With the Fed shifting from quantitative easing (QE) to quantitative tightening (QT) in recent years, and the end of unconventional monetary policy, interest rates are set to continue to rise as the central bank reduces its balance sheet. With bond yields already going up and volatility at all-time lows, questions remain about how the market will react to this normalization process. One thing is for certain, however: the recent rise of prices across several asset classes has coincided with the years of QE beginning in 2008. Home prices have soared, bond prices have soared, equity prices have soared, college tuition has soared, and even precious metals have soared (along with cryptocurrencies in recent months). While some commentators are alleging that we are now in the â€œeverything bubble,â€ the reality is that what is being seen is really nothing more than inflation in the works. The trillions of dollars of liquidity pumped into the markets by the Fed and other central banks (they are all essentially running the same play book) has caused investors to want to divest of fiat cash holdings and invest in real assetsâ€”whether that is a home, government debt, gold or a diploma. With China set to challenge the hegemony of the Petrodollar with its own gold-backed yuan oil futures contract, keeping oneâ€™s savings in USD makes less and less sense. Even if the USD were to recover from its recent deterioration compared to the Euro or the Renminbi, the damage has already been done by QE and investors know it: the purchasing power of the dollar will never be as high tomorrow as it was prior to QEâ€”and, in all likelihood, it is going to further decline. For this reasonâ€”and knowing that interest rates would be risingâ€”it made sense to make a large purchase, while I could obtain the credit to do so, and buy a home.
Other factors to consider include Real Gross Domestic Product (GDP) and Real Personal Consumption Expenditures (PCE). Real PCE has essentially stayed the same over the last 10 years (between .68 and .69), indicating that the FEDâ€™s unconventional monetary policy has not worked to kick-start the economy in any meaningful way.
And while Real GDP has risen from 14938 in 2007 to 17163 in 2017, the measures of Real GDP may not be as effective in determining economic health as the FED might have the public believe, especially when one considers the effect of the shadow or hidden economy (Dixon, 1998).
What is interesting to note is that GDP has increased while PCE has stagnated. Using the Expenditure Approach, GDP is measured by totaling the money spent on 4 categories: Consumption (C), Investment (I), Government (G), and Exports minus Imports (X-M). GDP = C + I + G + (X-M). PCE uses the same data points as GDP but focuses on consumption whereas GDP is said to measure production. If consumption is only moving sideways and production is supposedly going upâ€”what can be determined from this? It is possible that wealth is being distributed among the majority of the populace but rather consolidated, with profits from production rolling into the pockets of the 1%.
Another indicator of the condition of the economy is the Effective Federal Funds Rate and on the Consumer Price Index: All Items Less Food and Energy by year for the last 30 years.
As the graph above shows, the Federal Funds Rate has seriously diminished over the past 30 years in a downward trend that has culminated in a sustained flat-lining since the Great Economic Recession of 2008. Is it possible that artificially low interest rates have resulted in deflation in some sectors while causing inflation in other sectors? The evidence would indicate as much, what with housing prices up and energy down (WTI crude oil is at less than half its value at the height of the last â€œbubbleâ€).
As I took a loan out to pay for my house, I benefited substantially from the FEDâ€™s low interest ratesâ€”my loan was given at 4%â€”a modest uptick from the year prior, but still historically very low. Are low interest rates inflating housing prices? Most likely. However, the dilution of the dollarâ€™s value is most likely playing a role in asset price inflation as well. Waiting to buy a house might see housing prices come down with interest rates risingâ€”but interest rates rising will mean more expenses on the backend and no guarantee that prices will actually come down, since trillions spent on QE have surely left a mark.
Government incentives did not factor much into my consideration, fortunatelyâ€”especially since the new tax cuts signed into law by the Trump Administration have effectively capped the amount of deductions that one may take. My house was not so expensive that this would make much of a difference either wayâ€”but for some it will matter.
The state of the economy today is such that there is a great deal of concern among investors. Credit is still relatively cheapâ€”but interest rates are set to rise. The new chair of the FED has questioned the policies of the central bank since 2008 and whether hawkishness is in the forecast is anyoneâ€™s guess. As the U.S. government has taken on much more debt in recent years, servicing that debt will become quite difficult should rates rise too high. For my money, I am watching the uptick in PMs vs USD as an indicator of where we are in the game of musical chairs. I expect the music to stop shortly, and for that reason I am happy to have made a purchase of a real asset like a home.
In conclusion, sensing from the above-mentioned indicators that the value of the USD has diminished since the FEDâ€™s adoption of unconventional monetary policy, it seemed rational to get out of USD now rather than later. Assuming a houseâ€™s worth of debt at a historically low interest rate made more sense than waiting for rates to rise and asset prices to continue to go up as the market prices in the fact of QE and its concomitant inflation. Wages have not gone up (except for those of the 1%) and while deflation may be evident in some sectors, the fact of inflationâ€”otherwise known as the â€œeverything bubbleâ€â€”is enough to make me want to invest in a real asset while rates are still low.
Dixon, H. (1999). Controversy: on the use of the â€˜hidden economyâ€™ estimates. Economic
Journal, 109(456), 335-337.
FRED. (2017a). PCE. Retrieved from https://fred.stlouisfed.org/graph/?g=hh3
FRED. (2017b). GDP. Retrieved from https://fred.stlouisfed.org/series/GDPC1 utm_source=series_page&utm_medium=related_content&utm_term=related_resources&utm_campaign=categories
FRED. (2017c). CPI. Retrieved from https://fred.stlouisfed.org/graph/?g=5rJe