From Karl Denninger’s Market Ticker:
Deflation, in size, is coming.
I know this is an “outlying” opinion.
But it is inevitable for one reason above all others: The other alternative is the economic and political collapse of the nation.
The market is telling you it will not be collapse – it will be deflation.
Because the dollar isn’t in the toilet. And it won’t go there either.
Powell lacks the stones to publicly tell Congress to either cut the deficit spending or the market is going to take away the rate question from The Fed entirely and, in fact, it always has in that The Fed has always, historically, followed market rates. They maintain the illusion of it being otherwise because without that what can The Fed sell the public as their value, never mind the so-called “independent” central bank?
But that has always been illusory. If you look at the 4 week and 13 week T-bills and graph them against the Fed Funds rate you will see the market almost-always leads and the Fed does what the market says. There are scant instances otherwise over the entire time period for which the data is available — which spans decades.
So no, the Fed is not going to “cut rates and save your mortgage, house value, or anything else.”
The fact is that Congress continues to buy votes with money they refuse to tax first. Both sides of the aisle are guilty of this and it goes back decades. As I have pointed out repeatedly in my lilypad essay years ago this is common for governments because in the first years of it you think you got a free lunch.
That belief is false; there is never a free lunch and never has been. Two exponential functions where one has a higher growth rate than the other always cross. If debt is created faster than GDP this always eventually leads to a collapse. The only question is what collapses: Either prices, including asset prices and then wages, with those who are in debt at the higher valuations being wiped out, or the entire currency system in question collapses.
5% short-term (2-3 year) rates are not unreasonable in a 3% growth economy and neither are 7% long (30 year) rates — such as for a purchase money mortgage! They weren’t unreasonable 30 years ago and they’re not now — math hasn’t changed!
People say “but the government can’t pay so it won’t be me.”
If you borrowed $600,000 to buy a house that three years from now is worth $300,000, you might try to walk away from that. If you took it was a purchase-money first mortgage and never refinanced you might be able to “put” the property back on the lender, effectively forcing them to eat it. It’ll ruin your credit but otherwise can be “no recourse.”
However, most people didn’t do that; they refinanced and once you do that its a recourse loan and they will come after you.
Remember that these days those loans aren’t held by a bank that can be threatened (by the government) into not coming after you either. They’re all packaged up, securitized and sold. Your Grandmother might own some of that note in an income fund she has. The political implications of them trying to force Granny to eat your foolish decision are stark — and unlikely to play in your favor.
This applies to commercial entities as well. A stock is, in reality, nothing more than the discounted cash flow of the company. Well, that’s what it should be. But that’s not what it has been the last 20 or 30 years; instead it has become more and more-akin to two dudes staring down each other over a poker hand, each saying “raise!” back and forth — but the cards are what they are.
The good news is that if you didn’t participate in any of this foolishness then when both your salary and property value reset back down to something reasonable you’re back where you were and all is well. That’s deflation. If you managed to sock away some cash then its even better because people who blow up have to puke up assets, whether it be buildings, commercial equipment or other items at a fraction of their acquisition cost. If you can take advantage of this with cash (financing will be uneconomic or even impossible — remember, in this event there is no asset appreciation that will go into loan models) then there will be some crazy-good deals to be had.
Need a work truck? Half what they sell for now, or less, is probably where you’re going to wind up.
Need some equipment in the technology space? You might be able to get it for a nickel on the dollar of today’s price. No, I’m not kidding about five cents on the dollar and I speak from experience in a much less severe situation than we face now.
Restaurant equipment? You might be able to get it for basically nothing if you can haul it off! Yeah, that would be good if you had a use for it, eh?
Used medium duty and heavy equipment auctions? Bring money; the deals will be there.
Houses? Ditto, especially where the screaming price increases have been their worst: Tourist and vacation-heavy areas. Those who say “oh people won’t sell” are wrong; forced selling is coming; some people in all those areas did buy with debt, they have to service it, when the customers dry up they will blow up and reset valuations back to a reasonable level. The 3, 4cap will go back to 10-12 and the way it will happen is by price falling by two thirds!
Municipal governments had better have a plan to deal with the tax implications of this because attempting to raise millage levies will force even more selling and even lower prices as operating expenses are a part of cap rate computations. Trying to tax their way out of this will not work; the simple reality is that expectations must reset across the board.
This also means that those who have plied their political trade on “gimme-dats” are going to be forced to change their tunes. They won’t like it, but its inevitable and inescapable. I look forward to it; this should have happened a long time ago. Whether the Chambers of Congress or other pressure groups like it or not those who are tax sinks instead of tax sources, especially those who are non-citizens, are in for a very rough time of it.
For those who believe there’s another way — there isn’t. The alternative to the right choice here, although there will much arm-waving and denial, is literal collapse and no, you can’t and won’t escape that and if you think you can or will you’re not only sadly mistaken you’re going to get a very rude and expensive surprise.
IMHO if you bet that way you’re going to be tragically wrong.