The U.S. yield curve is flatter than Kansas, but Federal Reserve Board chairman Ben Bernanke says this doesn't necessarily portend a recession. Okay, sure, the recent inversion of the curve could have been caused by a little irrational exuberance, er, enthusiasm, about the United States' economic prospects attracting investors to buy long bonds, although, if you'll buy that one, perhaps I could interest you in some beachfront property on Ellesmere Island. And as for the much vaunted housing bubble, Mr. Bernanke says "the increase in mortgage debt may not be a particularly serious problem."
I hope he's right, but that chart of U.S. new-home sales sure looks uncomfortably like a chart of the Nikkei in 1990 -- or as a technical analyst might say, like it's fallen off a cliff -- and it's only now showing the effects of rate increases from several months ago. And the Fed is still in rate hike mode. This is a good time to recall Harry's Law of Central Banking, one of the immutable organizing principles of the financial universe: They always raise (or lower) interest rates once too often.
The housing thing is scary. Roughly 55 per cent of the two million new jobs created in the United States in the past five years were associated with the housing industry, and not just in construction and at Home Depot, either -- there were 430,000 more real estate agents in the U.S. in 2005 than in 2000, according to the National Association of Realtors.
Americans take equity out of their homes every year in an amount equivalent to 6 per cent of gross domestic product, and spend more than two-thirds of it buying things, according to Goldman Sachs. If the housing market bubble leaks a little more air, that will put a rather large crimp in the U.S. economy, and despite Mr. Bernanke, bring about that recession that the yield curve isn't predicting.
There's been a lot of discussion in the market about the housing bubble, and I won't rehash the arguments here. Still, based on my own local observations, the omens are not auspicious. A couple of instances that are FFWSS (fairly fraught with semiotic significance): Nobody at what my wife calls the nightly dog meeting in the park ever talks about how much more their house is worth than when they bought it any more, and the half-dozen phone calls I used to get every week from realtors wanting to know if I might be interested in selling my house have stopped. I guess they must have enough unsold inventory right now and don't need to scout up more new listings.
Meanwhile, the yield curve, like Yoda, is picking up other perturbations in the Force as well.
During the First World War, agriculture boomed as North American farmers expanded to feed war-torn Europe. In the 1920s, as Europe rebuilt its own capacity, agricultural prices plummeted. Herbert Hoover pledged in the 1928 presidential campaign to help the American farmer by raising tariffs on agricultural products. In 1930, Senator Reed Smoot (R-Utah) and Representative Willis Hawley (R-Ore.) proposed an act to drastically raise tariffs. Naturally, as is always the case, when a government jumps on a stupid idea, it finds it difficult to stop -- U.S. imports from Europe dropped by more than 75 per cent between 1929 and 1932, and exports to Europe fell by two-thirds. Total world trade slumped by two-thirds from 1929 to 1934. Now, we could argue all day about whether the Smoot-Hawley tariffs actually caused the Great Depression, but they certainly made it a lot worse.
That's ancient history, but as George Santayana once said, "those who cannot learn from history are doomed to repeat it." As it happens, there are enough slow learners in the U.S. Senate today to fill a Special Ed class, led by Senators Charles Schumer (D-N.Y.) and Lindsey Graham (R-S.C.). These Solons propose to combat the burgeoning U.S. trade deficit by slapping a 27.5-per-cent tariff on everything that comes into the United States from China -- which is pretty much everything on the shelves down at the local Wal-Mart -- unless China gets the yuan up to much higher levels against the dollar.
Well, that shouldn't be too hard to do. All China has to do is sell the hundreds of billions worth of U.S. Treasury bonds that it holds, which would drive U.S. interest rates to much, much higher levels, in turn making all those "innovative" no-money-down, 110-per-cent loan-to-value, reverse-amortizing mortgages that are propping up the housing market about as much fun to hold as plutonium.
Okay, while China isn't likely to do that any time soon, the very thought of it gives the bond market the heebie-jeebies.
Given the demonstrated propensity of governments the world over, when faced with a choice between doing what makes good economic sense and doing something incredibly stupid for short-term political gain (U.S. mid-term elections are coming up), to opt for the incredibly stupid, it's hard to be overly optimistic about interest rates or, by extension, the housing market. Just as your mother used to say when cautioning you about running with scissors, "it'll end in tears."
Harry Koza is senior Canadian markets analyst at Thomson Financial and a columnist for GlobeinvestorGOLD.com.