Posted by: Bruce Allen | August 6, 2008

Rock–Ben Bernanke–Hard Place. Seriously.

Seal of the United States Federal Reserve System.

August 6, 2008

Wall Street greeted yesterday’s Fed announcement as if it was a declaration of victory, when in fact the Fed is now officially handcuffed, locked at the rates in effect when the summer paralysis set in. Played “Fed Funds Musical Chairs” for months, and the music stopped at 2%. Now, they need to raise rates, need to lower rates, can’t fish, can’t cut bait. Too hot to spit, too wet to plow. Reduced to “observer” status. We’re not afraid to raise rates, we’ll raise them if we must, really we will. Sure you will.

Disequilibrium: Weirdness in Abundance

A financial world, where the Fed “should” raise rates in the face of significant inflationary evidence and “should” at the same time lower rates to help boost economic activity. The result of decades of easy money, lax regulation, fiscal irresponsibility, and a sudden new world energy order.

A political world, where Congress “should” be cutting the Federal deficit by reducing spending and “should” at the same time inject hundreds of billions of dollars to stimulate private economic activity. (Congress also “should” never think of raising taxes on anyone.)

An entitlement world, as Dave Barry once observed, where wealthy people use Social Security checks to buy sunbonnets for their racehorses.

A peak oil world, with John McCain leading a crowd of supporters chanting “DRILL! DRILL! DRILL!” Mocking Barack Obama for even mentioning conservation as part of the strategy for dealing with dwindling resources. A fossil promoting fossil fuels—seems almost cannibalistic.

Immovable Object vs. Irresistible Force

I’m thinking about comedian Steven Wright’s routine, putting his dehumidifier and his humidifier in a room, turning them on, shutting the door, and letting them slug it out. Oil-driven inflation vs. growing unemployment and the housing crisis.

Maybe $2 trillion, ultimately, lost downstream in the “pump and dump” subprime business. (That whistling sound you hear is synthetic homeowners’ equity leaving the residential real estate bubble.) The bottom is not yet in sight, and may reach 25-33% nationally, perhaps the largest aggregate negative wealth effect since the 1920’s. Others have described it as a disaster in slow motion.  People’s largest assets, melting before their eyes.

For some time, I have been concerned about inflation, led by high energy prices and growing global demand. Yesterday, oil dropped below $120 a barrel, a price “not seen since May 2nd” and there was dancing in the streets. We forget that on May 2nd we were hysterical, gnashing teeth, putting groceries on credit cards because all of our cash was going in the gas tank. (The recent decline in oil prices may simply be China having cut its use 30% by turning off Beijing for the Olympics. BTW, nice environment you’ve created there, Mr. Chairman.) Most of us used our tax rebate checks to pay toward credit card balances.

I’m starting to think that deflation may eventually win.

The statistical data the government uses to measure retail sales, which are currently described as “healthy,” do not reflect the substitutions that most median-income-and-below consumers have been making this year. Not just substituting paying credit for cash. I can’t find the data to support this one, but my instincts tell me that the following is representative of what’s been going on with these households. This is mostly guesswork on my part. That’s okay, it’s my blog.

2006%     _______Category    __________ 2008%  ___ ____hange

30                         Housing[1] 32                        +10%

15                         Utilities[2] 21                        +50%

7                            Gasoline                         15       +110%

13                         Food                               18           +35%

5                           Medical                           6             +20%

5                           Clothing                          5          ——-

10                         Entertainment[3] 2                      -80%

5                           Vacation                         1            -80%

5                           Cars                               3             -40%

5                           Savings                          -3               now negative

100                                                             100

$250,000    Home Value                              $175,000              -30%

So, although retail sales may be “holding up”, people’s balance sheets and standards of living are clearly declining. Data through May show consumer credit growing, despite the initial round of tax rebate checks in April and May. Data for the summer will include those checks. If credit card debt continues to grow despite the tax rebate checks, it is going to jump when they’re gone.

No matter what the Fed does or doesn’t do, people are feeling poor. They are angry at a Republican administration that has engaged in a brutally expensive war, in human and financial terms, and allowed lax regulation of markets that enriched their friends and drove world financial markets off a cliff. Independent voters seem likely to consider a young, smart, flawed, black liberal, willing to propose new ideas, over an honorable relic of the 20th century ruling class that brought us Iraq, the subprime crises, and a trashed dollar. Our national security is now fully subject to the whims of your basic Arab oil sheiks, with growing negative leverage in the form of megabillion dollar trade and fiscal deficits. I can’t quite hear the music…

[1] Rent, mortgage, insurance, property taxes

[2] Gas, electric, phone, cell, water, sewer, trash, cable

[3] Includes restaurants

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