What Happens When Quantitative Easing Finally Fails

Gregor MacDonaldGregor.us | Aug. 6, 2012, 1:39 PM
Source – Business Insider

Gregor MacDonald is a researcher and investor in the energy sector

Dear Readers: I’m currently writing a long-form post twice a month now for Chris Martenson’s excellent website, Peak Prosperity.com. Accordingly, I’ll be publishing the first (and free) part of these essays here at Gregor.us. Enjoy. — Gregor

While markets await details on the next round of quantitative easing (QE) — whether refreshed bond buying from the Fed or sovereign debt buying from the European Central Bank (ECB) — it’s important to ask, What can we expect from further heroic attempts to reflate the OECD economies?

The 2009 and 2010 QE programs from the Fed, and the 2011 operations from the ECB, were intended as shock treatment to hopefully set economies on a more typical, post-recession, recovery pathway. Here in 2012, QE was supposed to be well behind us. Instead, parts of Southern Europe are in outright depression, the United Kingdom is in double-dip recession, and the US is sweltering through its weakest “recovery” since the Great Depression.

It wasn’t supposed to be this way.

Recently-released data from all these regions now confirm that previous QE, at best, merely bought time against even more grueling outcomes. Spain’s unemployment, for example, has just hit a new post-Franco high of 24.6%, and the forecast for this crucially important EU economy remains negative. Recently revised US figures on GDP show that the post-2009 recovery was even weaker than previously estimated, with the first year post-crisis crisis clocking in at 2.5% vs. the expected 3.3%.

Plodding, slow growth in the aftermath of a global financial crisis is a recipe for stagnation. The inability of the US economy to work off its surplus of labor appears to have finally stirred OECD policymakers into action. This is, of course, a great and humbling disappointment to the recoverists, who keep mistaking various economic oscillations around a bottom for the start of a typical post-war, V-shaped recovery. Housing, autos, jobs, Internet IPOs, state tax revenues, and train traffic have all been called upon by optimists to sound the clarion call for a broad economic recovery. Yet the US economy still is only able to produce sector-specific or selected regional strength that never adds up to quite enough to restore national growth.

When we look at national GDP, at 1.5% in the most recent quarter, it is not clear the US economy has enough forward speed to statistically distinguish between slow growth and no growth. Large states like California, for example, are already seeing the return of declining state revenues. Meanwhile, national poverty — one of the best measures of aggregate economic health — continues to soar.

There is no doubt that any new round of QE — especially a double shot from both the Fed and the ECB — will have psychological impact. For Europe, QE would once again allay systemic risk. And for the US, QE will surely find its way to the stock market; which is not an insignificant outcome as America increasingly relies on the stock market to produce retirement income. However, the question arises, What series of radical measures policy makers will turn to after the next round of QE wears off?

Before we answer that question, let’s review the poor economic conditions leading to the next (and final) round of QE.

Housing

House prices in the US have done an excellent job of adjusting downward over the past 5 years to reflect the stagnation in US wages, the overhang of private debt, structural unemployment, and the rising cost of energy.

But there has been a recent media celebration of sorts over this story, as it now appears that housing is bottoming. To be sure, certain housing markets like Miami and Las Vegas continue to recover from completely bombed-out levels. Additionally, construction of new homes, especially multi-family homes, is off the bottom. For now.

The problem is that housing is a result, not a cause, of economic expansion. And unless housing is to work in tandem with wage and job growth, housing alone cannot power the US economy. Did the US not already learn that lesson already over the past decade?

Let’s take a look at fifteen years of home prices, from the US Census Bureau:

The unsustainable peak in 2006, when single-family homes reached a median sales price of $222,000, marked a near-doubling of price over the ten-year period from 1995. But as we now understand, not only were wages (in real terms) not rising during this period, but a new bull market in commodities was getting underway, robbing Americans of discretionary income.

The result is that house prices were able to keep up with the loss of purchasing power until slightly past mid-decade. Then they collapsed. Worse, the phase transition in rising energy prices kept going (and continues through today), which had an outsized impact because the topography of US housing, largely dependent on roads and highways, is quite exposed to transportation costs.

We can think of housing as facing several key constraints that will be sustained for at least another five years:

  • First, there is the tremendous overhang of personal debt in the US. Much of this is still carried within the mortgage market itself. (Additionally, student loan debt has also emerged as an enormous barrier to home buying.)
  • Second, there is the lack of wage growth and the problem of structural unemployment. The surplus of labor prevents the broad, marginal pressure needed to force national house prices upward.
  • Third, the constraint of oil prices will not ease. This means that urban real estate may do well on a relative basis, but the majority of US homes will continue to adjust downward to reflect the permanent repricing of oil (and hence gasoline).
  • Finally, the notion that real estate prices have bottomed with mortgage rates near all-time lows seems a very risky call. Is it more prudent to presume that a new advance in national real estate prices will be carried on the back of rates going even lower — or higher? Which is it? The view that real estate has bottomed appears to assert that no matter where interest rates go from here, real estate is going higher. That is the mark of hope and belief; not analysis.

It seems very unlikely only five years into such enormous, structural shifts in the US economy that the repricing process is over in housing.

At minimum, I expect the median price of single-family existing homes to revert to the 2000 level of $147,000, with the strong possibility of an overshoot to the $125,000 level. This process will take several more years.

Jobs

As early as 2009, many of us understood that this was not a normal economic decline and therefore would not be followed by a normal economic recovery. Here’s the lead paragraph to a New York Times piece, covering the latest GDP data:

 

U.S. Growth Falls to 1.5%; a Recovery Seems Mired

Click Here to continue reading.

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