I took this pic of a bear in my backyard staring at me while I was sitting on the porch, it was a good reminder…. 1.9 trillion is a huge number flowing through to the economy in one fell swoop. What do both Republican and Democratic economists agree on regarding the new stimulus? There has been allot of talk about “Bubbles” how does the stimulus change the discussion? How will this impact real estate going forward? Will the bear win as a result of the new stimulus?
What does Larry Summers, former Democratic treasury secretary, say about the new stimulus?
It is important to note that Larry Summers is a former democratic treasury secretary under Bill Clinton and director of the national economic council under Obama and a prior World bank chief economist. It is surprising how forceful Summers has spoken out in response to the new stimulus plan traveling through the senate and the reconciliation process where it is sure to pass. Regardless of your political bent, when both Democratic and Republican leaning economists come out with similar concerns about a proposal it would be wise to take notice. Here is what Larry Summers has to say about the new stimulus being proposed.
“First, unemployment is falling, rather than skyrocketing as it was in 2009, and the economy is likely before too long to receive a major boost as covid-19 comes under control. Second, monetary conditions are far looser today than in 2009 given extraordinary Federal Reserve policies, the booming stock and corporate bond markets, and the weakness of the dollar. Third, there is likely to be further strengthening of demand as consumers spend down the approximately $1.5 trillion they accumulated last year as the pandemic curtailed their ability to spend and as promised further fiscal measures are undertaken.
While there are enormous uncertainties, there is a chance that macroeconomic stimulus on a scale closer to World War II levels than normal recession levels will set off inflationary pressures of a kind we have not seen in a generation, with consequences for the value of the dollar and financial stability. This will be manageable if monetary and fiscal policy can be rapidly adjusted to address the problem. But given the commitments the Fed has made, administration officials’ dismissal of even the possibility of inflation, and the difficulties in mobilizing congressional support for tax increases or spending cuts, there is the risk of inflation expectations rising sharply. Stimulus measures of the magnitude contemplated are steps into the unknown. For credibility, they need to be accompanied by clear statements that the consequences will be monitored closely and, if necessary, there will be the capacity and will to adjust policy quickly.” (Washington Post)
Furthermore, “I worry that containing an inflationary outbreak without triggering a recession may be even more difficult now than in the past.” (Bloomberg)
Creating of a Bubble that will ultimately pop?
With loose monetary and fiscal policy, the economy is being “flooded” with money. Investors want to spend this money and/or put this money to work for them in various investments. With interest rates so low, borrowing has further increased the money supply.
All this money must go somewhere and with yields holding at historic lows in safe assets like bonds and treasuries there is an increasing urgency to take steps to increase returns. To increase returns investors are looking into riskier bonds with higher yields, the stock market, and various alternative vehicles to try to boost their returns. The stock market is a key example of possible bubble mania with stock prices increasing far beyond reasonable expectations for income in many cases. As interest rates rise (see below on inflation) this will quickly pop the various bubbles in the economy as investors retreat to safer assets as their yields increase.
What does the stimulus bill mean for inflation?
There is no doubt that we will see a pickup in inflation. The stimulus bill provides further cash payments to individuals that will substantially increase demand for various goods and services. At the same time as demand is increasing, prices will rise creating inflation.
Here is a simplistic example. I went out to lunch recently at a restaurant in a ski town and looked at the menu, I was floored to see that the turkey sandwich price increased from 11 dollars to 18 dollars since my last visit a few months earlier. This is a 64% increase. Why the huge increase? Demand remained strong to eat out while at the same time the availability had decreased. Due to Covid restrictions, the restaurant was operating around 30% capacity which substantially reduced the number of patrons. These two factors led to a sudden increase in prices (inflation). This is not unique to a restaurant. Thinks of Airlines, hotels, etc… that drastically cut supply during the pandemic. As demand comes back even stronger because of the stimulus this will no doubt allow businesses to increase prices and in turn foster in inflationary pressures.
How will real estate be impacted from the stimulus?
Inflation, interest rates, and real estate go hand in hand. As treasuries begin to rise as future inflation expectations rise, mortgage rates will also rise. This rise in mortgage rates, depending on how much they rise and how quickly, could easily stop the current real estate market on a dime. Along with rising rates, the stock market will do a reset which will in turn lead to hits in consumer confidence. As the consumer is less confident about the future, they pull back on “durable” goods purchases like houses. Furthermore, houses will be relatively more expensive due to higher payments from higher interest rates further crimping demand.
Summary
We are partaking on a very risky economic experiment. The new stimulus measure is like throwing gasoline on a fire that is already burning ( a much more targeted stimulus plan would be better with less economic consequences). Covid has delayed demand, not eliminated it. As the vaccine rollout continues, this demand will no doubt increase on its own. The stimulus will further the demand side and cause various side effects including inflation.
Unfortunately, this experiment will end very badly with inflation rising faster than expected thereby forcing the federal reserve to react sooner than they had wanted to contain inflation through tightening of monetary policy. Furthermore, as Larry Summers alluded to, it will be next to impossible for the federal reserve to implement a soft landing as the markets today are anticipating something radically different. Unfortunately it looks like the “bear” will have the upper hand in the economy. This will ultimately lead to another slow down/recession and popping of many bubbles that have formed in the economy. We have seen how this party ends on multiple occasions throughout history and they all end badly, the only mysteries that remain are: when will the party end and how bad will it be.
Additional Reading/Resources
- https://www.washingtonpost.com/opinions/2021/02/04/larry-summers-biden-covid-stimulus/
- https://www.bloomberg.com/news/articles/2021-02-07/yellen-summers-spar-about-overheating-risk-in-stimulus-debate?srnd=premium
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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