundant liquidity. Investors had literally baked this assumption into their deals and offerings. The entire market is structured around the Fed’s liquidity backstop. 

This chart below comes from a report published by the Fed each quarter called the Z.1 Financial Report of the United States. The blue line shows total debt securities outstanding, issued in the United States, have now reached $57 trillion. The red line shows the GDP of the US. Look how the debt has grown so much faster than the GDP. 

(Source: fred.stlouisfed.org)

Currently, the total debt securities-to-GDP ratio is 235%. This ratio was at 201% at the end of 2007, 158% at the end of the nineties, and 124% at the end of the eighties and 100% in 1985. It’s been an epic debt inflation. 

Now, for the first time in my career, the Fed is telling the market these guarantees don’t exist. American finance is about to be wholesale restructured at a higher cost of capital and hedged with more expensive insurance. It’s terrifying...

As members well know, Tom has set the BPR investment strategy dial to “maximum safety mode.” And with good reason…

“The global economy is sinking inexorably into a depression,” he warned readers yesterday. “The outer bands of rain are arriving. And now we’re feeling the first 80 mile per hour wind gusts. This storm is going to be a big one…” 

Priority #1 for Tom over the coming months and (even) years: Capital preservation. Tom aims to weather the storm and emerge with purchasing power intact, ready to scoop up whatever high-quality bargains he can find on the other side. And he wants to help you do the same. Prepare for what’s coming by becoming a BPR member today…