According to the AP, new-home sales fall for the third straight month in July, setting a pace that would mark the worst year since 1963. For those who are surprised, I ask: why? This is yet another example of why the Federal Reserve should be completely dismantled and abolished, never to arise again.
Why, you ask? It’s the Fed’s policy of keeping interest rates artificially low that is the main cause of prolonging the hurt that is the depression we are currently in (along with many previous ones, most notably the Great Depression). Let’s look at two paths to take: the path of keeping interest rates low and the path of letting market prices reset.
The Fed operates on the Keynesian theory of keeping interest rates low and prices high. The belief is that keeping prices high, or “stable”, will keep fears of a recession or depression down and will spur investment spending. The idea is to keep investment spending up so that unemployment is not hurt and therefore the economy can keep booming. There is a fundamental flaw in this though. In order to keep rates low, money needs to be printed. Otherwise, the cost of borrowing money will be higher than the Fed’s intent and curb investing. So the money supply is increased.
This is where it gets messy. Because rates are low and the money supply has increased, the investor now has an inaccurate view of economic conditions. The investor will borrow money and invest where he otherwise wouldn’t. In addition, the investor is also going to run into unforeseen budget overruns. We’re taught to accept that all projects run over budget. However, the Fed has a hand in this as well. Because of the increased money supply (and the resulting devaluation of the dollar) cost of goods go up. The investor doesn’t take this into account because, again, he has an inaccurate view of the economy. So the investor is now investing where he otherwise wouldn’t. Cost overruns cause problems at the end of the project (let’s say building a house) and now he cannot finish. He now has to abandon the investment, squandering the time, labor and materials. Even if he had the resources to continue to completion, the cost overruns eat into the profit margins. So we have a completed house the cost more to build than budgeted due to the increase in cost of materials. In addition, because we’ve built a type of house that, if we had an accurate market, would not have built, the consumer does not buy it. We’d have to reduce the price of the house anyway and the investor takes a loss which will keep said investor from building any more houses.
The problem with the Fed policy is that we’ve misallocated resources into an area of the economy that didn’t want it. If I’m a homeowner and the price of housing is too high, why would I want those prices to continue to be high? It discourages buyers.
The second path is to let the prices adjust naturally. With a recession, we see a natural adjustment. The economy has determined through consumer preferences that the prices are too high to be sustainable (again, this is due to the Fed printing money and creating the housing boom). So if we allow prices to come down and let investors make the choice on the true economic conditions, we will see a turnaround. The reduction of prices is not a bad thing. If anything, we should continue to see reduction in pricing due to efficiencies and higher production. This stretches your dollar further as well. When the dollar is stretched further through efficiencies and production, we see a true wage increase rather than an inaccurate wage increase through printing of additional currencies and increase in physical wage.
Back to the housing example, if I’m a potential homebuyer and I’m looking to buy a 4 bedroom 2 bath for $300,000 and the current market price is $450,000, I’m out of the price range. However, if the market has determined that this price is inflated, the natural deflation of this price takes place. Now the price begins to gravitate closer to where I, and other consumers, would purchase this house. With the increase in potential buyers, we now have an equilibrium price that is a truer indicator of what the actual market price is. However, under the Fed policy, keeping prices artificially high would eliminate those potential buyers.
One might argue “What about the one who is selling the house? Won’t they potentially take a loss?” Yes, they may and almost certainly will. But the reduction of price is due to the inflated value of the home that was unsustainable to begin with. So should we allocate economic resources from good pools to prop up bad ones? Or should we let the prices fall, have the losses taken and the resources reallocated to good sectors of the economy? In the second scenario, we’ve lessened the hurt. Under the first, we not only allocate resources to bad sectors, but we also encourage riskier behavior. Take the bailouts for example. Should we let the banks reallocate their resources to profitable parts of their company and grow them and discontinue their non-profitable sections? Or should we bail them out using money from consumers (taxes)? If we bail them out, we’ve essentially said that no matter what half-baked ideas you invest in, the government will be there to bail you out. This is the main reason why our current recession is still going on four years after the initial conditions started showing.
The bottom line is that we should not be surprised that new-home sales are falling to record lows when we’ve essentially mislead investors on the true economic conditions. Government intervention has always been the cause of the problems, not the solutions. Just let the market make the corrections and we’ll all move on that much quicker and a lot less painfully.
No comments:
Post a Comment