The Case-Shiller National Home Price Index registered a 13.2% year-on-year increase as of May, just below the all-time peak gain of 2005 during the worst of the last housing bubble. That didn’t end well.
The whole leadership of the US Federal Reserve System has the same mantra: “Inflation is transitory.” Vice-Chairman Richard Clarida repeated it again Tuesday. Indeed, some price pressures might be transitory.
But sustained, intractable inflation follows a fundamental shift in expectations among businesses and households. When everyone piles into inflation hedges in anticipation of worse to come, the result is a self-fulfilling prophecy.
Historically, home prices have been the refuge of American households during periods of inflation.
During the late 1960s, when the inflation pressures of the Vietnam War led to the de-coupling of the dollar from gold, and again in the late 1970s, during the postwar inflation peak, homes were the only asset class (except gold) that offered positive real returns.
As the Chart of the Day shows, shelter inflation led overall inflation.
As a matter of arithmetic, double-digit inflation in home prices translates into future increases in the Consumer Price Index with a 12- to 24-month lag (see “Who are you going to believe – the Fed, or your own eyes?“).
But that’s not the only problem. The inflation-driven reenactment of the Oklahoma Land Rush is creating a snowball effect.
Demand for houses has forced up lumber prices, which nearly doubled over the past twelve months, the biggest jump in this commodity since the government began keeping records during the 1920s.
The incremental cost of lumber adds about $37,000 to the average US new home price of $408,000. Inflation expectations push household (and a lot of institutional) portfolios into housing and that in turn increases the cost of lumber, copper, and other commodities.
Ultra-loose Federal Reserve monetary policy, moreover, weakens the US dollar exchange rate. When that happens the world adjusts its portfolios, shifting currency balances into hard commodities. A weaker dollar corresponds to higher commodity prices, and, with a roughly three-month lag, to a higher consumer price index.
Inflation doesn’t drop from the sky like Oobleck in the old Dr. Seuss story. It starts with decisions on the part of millions of households and investors.
The US government threw $5 trillion of helicopter money into an economy with sclerotic supply chains, and prices began to jump for commodities in short supply – notably used cars, up 50% during 2021 to date.
The Federal Reserve bought $4 trillion of Treasuries, saturating the banking system with excess cash, and pushed short-term interest rates to zero. The dollar fell while imports surged, further increasing prices. Now everyone expects higher prices. If you can hedge, you do. And that creates a snowball effect.
By the time the Fed gets around to “talking” about “tapering” its $120 billion a month of asset purchases, it will be much too late. So the place to be is, out of the US dollar. We continue to like the Chinese yuan, which broke through the key 6.40 barrier to the dollar overnight.