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Inflation, a healing hand?

Written by A Forex View From Afar on Thursday, April 24, 2008

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It is pretty clear what is wrong with the US Economy at this point: a falling housing market and tighter credit conditions, developed by the housing market's negative performance.

A housing market that worked -stable prices and a hand-full of buyers- would certainly heal some parts of the economy; At least it will make the stock market perform like in the good old days, and make Banks rub their hands in anticipation of the borrowers.

If we take out the main ideas from the above paragraph, we can conclude that we need:
1. stable prices - at least to stop them from free falling
2. cheap credit - cheap money and available credit are some of the most important conditions for a working housing market
3. buyers - someone has to actually buy the house

To put it simply, cheap credit means low interest rates. Cheap credit will make homes more accessible for a larger degree of persons.

There are two ways to achieve stable prices: the fist solution is to work on the supply/demand side of things. Either increasing the numbers of buyers (the Fed can achieve that by lower interest rates; our case now) or reduce the number of sellers (the Fed doesn't have a big influence over this part).
The second solution is to create a general increase in prices, which in time will affect the housing markets too - this is called inflation, and it's achieved by low interest rates; what we have now

After all the times that the Fed has been critized for letting inflation appear and affect the economy, now comes am A-ha momemt that it isn't so bad, after all;
The low interest rate creates liquidity in the markets, helping banks to consolidate their balance sheets after all of those write downs, it helps to create inflation, which in time will lead to an increase in CPI prices, followed by an increase in housing prices. In the short to medium term it will create the impression of welfare, just what is needed to make consumers spend.

The problems will come when inflation gets out control, even getting some help from lose fiscal policies, which won't be hard to find since we are in a year with elections.


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