Whether for year-end management reasons, or as a result of political considerations, it is a fact that the US Federal Reserve has allowed effective monetary conditions to ease over the last month. The public sector has injected more than $200 billion of liquidity into the financial system. It therefore comes as no surprise that financial markets are booming, yields are tumbling and the dollar is weak, a situation that we expect to continue into year end. It may even continue into 2024 if the politicians have their way. However, we fear that over the longer term – and perhaps as soon as the second half of 2024, this expedient easing may result in a new wave of inflation within the global economy. Late 2024 could even seeing rising short term rates in the US.
Three weeks ago I walked along the street depicted in the photo below. The four-mile walk along Silicon Valley’s main highway saw me walk past 40 or so RVs, most of which looked to have been parked for some considerable time. Most appeared to contain families and we can presume that most of the adults living in these vehicles worked at least one job. The Stanford Daily, like many local newspapers around the World, refers to this as a “housing affordability” crisis and most such articles advocate the building of more homes as a solution. Indeed, we came home to even our little island to find the local paper saying exactly the same thing.
source: The Stanford Daily
In reality, any new homes that are built tend to be purchased by explicit or merely implicit housing market investors, who believe that the rental yield / capital appreciation that they will experience through home ownership will justify either being cash or credit-financed buyers.
While people may talk endlessly about the effects of population growth and migration on house prices, in reality it has been low borrowing rates, boom mortgage supply, and supply-limiting planning rules that have driven up house price to income multiples and caused the affordability crisis. The value of housing relative to per capita disposable incomes has doubled in many countries over the last 30 years but the affordability crisis would of course “go away” if either house prices halved, or wages doubled…
USA: House Prices Versus Wages
Modern economies are today ridden with several other similar relative price disequilibria; we have written endlessly that traded goods prices appear absurdly low relative to service prices and non-traded goods (in no small part due to the large property price component implicit in many service and non-traded goods prices).
USA: CPI by Component
1992 = 100
The lack of affordability of housing and concentration of ownership within parts of the population equates to wealth inequality, which of course has important political dimensions. High house prices and high non-traded goods prices have meanwhile hollowed out manufacturing industries in the West by raising the countries’ costs bases, with the result that the “middle ground” in the income distribution has been lost (along with productivity growth). This “overvaluation of the real exchange rate” has led to high rates of income inequality and low trend growth – and weak real income trends for many. Many of societies’ current and disturbing ills can be traced to these price disequilibria.
As regular readers will know, we have been writing much of this for thirty years now – ever since the problems first started to surface during the mid-1990s. However, many governments still talk about trying to boost house prices as though this was the cure for their society’s problems rather than the disease. If their policies to “revive” housing work, they will make the World’s problems worse.
In our commentaries, we have always alluded to the fact that at some point the ratios between house prices and incomes; non-traded and traded goods prices; service and goods would become so stretched that they could rise no more. We also opined that eventually they would cause such deep-seated problems that society would demand a change. We may have reached this point.
Solving the problems can occur in two ways – house price and service sector deflation (the route favoured by Governor Mieno in Japan during the early 1990s – make no mistake he saw this as a viable and necessary cure to society’s ills); and / or wage and goods price inflation. Generally, policymakers do not want property and service price deflation, particularly in over-indebted economies (and most economies are nowadays…).
We believe that the latter route of wage and goods price inflation has so far not occurred because it has been repressed by China’s non-profit-maximizing emergence as a global price setter in goods markets, the impact of migration flows, weak labour bargaining positions, and even the easy access to credit that allowed households to borrow rather than earn the necessary money to spend. Today, we are deglobalization, migration is a thorny subject, and credit availability has been reduced for most households. The factors that repressed inflation in these sectors may have been lifted and it is therefore of no surprise to find that wage and price inflation expectations are sticky or even picking up at present.
Auto prices and the flawed rental terms in the CPI may have depress headline inflation rates in the USA for a while longer, and the Fed’s latest forbearance of yet another liquidity boom may be depressing yields in the near term, but out in the real economy there is a growing risk that the necessary inflation that has so long been repressed within goods and labour markets is starting to appear. Next year will represent a big test for those expecting lower inflation and, for societies’ longer-term health and balance, we do need a period of rapid wage inflation, however bond unfriendly that might seem.
Disclaimer: These views are given without responsibility on the part of the author. This communication is being made and distributed by Nikko Asset Management New Zealand Limited (Company No. 606057, FSP No. FSP22562), the investment manager of the Nikko AM NZ Investment Scheme, the Nikko AM NZ Wholesale Investment Scheme and the Nikko AM KiwiSaver Scheme. This material has been prepared without taking into account a potential investor’s objectives, financial situation or needs and is not intended to constitute financial advice and must not be relied on as such. Past performance is not a guarantee of future performance. While we believe the information contained in this presentation is correct at the date of presentation, no warranty of accuracy or reliability is given, and no responsibility is accepted for errors or omissions including where provided by a third party. This is not intended to be an offer for full details on the fund, please refer to our Product Disclosure Statement on nikkoam.co.nz.