Did the federal reserve’s taper slow housing and cause a new recession?
The federal reserve began tapering bond purchases in December 2013, and the US economy shrank at a 2.9% annual rate in the first quarter of 2014. Coincidence?
The federal reserve works to minimize the damage caused by economic downturns by stimulating the economy during recessions to prevent widespread price deflation and prevent widespread unemployment. People debate the efficacy and desirability of the federal reserves policies of central planning and interventionism, but the policy is supported by politicians and bankers while the public is largely oblivious to what goes on.
When the Great Recession began in 2008, the federal reserve lowered the federal funds rate to zero; since it couldn’t lower interest rates any further, the federal reserve began buying longer term Treasury Bonds and took the unprecedented move of buying mortgage-backed securities to stimulate housing. Many people don’t understand that when the federal reserve buys bonds, it doesn’t have the money stored in a vault somewhere to complete the purchase: the federal reserve prints money when it buys bonds.
There are limits to how much money the federal reserve can print. Ultimately, the total amount of money in circulation represents the total value of goods and services in the economy. If the federal reserve prints too much — and there is always pressure to print free money — the excess causes price inflation. Fear of price inflation and a loss of confidence in the US dollar are two of the reasons the federal reserve decided to taper its bond purchases in December of 2013.
Monetary Deflation from the Housing Bubble
During the housing bubble, lenders created a large amount of mortgage debt. Ostensibly, this was backed by the “value” they were creating in housing. Unfortunately, since this value was not real, the mortgage debt bloated the money supply and created a false economic boom, leading directly to the economic catastrophe of the 2008 Great Recession and the deflation of the Great Housing Bubble.
One of the federal reserves missions is to prevent widespread price deflation; unfortunately, when lenders make loans that don’t get repaid and can’t be recovered through foreclosure and resale, deflation results as money is “unprinted” by the loss. The main reason we haven’t seen inflation from the federal reserves endless quantitative easing (fancy term for printing money) is that the new money being printed is merely offsetting money being destroyed by bank write downs from consumer deleveraging. (Also, some inflation is being exported to countries with a currency pegged to the dollar.) For six straight years, deleveraging was ongoing, but in the 4th quarter of 2013, the trend reversed.
The federal reserve can keep printing money as long as bond investors don’t believe printing money is inflationary. Now that consumer deleveraging stopped, money is no longer being destroyed faster than the federal reserve can print it. In my opinion, the main reason the federal reserve decided to taper its asset purchases and thereby print less money is due to the increase in debt shown in the chart above.
The federal reserve works to prevent deflation by stimulating borrowing or printing money when the economy contracts; however, the federal reserve must be very careful: If the federal reserve prints too much money, inflation expectation will cause investors to abandon the bond market, bond prices would crash, interest rates would spike, nobody could afford today’s house prices at 10% interest rates, and the resulting housing market crash would rival 2008.
Since the federal reserve committed to its interventionist policies, it walks a fine line between too much stimulus and too little. When the economy was beginning to recover from the Great Depression, the federal reserve applied the breaks once the economy began growing after the Depression, and many economic historians blame the recession of 1937-1938 on the federal reserve’s actions.
Is it possible that the taper of asset purchases that began in December is directly responsible for the slowdown in housing and the big economic contraction in the first quarter of 2014?
Jeff Cox | @JeffCoxCNBCcom, Wednesday, 18 Jun 2014 | 2:00 PM ET
The Federal Reserve continued to reduce its monthly bond-buying program and held interest rates near zero even as it debated persistent conflicting signals in the economy.
In addition to continuing the scaleback of its monthly money-printing efforts, the Fed slashed its outlook for full-year economic growth, cutting gross domestic product from a 2.8 percent to 3 percent range expressed in March down to 2.1 percent to 2.3 percent. The change comes on the heels of a 1 percent drop in first-quarter GDP.
Final Revision for First-Quarter GDP Shows 2.9% Contraction
By Jonathan House, Updated June 25, 2014 8:29 p.m. ET
Weather disruptions at home and weak demand abroad caused a contraction of rare severity in the U.S. economy in the first quarter, renewing doubts about the strength of the nation’s five-year-old recovery.
Weak demand abroad?
Perhaps the withdrawal of printed money had something to do with it.
Gross domestic product, the broadest measure of goods and services produced across the economy, fell at a seasonally adjusted annual rate of 2.9% in the first quarter, the Commerce Department said in its third reading of the data Wednesday.
That was a sharp downward revision from the previous estimate that output fell at an annual rate of 1%. It also represented the fastest rate of decline since the recession, and was the largest drop recorded since the end of World War II that wasn’t part of a recession.
To be sure, many signs since March, including reports of growth in consumer spending, business investment and hiring, indicate the first quarter doesn’t mark the start of a new recession. And revisions in future years could alter the first-quarter figure.
Notice the obsessive need financial media reporters have to provide emotional therapy and reassurance? Notice the bookends on sentence above: “To be sure … the first quarter doesn’t mark the start of a new recession.” By the time we know the truth about the second quarter, which probably won’t be until December, we will see that the first quarter did mark the start of a new recession.
J.P. Morgan Chase economist Michael Feroli described the decline as “mostly a confluence of several negative, but mostly one-off, factors.”
More emotional assurance with no data or factual support.
But the severity of the drop, he said, “calls into question how much vigor there is in the pace of activity” going forward.
Followed by a dose of truth…
One factor in the government’s revision of first-quarter output was difficulty in estimating the impact of the Affordable Care Act on health-care expenditures. Actual health spending came in substantially lower than expected based on ACA enrollments and Medicaid data, declining at a 1.4% annualized pace in the period compared with an earlier estimate of a 9.1% increase. …
Does that mean Obamacare, rather than being another expensive entitlement subsidy, is actually curbing healthcare costs? If so, that’s a great thing.
Meanwhile, early data from the second quarter indicate the economy has improved this spring, as warmer weather has helped release pent-up demand.
Blaming the weather and citing bogus pent-up demand are two of my least favorite peeves, and this reporter managed to squeeze both into the same sentence.
Sales of new homes surged to a six-year high last month, while existing-home sales rose to their highest level since October, data released earlier this week showed.
More spin. The report on the increase in existing home sales was for May which was coming off a terrible April.
New and resale home sales slump in 2014 prime home selling season. It would be great for the economy if new home sales were to pick up further. Recent reports of a sharp increase in new home sales is a good sign, but be prepared for a downward revision later.
“It does not sound like the economy has reached escape velocity no matter how you try to spin it,” said Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi.
More truth saved for the end of the article.
For economic output to ratchet up to a healthier long-term trend, economists say consumer spending must rise to its prerecession pace of about 3% growth. But five years into the recovery, high unemployment and stagnant incomes continue to restrain the American consumer.
“We just don’t see consumer spending coming back to the levels that they were before,” Virginia McDowell, chief executive of Isle of Capri Casinos, Inc., recently told investors at a presentation of the company’s fourth-quarter earnings. “We continue to get pressured on the top line because our consumer spending habits have changed,” Ms. McDowell said.
If our consumer spending habits have changed, it is in part because lenders are no longer giving out free money to Ponzis, and that is a good thing.
When the economy first enters a recession, the government does everything in its power to prevent people from realizing it. When the economic data from the first quarter was released, at first they fudged the numbers to show a 0.1% increase in the first quarter. Later, they revised the number down to a 1% decline, and now, months later, they’ve finally told us the truth about how bad it was — but eager reporters are there to assure us everything will be okay.
A recession is defined as two consecutive quarters of decline. The government does this to buy time. Most recessions are short, and by the time the data reveals the second quarter of a recession, the economy has generally already pulled out of its slump. The goal of politicians and bureaucrats is to keep people in the dark during the recession, then tell them about it after the recovery is underway.
I believe we are in recession right now, but we won’t have confirmation until late this year.