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Thursday, October 18, 2012

US housing starts at record highs -

In my lengthy post from September 2011 (The "Inflation Storm", initially posted on, now discontinued, but re-published on this site, below) I assigned a high probability to the US housing market would turning in 2012.

The housing market has now turned. September 2012 building starts are the highest in 4 years, and house prices have increased about 2.2% in the second quarter of 2012 (up 1.2% year on year, according to the Case-Schiller index).

With the Fed recently mandated to buy $40 billion of mortgage backed obligations per year, this is likely to continue. Banks have massive un-used ability to lend and the velocity of money (how fast new funds trickle into the economy) is at an all time low (see the below chart).

Graph of Velocity of M2 Money Stock

With housing prices now poised to rise at rates that are higher than the cost of financing, funds will continue to be deployed in the housing market, driving up prices, creating expectations concerning future price increases etc. Unemployment (latest figures reported at 7.8%) will continue to decline as the construction sector picks up, and consumer credit grows again. If the US government can continue to finance (and increase) its debt burden, 2013 may be a boom year, instead of the depressing recession currently predicted by so many (Nouriel Roubini, Jim Rodgers etc). T-bonds and T-bills have yields at all-time lows, so it seems like the market (e.g. the Chinese central bank, sovereign wealth funds etc) are willing to do just that.

Many people have been predicting US hyperinflation since year 2000, the voices becoming stronger and stronger over the years. However, in spite of massive monetary increases by the Fed, inflation has failed to materialize. The divergence from the historic relationship between domestic monetary supply increases and inflation is due to the massive US' trading deficit versus the rest of the world, and the strong interest of major national governments to keep their currencies pegged to the US dollar. This factor is completely overlooked by most economic commentators.

The future welfare of US citizens is as such in the hands of Chinese policymakers. Luckily for them, both the US and China have an interest in allowing for the imbalances to continue, as correcting them would imply a painful restructuring in both economies, inevitably leading to social un-rest and regime changes. A prediction of hyperinflation in the US (which can easily materialize) thus becomes a question of game-theory more than anything else.

It is clear however, that the imbalances at some point must be corrected. The larger they become, the more painful the correction will be. The most likely trigger is inflation in countries with currencies pegged to the USD coming out of control, which is already happening; food prices are increasing all over the world, certain metal prices are near all-time highs. Rising food prices have the potential of toppling regimes everywhere; they were a significant factor in motivating the public during the Arab Spring, just as they were during the French revolution in 1789.

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