Governments are fond of referring to their dumping of cash into the economy as stimulus. There has been a huge amount of cash released into people’s bank accounts, and very little economic growth. How little? About 22 cents of GDP for each dollar of “stimulus” --- showing that governments have depleted their tools. They don’t know what to do. They are now sowing the seeds of a huge price inflation, and they don’t seem to care. Instead, they point to that lack of general price increases during this past year, and they have positioned Japan as the poster child debtor nation.
What appears to have eluded their notice is that the volatility of money is approaching zero --- a symptom of the lack of demand for goods and services. People want to save. Many are afraid to spend. So even though production and productive capacity are shrinking as businesses close down permanently, demand is falling even more, and prices have not escalated to the extent the money supply has. Once people feel confident, they will begin spending. Then see what happens to price levels. So far as Japan being an example, first, the Japanese economy has been stagnating for 30 years. Secondly, they owe that money to themselves, not to foreigners, so their very high debt to GDP ratio is not the problem our lower ratio is.
There is a problem developing. Commercial real estate has high vacancy rates. Many companies have come to see that they don’t really need all that office space. Empty buildings do not have the value of fully occupied ones. Prices of commercial buildings are bound to drop, at least in real terms, if not in nominal terms. I expect many of their owners will be in financial trouble and unable to meet their mortgage payments. This will reduce the value of the mortgages. The difference between the selling price of a mortgage and the contractual cash flow from the mortgage payments determines the effective interest rate. The cheaper a series of payments is to buy, the bigger the spread between cash paid for it and cash to be collected from it, and the higher the effective interest rate.
When mortgages can produce much higher yields than bonds now do, what will happen to bonds? Investors will not be willing to pay as much as they are now. So, bonds should fall in price. Makes sense since the bond market is a bubble waiting for a pin to pop it. I suspect that a deteriorating mortgage market will be the pin. This is a major economic problem. The bond market is much bigger than the stock market, and the value of daily bond trades dwarfs stock trades. Falling bond prices means higher effective interest rates. When interest rates rise, more real estate owners will be caught in a squeeze that will wipe them out and precipitate even greater problems in the mortgage and bond markets. As the value of real estate declines, balance sheets will deteriorate and credit will tighten up.
Of course, central banks may decide to buy the mortgages and bonds, thus monetizing the debt. More inflation. More problems. No, it’s not looking good.
It is time to be liquid (in cash or in investments that can almost instantly be converted into cash). Time to consider Warren Buffett’s expectation of a stock market crash. Stock markets will not take rising interest rates very well. Neither will real estate markets. There could be blood in the streets. It’s time now to mend relationships and build new ones.
