Bernanke should be raising rates

The sky is falling, according to Ben Bernanke. We are in the throes of a financial crisis! Hurry lower rates before it spreads and we have a full blown depression!


Yes the economy is slowing, there is no denying that. The housing debacle in the United States has reduced (or eliminated) people's equity in their homes, and that has left them feeling less wealthy. Also construction, which was a big part of the nation's economic recovery after the 9/11 terrrorist attacks, has slowed dramatically. This has of course led to job losses in that sector, and we've also lost much of the huge spending that comes with large construction projects.


There are some bright spots, however. The weak dollar has pumped up exports and the trade defecit has declined. It is amazing for all the talk of the trade defecit and protectionist measures, nobody talked about the obvious problem, that the dollar was simply too strong. Now if we can just get China to allow their currency to be valued fairly by the market we could make some real progress with the defecit... Due to the weak dollar earnings across most sectors of the economy not related to housing have remained remarkably resilient. In fact before the 1990's procolamation of a "new economy" the current unemployment rate would be considered dangerously low and inflationary.


Which brings us really to the broader problem, that most Americans don't want to accept. Free markets do ultimately produce the most efficient result, but the cost of that efficiency is fluctuation. In order to discover the most efficient way to do things, businesses have to try new things. Sometimes they make mistakes. Mistakes cause fluctuation, in the form of job losses, slower growth, inflation, etc. Ultimately however the businesses learn from their mistakes, implenting what worked and getting rid of what didn't. This process ultimately leaves us stronger and more efficient (thus more wealthy) than when we started. But in order to get there you have to endure some fluctuation, and pain, which people of course understandably dislike. But it is part of the process that we have to accept. Business cycles are always going to occur, and we have to allow them play out.


Bernanke's primary concern right now should be inflation. Oil prices get all the attention, but due to increasing affluence in the world (especially in China and India) and partly because of our ill-conceived subsidies and love affair with corn based ethanol, food prices are also skyrocketing. It is hard to ignore that the price of almost everything much higher than it was a few years ago. This represents a much larger danger to the economy than unfolding of the current business cycle.

What would happen if Bernanke raised rates? First the bubble in oil prices would pop. Yes oil is going to remain high regardless, but it currently prices much higher than it needs to be. Supplies remain abundant, the market is engaging in pure speculation. Prices did come down briefly, but due to Bernanke's rate cuts the market now is speculating that the US may avoid recession. Bernanke's cuts have also weakened the dollar, which has also put upward pressure on prices. Rate increases by the Fed would finally pop the housing market bubble. Yes prices are coming down, but they have much further to go. An increase would accelerate the decline to true market levels, which would finally stimulate demand and help us get rid of all this excess inventory. Of course we would endure some pain during the process. But that pain has to be endured. We can either get it over with and bring prices under control and move back to a period of prosperity, or we can go through a prolonged period of stagnation and rising prices.


The fed mercilessly raised rates in the early 80's to bring inflation under control despite the economic pain it caused in the short term. But it led to almost 20 years of unparalleled prosperity. It's a lesson that should not be forgotten.

The US real estate market

These are tough times for the US real estate market. Existing home sales continue to plunge, along with prices. Here in Orlando, FL there were only 924 contracts signed in September of 2007, down from 2054 in September of 2006, according to the Orlando Regional Realtor Association. During the peak of the boom, Orlando saw 3000+ contracts signed a month. Similar scenarios are playing out in metro areas across the nation. What happened? And where are home prices going from here?

First culprit, one that is not talked about much, is the media. Yeah they love to stick it to the lenders (and everyone else), and certainly there are others who deserve blame for this mess (we'll get to them in a minute), but first and foremost the media is to blame. During the boom years every other story in the news was about how home prices are going up, and how so many people are making money flipping homes & condos. They held these people up to be geniuses. Everyone wanted in the action so they could be a "genius". People were scared if they didn't buy now they'd miss out, and people dreamed of easy riches from buying a home, waiting a few months, and then selling it off. But of course this speculation driven frenzy couldn't last forever. There were too many people buying property just for the chance at easy money, and not enough people who actually wanted to live in them, which, believe it or not, is all that residential real estate is good for. Eventually people woke up this reality.

When things started to go south, all the media could talk about is the subprime mess and how the real estate market was primed for a huge fall. They've talked down the real estate market so thoroughly over the past couple years that now the opposite is true, people are afraid if they buy now they'll miss out on huge price declines to come. The media did the exact same thing during the stock market bubble. Here we go again...

Second on my list of people to blame are the speculators/buyers. Somehow these people didn't learn their lesson from the "dot com" bust. Everyone convinced themselves that real estate was different. I talked to many of these smug people during the boom years, it just sickened me how smart they thought they were. How long did you think prices could keep going up at 40% a year? Whose income is going up that much (besides yours I guess), and who is going to be able to afford these properties?

Third on my list are developers. Developers simply closed their eyes and kept building. Anyone could crunch the numbers and see that there was not nearly enough population growth occurring to support the number of new units being created. But who cares? They're selling! This is the new economy! Reality does not apply!

Fourth on my list is lenders. I know lenders are on the top of most people's list (especially the media, they make a very easy target since they're foreclosing on so many properties now), but lenders provided what the speculators wanted, if the players mentioned above hadn't created the situation, lenders wouldn't have had any loans to make. I know there were some shenanigans in the marketing of loans to the secondary market, but again without all of the get rich quick speculators demanding no doc loans, lenders wouldn't have started offering them.

So now that we're in this mess, where are prices headed? A lot will depend on the individual metro area in question. Every metro area is different some markets rose a lot more than others. And it will also depend on sellers. They need to finally accept that the prices that existed during the boom were artificially created and didn't reflect reality, and that reality has now finally set in. Here in Orlando for example I believe homes are overpriced by about 20%, when you look at peak of the boom prices. The reason we only had 924 sales last month is that most homes are still priced at peak of the boom levels, and buyers are not touching those houses with a ten foot pole. Many sellers continue to insist that they will not sell unless they "get their price". If this standoff continues, then prices will decline very gradually over the next 4-5 years before stability returns to the market. If sellers get smart and slash their prices 15-20% then inventory will start moving again, and we can get through this much sooner. If you bought at the peak of the boom, then either just keep living in your house or rent it, because you're not going to get that price for your home anytime soon. Nobody should be trying to sell a house right now unless they have absolutely no other choice.

The Fallacy of the Minimum Wage

Democrats, having very little in the way of useful ideas, pushed through the Fair Minimum Wage Act of 2007. Many people will tout this as a victory for low wage workers, but the whole idea is seriously flawed. As a result of the legislation the minimum wage will rise to $5.85 an hour on July 24, 2007, $6.55 an hour on July 24, 2008, and $7.25 an hour on July 24, 2009. So now $7.25 an hour is "fair". Why not $10 an hour? Or $12 an hour? $50 an hour? Now that would really help some low income Americans (I wouldn't mind that myself)! How is a fair wage determined? How do you fairly determine the price of anything? Simple, through free market negotiation. Employers will offer employees what they are willing to pay, and a potential employee is free refuse or ask for more. Democrats however have decided to use the power of government to force employers to pay more for employees than they are worth. But "Greedy corporations will never pay what's fair to the employees, they will shortchange everyone!" you may say. Then why don't engineers make minimum wage? Baseball players? Even many liberal arts majors pull down more than minimum wage! In fact only 1.7 million US workers make the minimum wage or less (and many of those are waiters and waitresses who make more than minimum wage when you include tips), which is a very tiny percentage of workers. "Well ok," you may say, "but what harm does it do? Let's put a little extra money in the pockets of these workers!" Ok let's take they hypothetical example of a small business that employs 20 minimum wage workers, and now that business in the summer of 2009 has to pay it's minimum wage workers 7.25 an hour instead of the current minimum wage (at least until tomorrow anyway) of $5.15 an hour. That translates to an extra $2.10 an hour for each employee, and assuming fifty two forty hour work weeks that would equal $87,360 a year in extra salary for those employees. Now let's say that business had planned to hire an IT person to streamline the operation of it's computers and networks, or maybe a bookkeeper to handle some accounting. The business now wouldn't have enough money to do so, and that relatively high wage job would be lost. The business would also lose any productivity gains that it would've realized as a result of that employee, which ironically probably would've increased the size of the business and it's demand for labor which may have led to an increase in how much the business would be willing to pay it's workers. In fact in many tight labor markets today the minimum wage is a non-issue as nobody is willing to work for the minimum wage anyway so the effective "minimum wage" is much higher. So I have no problem with seeing the wages of lower income individuals rising, I would just like to see them earn it through market forces rather than using government to force their wages to rise. I don't doubt that low income workers work very hard, but jobs that require mostly physical labor just don't have a lot of value in today's economy. Maybe government should focus on increasing people's skills so that they can actually deserve a higher wage, rather than artificially increasing their pay, then everyone will be better off.

Introduction

I wanted to write a blog on subjects I am interested in and hopefully stimulate some meaningful debate. So a little background on myself, I am a former software engineer and now a real estate developer, just turned 34, living in Central Florida. Politically I am a moderate, and I tend to vote Republican because I view the Republican party as the lesser of two evils (more on that later). I have two children, one 7 months old and one 4 years old. As far as my religion, I am an agnostic, and my wife and parents are Hindu. Through this blog I hope to explain why both political parties are awful and why the country is so polarized, why free markets beat government intervention, and why religion is the root of all evil. Easy enough, huh? :)