As the housing market weakens and jobs decline, it is likely that the Federal Reserve will be forced to expand its balance sheet by purchasing additional assets.
In other words, the Fed will likely need to resume printing dollars again in the not too distant future.
Tuesday’s dismal report on Existing Home Sales probably indicates a level of undershooting given that sales were pulled forward by the tax credit. But discounting for inflation, prices are back to late 1990′s levels while inventories are twice the amount (excluding the shadow inventory).
Meanwhile, last week’s report on New Unemployment Claims (500k), which covers the period of the BLS survey, indicates that the number of private sector jobs could fall between a loss or gain of 10,000 or so.
What is evident is that even with depressed prices and interest rates at record lows, the housing market is likely to remain very constrained as consumers, who still fear for their jobs, stay on the sidelines.
The U.S. economy has undergone a radical transformation during the Great Recession in that GDP has nearly returned to pre-crisis levels even as over 8 million jobs have been lost. The enormous gains in productivity means that employers are doing more with much less and that absent a growth in aggregate demand, are not likely to add to their fixed labor costs.
But demand from U.S. consumers cannot increase if new jobs are not being created and if demand cannot be created internally, the only avenue available is to import it. And in order to do that, the Fed will need to resume purchasing assets which means printing, and therefore depreciating, the dollar.
When might we see this happen? Not immediately, because despite some downward revisions, the Central Bank is still forecasting growth of around 3% in 2011, an estimate that probably is too optimistic. But as jobs continue to decline through the third quarter and into the fourth, Bernanke & Co. will be left with no alternative but to announce they intend to purchase another trillion dollars’ worth of securities.
The Chinese, shrewd as they are, are way ahead in this regard. Since annoucing on June 19 they would depeg and allow the yuan to trade in its 0.05% daily band, their currency has gained nothing on the dollar but has depreciated by just over 2.5% against the euro and by nearly 3.9% against the yen.
But a deeper look into these numbers is even more revealing. The yuan was depreciating by 6.5% against the euro back on August 9 as the dollar declined against the common currency, just before the most recent decline in the stock market prompted a risk-off trade back into the USD.
A move by the Fed to depreciate the dollar will force investors to seek higher yielding assets like stocks, because surely there will be little desire on the part of investors to hold on to an investment that is losing value. And although interest rates on Treasuries will tend to gain, it may work to the advantage of housing because those who are able to buy will be more inclined to do so if they believe that the cost to debt service will increase as time goes on.
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