An Economic Balancing Act… For How Much Longer

The U.S. Labor Department reported yesterday core inflation prices rose only 0.2% in April to an annualized rate of 2.3%. The inflation rate in the U.S., also known as the Consumer Price Index, is a paltry 2.3%.

So what’s the big fuss at the Fed about its worries of inflation continuing to be the central bank’s “predominant concern?” In my view, inflation is not a concern in the United States. After all, gasoline prices and stock prices have been about the only two things going up in price so far this year.

The housing market is deflating like a balloon running out of air. Yesterday, the U.S. National Association of Home Builders/Wells Fargo index fell to the lowest level since 1991. That can’t be good for home builders who want to sell homes or for consumers who want to see their homes rising in value.

One of the worst economic situations we could face in the U.S. is deflation — a period when prices for goods and assets are falling. Unfortunately, debt does not deflate when assets deflate, presenting an economic environment where consumer assets, such as homes, are falling in price compared to their debt, such as mortgages.

Who wants to own a home worth less than the debt on it? Last time the housing market was in such bad shape, in the mid- to late- 1980s, consumers started a trend of dropping the keys to their homes off at their mortgage company. Could the same events take place here in 2007? Sure they could.

The balancing act at the U.S. Fed continues: Keep interest rates high to keep the U.S. dollar artificially propped up in price against other world currencies… Tell the public inflation is a problem while really worrying about deflation… Keep the money supply expanding aggressively in hopes of maintaining rising prices…

How long can the balancing act continue? It’s been going on since President Nixon did away with a gold-backed currency model. At some point ahead, and I suspect it’s not too far in the future, we will have to face the economic music of the excess caused by too much liquidity and too much debt.