Popular Economics Weekly

Inflation has fallen so low that it threatens this economic recovery. Why? Producers can’t charge more for their products, therefore can’t increase profits unless they use fewer workers and greater automation to replace them. So there is no incentive to hire more workers, which would increase the demand for their products, and so increase economic growth.

The median household income declined some 10 percent from 2000, after inflation because of less need for highly skilled workers. And the unemployment rate is still above 7 percent, some 4 years after the end of the Great Recession.

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Chart: Trading Economics

That’s because with automation and the Global Information Age, things can be produced more cheaply anywhere in the world where things are cheapest to produce, which puts pressure on workers’ incomes everywhere. So we know there can’t be as much inflation with unemployment remaining so high.

In fact, it is remarkable how closely inflation has tracked historical unemployment rates in these charts that begin in 1948, the beginning of the modern consumer economy. For instance, inflation began its steep decline after 1980 when Fed Chairman Volcker pushed interest rates as high as 16 percent, causing the 1981 and 1983 recessions.

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Chart: Financial Times

So Fed Chairman Bernanke basically inherited an almost deflationary economic environment in 2006, with the Great Recession that began December 2007 and ended June 2009. That is why the Fed has been keeping interest rates so low, and why the Fed Governors aren’t yet ready to end the QE3 purchase of securities. Without QE3, we could be in deep trouble with real estate still in the doldrums.

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Chart: Calculated Risk

The good news is that July existing-home sales rose to the highest level in 4 years, or since the end of the Great Recession. The consensus is that most of these homes were put into contract before the recent rise in interest rates, and that the current rise in mortgage rates since then will slow down sales.

Total existing-home sales, which are completed transactions that include single-family homes, townhomes, condominiums and co-ops, increased 6.5 percent to a seasonally adjusted annual rate of 5.39 million in July from a downwardly revised 5.06 million in June, and are 17.2 percent above the 4.60 million-unit pace in July 2012, said the National Association of Realtors.

But with just a 5.1-month supply, inventory levels are historically low during this sales season. That means values haven’t risen enough to allow more homes with positive equity on the market that would create a sustained recovery. With such a low inventory level there is no danger of either a new housing bubble (meaning too many homes for sale), or inflationary pressures.

Harlan Green © 2013

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