|
May 9, 2003
The Fed changed its own regime this week in a delayed acknowledgement of a deflation threat, as though the Information Minister appeared today to say that American troops might be in Baghdad after all.
There was nothing delayed about the response in the markets: mortgage rates reached a new-record low, 5.375% for low-fee deals. I suspect that we will not hold this low, and will retreat to 5.50% under the weight of an avalanche of refinances next week when the public learns what has happened (time-lagged surveys won't "discover" this news until then).
In the succession of rate plateau-and-cliff refinance episodes in the last two-and-a-half years, the scarp faces have been .25% deep, limited in magnitude by the volume of refis hitting the bond market. Rates then plateau for three to five months, just as they did at 5.75% from Christmas until now, while the mortgage machine worked through the trillion-or-so dollars worth of refis. We will plateau again near 5.50% for a few months, absent some surprising economic strength. If a rebound is still absent in autumn, there is nothing to prevent another .25% cliff, and another.
The Fed's statement means that it will do whatever is necessary to create more mortgage declines, as necessary.
The Fed flinched from the word "deflation", instead saying, "... an unwelcome substantial fall in inflation...." Nobody misunderstood. The Fed was late with the observation, but Baghdad Alan had some reason to hope that winning the war would unleash the economy. As it has not, it is time to acknowledge that the post-bubble damage is far from resolved, and is unique, out of normal post-recession pattern.
Everyone in the markets was raised on the history of fifty years of Fed fights with inflation. Nobody has experience with winning a fight with deflation (we think we know what the Japanese are doing wrong, but can't be sure), nor with repairing a post-bubble economy.
For uniquely post-bubble damage, look at Cisco. 1st quarter earnings up 35%, while revenue fell (again) by 4%. Making money, but hollowing out... can't cut costs forever. Eight billion shares of stock outstanding.
To investors, deflation is a post-bubble symptom, not the cause of the trouble. At Berkshire Hathaway's annual meeting, possibly the best businessman in the nation, Warren Buffett, acknowledged that he is sitting on $16 billion in cash because he can't find anything worthwhile to invest it in.
Another pretty good businessman, Ted Turner, dumped 45 million shares of AOL Time Warner, more than half his holdings, in a single fire-sale transaction. That's a vote against the profitability of the business and its industries, not merely the near-term future of the stock price.
So, how do we get out of this post-bubble mire? The textbook says to print money in two ways. In the first, the Fed has at last transcended the traditional cuts in the overnight cost of money, and is getting on with the serious work: for the first time since 1952, it will print money as necessary to buy long-term debt and drive down long-term rates.
The second means of raining cash on the country: big deficits. Theoretically, we are doing so. However, budget-balancing effects by state and local governments are offsetting the federal deficit. Further, there is real doubt that tax-cutting is the right way to run a bubble-fighting deficit (Buffett again: "I don't know that these cuts will create a single job.") A better way, as in the 1930s: spend, big time, temporarily.
It is possible that the textbook is wrong, and that no amount of "jump-starting" will accelerate a natural process of restoring non-cost-cutting profitability to businesses. There may be only one solution: time.
|
