Is the FED Behaving Like A ‘Zombie’?

Central Bankers are continuing to use ‘old discredited’ models.  In these models, the ‘interest rate’ is the key policy tool, which are being used to be ‘dialed’, up and down, so as to ensure good economic performance.  If a positive interest rate does not suffice, then a negative interest rate should do the trick, right.

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In many economies, including the United States and Europe, the real (inflation-adjusted) interest rates have been negative by as much as -2%.  As real interest rates have fallen, business investments have stagnated.
If Central Banks continue to use these incorrect models, they will continue to go down the wrong path and consequently will implement the wrong polices.

Even in the best of circumstances the ability of monetary policy to restore a ‘crashing’ economy into full employment is limited.  Relying on the incorrect models prevents Central Bankers from contributing what they can and therefore may even make an already bad situation even worse!

The FED set an inflation target and did not let ‘deflation’ run its’ course, after the crash of 2008, which was a catastrophic mistake. During the 2001-2007 boom years, housing prices shot up. This ‘speculative bubble’ led to massive overbuilding of both private housing and commercial properties.

Deflation would have allowed a ‘realignment’ or a ‘Global Reset’ of relative prices closer to that which society desires and needs to be. However, by inflating the money supply, the FED interfered with this essential ‘cleansing process’ which was required, and necessary.

Housing prices should have dropped much more than they did, relative to other prices. Housing should then have remained in a ’slump,’ possibly for a decade or so until this ‘overhang’ of construction had been cleansed out. The new ratio of relative prices would have allowed the proper ‘reallocation of resources’ to move into the production of goods and services which would be more in line with what society would need within a ‘functioning market’.

Average Household Income VS Home Prices

Typically, as people make less money each year home prices tend to follow. This divergence paints a scary picture for some real estate investors as everything goes in cycles. What was or is good, will eventually become the bad investment for a time being.

Currently the Canadian housing market is most overvalued in the works according to a recent article I read. And While I love real estate as a long term investment I feel you need to be very selective in what you buy and rent to be sure you cater to a very specific niche of individual that will thrive during tough economic times.

Today, housing is back with price increases at ‘bubble-era levels’ and construction activity picking up momentum. Hence, the ‘overhang’ has not disappeared. It has merely been left in ‘limbo’ due to the “extend and pretend” strategy of banks which were made possible by the Central Bank’s massive printing, over the last seven years. Therefore, money printing stops, the adjustment downwards in housing will be even more ‘disastrous’ than it already is.

Chart 1

Concluding Thoughts:

Just look at the price of homes in the chart above. We are seeing record highs once again just as bad earnings are being reported, stock market health is terrible and pointing to much lower prices. Things could get ugly and with interest rates near zero already what can the FED do stop or slow things down this time?

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There are some incredible opportunities in both the stock market and real estate to profit from the down swing which I feel is about to take place.

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Chris Vermeulen

[Image Courtesy of Pixabay]

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