Too much of a good thing? Excess liquidity and rising inflation.
Hello, friends. I’m back on the West Coast after last week’s trip to New York City to see my mom and while it’s always good to come home, I have to say again just how impressed and excited I was by the positive energy and collegiality I experienced in New York. It seems that people are optimistic about moving past the pandemic’s major challenges, but they’re doing so with a healthy dose of pragmatism and caution. To me, that signals better chances of a successful reopening as summer approaches.
And while I love the overall sense of optimism as we reemerge, I have a concern that’s shared by many investors and analysts, as the markets have demonstrated.
Back in March in the post, “Mini-Inflation Nation,” I predicted that we’d see inflation slightly above the federal target rate of two percent—I pegged it at about three percent then. Now, though, I’m revising that prediction based on several factors, not the least of which is the potential for the federal government to infuse more liquidity into the economy, including via the $1.8 billion American Families Plan.
It’s hard to argue about the need for many overarching principles of this plan, but the potential ramifications of another infusion of liquidity into our economy leaves me torn.
I’ll share my opinions right after a brief market recap.
Market recap
As I predicted, there’s still extreme volatility all around. At the time that I’m writing this post, the markets are bouncing back on the good news from the Labor Department: it looks like jobless claims in the U.S. are at a pandemic low, with 444,000 new claims last week, as reported in the Wall Street Journal.
With the exception of housing and gold, which are traditional hedges against inflation, other asset classes show not-insignificant swings up and down. There also seems to be a general cooling in areas that blazed earlier this year, particularly with SPACs and NFTs—largely, I believe, because of the nebulousness of those offerings. In a nutshell, assets are reversing some gains, primarily in stocks and notably in cryptocurrencies.
Bitcoin was fun while it rose pretty steadily, but now there are likely some investors who are licking wounds. The pandemic brought on a march to digital currency (and I think it’s likely that the U.S. and most other countries will likely be in it soon, too). Where that will leave Bitcoin and the rest remains to be seen.
Looking ahead, I think companies that make tangible things—either supplies for other goods or finished products—are likely to be decently positioned. Tech will retain strength, too, although the extreme valuations that we saw in 2020 will unwind some, simply because as we emerge from the pandemic, we won’t be completely reliant on apps to take care of every need.
Residential real estate
Perhaps the most notable housing development this week has been the news of fewer-than-expected housing starts for new homes. But, really, with everything we’ve discussed in this blog—from the skyrocketing costs of lumber to shipping delays for supplies and a lack of labor—is this really a surprise? I don’t think so.
Here’s what Reuters reported on May 18:
“Single-family homebuilding, the largest share of the housing market, dropped 13.4% to a rate of 1.087 million units in April. It retreated further below the more than 14-year high scaled in December, a sign that builders could be holding back because of the more expensive materials and lack of labor.
Building permits for single-family homes fell 3.8% to a rate of 1.149 million units. The number of housing units authorized to be built but not started surged 5.0% to a rate of 232,000 at the end of April, the highest since the government started tracking the series in January 1999.”
Yes, there’s buyer demand for homes but all of the factors that go into building them are challenged right now, so supply won’t meet demand for some time still.
Coupled with rising interest rates now and even higher rates likely soon (in response to inflation), we should expect the housing frenzy to cool a bit -- but don’t expect it to fall or even for prices to decrease much, if at all. The ever-widening gap between those who have done well during the pandemic and those who have struggled means that those with money will continue to invest in real estate, particularly because it has traditionally been a hedge against inflation. For these reasons, I think the inventory levels will remain tight in most markets, although I expect some cooling in tertiary markets.
Where we can expect to see the most significant impact of Inflation on the housing market is likely in regard to renters. They have no way to control their housing costs and little-to-no protection from rising rents. And since the majority are low- to middle-income earners, this is one area in which even relatively low inflation rates tend to hurt.
Back in March, we took a look at “iBuying” in residential real estate. Then and now, my feeling was that there would always be a segment of the market that’s interested in this, whether as buyers, sellers or investors. But I also said that as the owner of a brokerage, I believed that this segment has growth potential but it isn’t where it needs to be and that people will continue to favor agent/client interactions.
Now that we’re emerging from pandemic-related restrictions, that prediction appears to be playing out. Here’s an update from the Wall Street Journal:
“Investors started to believe that the pandemic was just the impetus the industry needed to transform on a large scale. In an 11-month span from mid-March 2020, Zillow shares soared nearly 700%—more than 2.5 times the rise of Zoom Video Communications over that period.
But now, as vaccination rates tick up and workers filter back into offices, investors are starting to waver. Zillow shares have shed 43% of their value in less than three months, while Opendoor shares have fallen more than 50% from their highs this year. Compass, which went public in April, is now valued at less than it was after its last private round in 2019.
An analysis this month by Mike DelPrete, scholar-in-residence on real estate technology at the University of Colorado Boulder, showed that Zillow logged three consecutive quarters of net profit, stemming from its legacy Premier Agent business. The segment would have benefited from the pandemic-driven interest in home buying and selling—with or without iBuying technology.”
Inflation and liquidity: The federal government and other fueling factors
In several previous posts, I’ve talked about how the most recent round of federal stimulus funding, while necessary in many respects, would lead to inflation.
I thought then and still do believe that there were simply too many Americans who got financially clobbered by the pandemic to do nothing -- and most were people who were already short on savings and working low-paying jobs in industries that got shut down. Passing a massive stimulus bill was the only way to get enough legislators on board to get something through, so inflation was a price we knew we’d have to pay.
Earlier this year, I figured that we’d likely exceed the two-percent federal target for inflation but not by much: my expectation was that we’d land at about three percent.
Fast forward just a handful of months and I’m revising my prediction. As I see it, we’re more likely to see inflation of 6-7% this year. And from my perspective, it’s the result of a multitude of factors that include, but aren’t limited to, the federal government’s role.
But let’s start with that. If anyone asked me, I’d say that it’s time for the federal government to back off from additional, substantial stimulus funding. (Infrastructure improvements are a necessary investment, but I think some of the other funding that’s being discussed could do more harm than good right now, simply on an economic basis, although I agree with the principles behind it.)
It’s also likely that many investors (including some of you who are reading this post) will wonder what all the fuss is for: about half of the people in the U.S. are under 35 years old and have never experienced significant inflation, because the last time we had it was in the 1980s. (Back then, along with double-digit inflation, we had double-digit interest rates on our mortgages, too: As noted in this post, in 1981, mortgage-interest rates peaked at 18.45%!)
If you’d like to see how inflation will impact you and your household, take a look at this interactive inflation-impact calculator from the Wall Street Journal (note: the snapshots, below, are just images with two scenarios entered—you’ll have to click through the link to get to access the WSJ’s interactive component).
As this shows, what you could buy for $100 in April 2020 would cost more than $4 more now and what you could buy for $100 in April 1980 would cost nearly $330 today. That’s not a big deal if your earnings rise in lockstep—but for millions of low-wage workers, middle-income families and seniors on fixed incomes, the reality of inflation in day-to-day life is stressful at best and potentially devastating.
What causes significant increases in inflation?
The federal government is one source of increased liquidity and massive liquidity events, such as major stimulus packages, fuel inflation and ultimately can tamp down economic growth.
Another source of significant liquidity that gets less attention are banks. I won’t go too deeply into this today (maybe in another post another day, though) but in a nutshell, when central banks, like the U.S. Federal Reserve, ease the reserve requirements on banks, the banks are free to lend more, which puts more money into the economy.
Investments are other ways that liquidity is created. Take cryptocurrencies. Somewhere out there, someone or some group created what we now call Bitcoin and at the time that I’m drafting this post, it has a market valuation of about $784 billion, simply because enough people have bought into the idea of it (yes, I know that could be said of most or all currency, but still…) And if someone sells their Bitcoins for, say, $1,000,000, now there’s another $1,000,000 in liquidity floating around.
What do we do next?
In my opinion, there are two factors now that could make things more challenging for our economic recovery: Flooding the economy with liquidity, which we’ve done and may continue to do, and keeping interest rates low, which we’ve done but which we’re starting to reverse. And while raising interest rates can help to manage inflation longer term, this tool also acts as a damper on economic growth at a time when our economy is still vulnerable.
Since supply and demand also fuel inflation, using technology to try and manipulate them is another way to try and manage inflationary pressure.
I’ve always said that all economics is experimentation: We debate the pros and cons of various tactics, we try something, we make mistakes, we back off or jump in deeper and see what happens.
Thoughts about our collective challenges and shared responsibilities
No update this week would be complete without a mention of the new CDC guidelines regarding masks and socializing, as well as inoculation beginning for 12-15 year-olds. As of the time that I’m writing this, nearly 50% of our country—almost 160 million Americans—have received at least one shot. Everyone who can get vaccinated should, because those who can’t count on us to help keep them safer.
Among last year’s challenges was the loss of interpersonal connection: Time lost with family and friends, loss of the creativity that comes from casual conversations in the workplace and loss of the tremendous opportunities that arise from chance meetings between strangers. Over the last week or so, I’ve had all of these opportunities and I can’t begin to tell you how exciting it is to see communities coming alive again.
We’ve been through a life-altering event together.
Now, as we run to Target or to dinner or to a concert, I encourage each of us to take some time to truly appreciate how far we’ve come—and to remember those who weren’t as fortunate—as well as to be grateful to the people who worked so hard to get us here.
Thanks for checking in, see you next week.
