Federal Reserve blunder.

On 9/14/12 The Des Moines Register reported that The Federal Reserve (The Fed) announced it will spend $40 billion a month to buy mortgage bonds for as long as it deems necessary to make buying a home more affordable (“Fed unveils plan…”).  The Fed is not doing this to make homes more affordable.  They are doing it to inflate the prices of houses.  If everything else is equal, lower interest rates will result in lower house payments.  But everything else is not equal.  Lower interest rates also encourage sellers to ask for higher prices and allow buyers to pay more for homes.  Lower interest rates and higher housing prices also encourage home builders to build more homes.  That means more jobs and lower unemployment.
The problem is that The Fed policy of keeping interest rates artificially low has serious negative consequences.  The Fed buying $40 billion of bonds each month will not only keep interest rates low, it will also pump $40 billion of new dollars into our economy each month.  That will certainly lead to increased inflation.  (Inflation in housing prices is what the Fed wants.)  So, The Fed;s answer to a deflated housing bubble is to try to re-inflate the bubble. Low interest rates, especially when combined with inflation, also hurts savers who try to earn interest from savings accounts, CDs, and bonds.  With interest rates so low, some savers just try to get by with less, while other savers move money into the stock market looking for higher returns.  So, both housing prices and  the stock market are being propped up by the artificially low interest rates.
The Fed’s mandate from Congress is to, “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”  Their mandate should be changed to only promote stable prices.  That mandate alone is difficult to achieve.  The Fed’s current goal for stable prices is 2% inflation.  2% inflation will double prices every 35 years!  How does the Fed know that prices should not actually go down as we continue to become more efficient and productive?  The best answer would be a return to a gold standard so that our money supply can’t be manipulated by politicians or economists who imagine they can successfully control our economy.

Deflation is good!

Our federal government is doing everything it can to inflate housing prices. Of course, taxpayers are on the hook for trillions of dollars in mortgages, so increasing housing prices does reduce taxpayer’s liabilities. Inflation helps borrowers and hurts savers. If homes truly increased in value, that would be a great thing. But, if housing prices go up only because our government keeps interest rates artificially low and intentionally prints more money, then any housing price increases are not real. If the price of your home doubles, and all other prices also double, then there is no real gain.

If housing prices went down like electronics and clothing, what would be wrong with that? Wouldn’t it be nice if houses became more and more affordable? I know that people who own homes feel great when they believe that their home has increased in value. I feel the same way. But it is a false feeling. If housing prices went down, more people would buy houses – just like electronics. Do you not buy a computer or cell phone because you are afraid that the price will go down next month?

No one wants to see their pay go down. What if your pay got cut in half, but at the same time all prices went down by half? Would you be any worse off? No. We live in a world where the vast majority of people make less money than those of us in the U.S. There is, and will continue to be, tremendous worldwide downward pressure on wages and costs. The key for each individual it to be productive. If you are productive, as valued by others, then you will earn a competitive income. If you do not have skills and are not productive, then you will have problems. That is true whether we have inflation or deflation.