A Few Words In Defense of My Country
About five years ago, I was in Sydney, Australia for work when I came across a billboard announcing the arrival of the prophet. Ok, fine, maybe not quite, but close. Mandy Patinkin was singing his favorite songs at the Sydney Opera House that night. I love (L-U-V) Mandy Patinkin (if you wonder why, watch this). My wife makes fun of me for loving Mandy like I do. As you can imagine, I cleared my calendar that evening (as well as my colleague’s, with whom I was traveling). The stage was lit by a single lightbulb and Mandy — alone on stage with his piano accompanist — owned the entire Sydney Opera with his immense talent, grace, and humor. That night he sang “A Few Words in Defense of Our Country” by Andy Newman. I had never heard the song until that night. It was 2018 and historical records have been lost in the fog of time. But it is possible that tears were shed in the cheap seats where my colleague and I were housed that night.
In addition to being a proud naturalized American – and an equally proud natural-born Frenchman – I am an economist. The worst kind, too: A trained Ph.D. economist. So, as we near the end of 2023, I feel like I need to say a few words in defense of the good people at the Federal Reserve. I know people who work at the Fed. I went to school with some with them. They are smart, incredibly well trained, and very well informed. They are also completely at the mercy of being wrong and looking stupid, despite their best efforts. Ugh… Don’t you hate the real world sometimes?
Take Jerome Powell, our current Fed Chairman. Think back to one of his most publicly benevolent moments over the entire course of his stewardship so far. I remember watching the press conference last year when he went out of his way to tell young people to save themselves a whole lot of trouble and not be so silly as to go out and rush to buy a home. The exact line was:
“I’d say if you are a homebuyer, somebody or a young person looking to buy a home, you need a bit of a reset […] We need to get back to a place where supply and demand are back together and where inflation is down low again, and mortgage rates are low again.”
He was trying to be helpful: The Fed was hiking interest rates like it hadn’t done in a generation, thereby engineering a real-estate “correction” (aka making house prices come down). Young people should be patient and that patience would be rewarded with the opportunity to buy the same house they wanted now for cheaper (and with a lower mortgage rate) in just a little while.
How did Jay’s benevolent advice work out? Back in June 2022, the Case-Shiller Home Price index was 304.8 (Baseline of 100 in 2000). The latest reading? 304.6. That’s down 0.06%, which in the real world is, you know, flat... What about mortgage rates to buy that house? In June of 2022, rates were just shy of 6% on a 30-year fixed mortgage. Now? Over 7.5%. Definitely not flat. Yikes! Was Jay just silly and wrong?
The near-term mechanics are screaming yes: The jump in mortgage rates froze people in place and, with no homes hitting the market, the poor souls forced into buying now have no choice but to buy whatever is on the market for a lot of money. In a perverse way, the most basic model in economics (supply and demand) got it just right, and yet the captain of Team Econ got it just wrong.
Maybe. Then again, it ain’t over ‘til it’s over, they say. What if we give Jay just a little more time to be right and brace ourselves for a little more pain? What if the higher rates eventually force people to sell their homes because economic activity slows, corporate profits come down, and people lose jobs. That scenario quickly starts to look like 2008. This is what Bloomberg is calling the $300-trillion question. I hope this ugly scenario doesn’t play out. The latest jobs numbers suggest that’s not even on the table right now, but the Wall Street Journal reminds us that the job market can turn quickly. If you don’t believe the Journal, go look at the historical graph for unemployment in the Fed’s database.
How could we get there if interest rates alone don’t whack the US economy like Mister Jay thought they would? The Wall Street Journal is summarizing it nicely in this article: Maybe one shock doesn’t do it, but what about four? Our late-2023 bingo card is is getting punched with a strike in Detroit, a US Congress that’s giving itself a timeout, the return of student-loan payments, and rapidly rising oil prices. What’s so special about these? They are perfectly fitting puzzle pieces that combine to push inflation higher (oil and strike) while making paychecks thinner (potential government shutdown and student loans). And as of this weekend, we have the potential impact of hot war in the Middle East, which is always and everywhere bad and inflationary. Oil is shaping up to be the most concerning if you believe this Wall Street Journal article.
“Some investors hope that if […] stresses spread, slowing U.S. growth, the Fed might lower interest rates next year to juice the economy. But oil-price spikes have previously contributed to much harder landings after the central bank started cutting rates in 1990, when Iraq invaded Kuwait, and in 2008.
In the latter episode, oil prices skyrocketed to record highs, pushing Americans to cut purchases of gas-guzzling cars and leading to factory slowdowns among domestic automakers, said James Hamilton, a professor of economics at the University of California, San Diego. That later combined with the subprime mortgage crisis and other factors to wreak economic havoc.
Benchmark U.S. crude’s 29% run-up in the past three months is smaller by comparison to the price shock from 2007 to 2008, as well as the steep rise from 2020 to 2022 that helped kick off the current inflation bout.
“It’s a much more modest increase,” Hamilton said. But “that’s enough to make a little difference, and the Fed is watching little differences right now.”
Inflation… That’s SO last year! The thing about inflation is that it’s the rate of change in prices, not the prices themselves. But people live in the real world, where prices are causing trouble by staying just where they are. Yes inflation might be lower than it was a year ago, but those prices that went up, they stayed up. And that’s not good, as this Bloomberg article reminds us.
“It costs $734 more each month to buy the same goods and services as two years ago for households who earn the median income, according to Mark Zandi, chief economist of Moody’s Analytics.”
Overall consumer prices are up 20% relative to where they were in March 2020. White bread is up 40% and gas prices are up 92%. And nobody thought March 2020 was all that great (Remember watching that Tiger King guy on Netflix? He was the worst!). Silliness aside, read Adina Diaz’ story to get a feel of what it’s like on the ground in Tucson, AZ for a young working person trying to find a way to live on the cheap. Combine this with the fact that only the richest 20% of Americans still have excess savings from the Covid era, and quickly it’s no wonder why everyone wants a raise. And that’s what economists call the “price-wage spiral,” i.e., self-fulfilling inflation. Somehow, while that seems possible, the odds look better that we get the type of economic slowdown that makes workers put away their freshly-painted picketing signs and start to stay quiet for fear of finding themselves out of work. None of these scenarios are particularly appetizing. Austan Goolsbee is one of our Fed men, and a favorite of mine. He sees the Fed succeeding at what he calls the “Golden Path,” or the mother of all soft landings. I hope he’s right, and I know he’s very thoughtful and data-driven, but it seems like less than a certainty that we get the golden-path outcome out of this situation.
OK, where does this leave us? The bottom line is simple. Economists are easily wrong, particularly in the near term. Our economy is steered by technocratic experts who are both well-intentioned and painfully prone to error. Like it or not, we have nobody better for the job. And yet… at the last Fed press conference, our man at the Fed, the Honorable Jay Powell basically took Goldilocks out back and shot her, and long-term rates have jumped in response. The economy is a huge game of “reaction functions:” What you do at the personal level impacts the overall economic picture, which in turn, impacts how you feel about things, and thus the next thing that you do in response. We should all aim for behavior that avoids downward spirals, but sometimes self-preservation kicks in. And there is no stopping people’s survival instinct. That’s what happened in March when we got a couple of bank runs and it could happen again. In fact, we can easily argue that it’s started happening again in September and so far in October, which we will talk about next time. Everyone should have a plan for the if and the when, and please make sure you can live with what your portfolio looks like if we hit a pothole later this year or in 2024. The mother of all soft landings sounds nice. I hope that’s what we get. But as the French say: “Un homme averti en vaut deux.” I’ll let you google that one.
Extra Credit Reading:
Real Estate in San Francisco isn’t doing great.
Private equity is becoming the land of zombies.