The Fed Is Tied up in its Own Gordian Knot
What do you do when raising interest to fight inflation makes inflation rise much faster, but not raising rates allows inflation to keep rising? We are seeing that now in housing.
The Gordian knot was a mythical knot that could not be untied, except by one person in the world. What do you do when you get tied up in one that actually happens, and the only party that can untie it is the Fed because the Fed is creating it, but the Fed doesn’t have a clue what it is creating or how to untie it and is the party that has tied its own hands in the knot?
Near the start of this year, I warned that the worst possible risk that could happen from Fed tightening is something no one was talking about at all — that Fed tightening could actually start causing higher prices. At least, I have not heard the idea from anyone, though I explained to my supporters back then how it could happen. It was not something I said was going to happen, but it was a grave risk I said I’d keep an eye out for and would alert my readers if I saw it starting to happen. Well, this summer it started to happen in just one sector of the economy, so I just reminded them of how it works and where they could see it happening now that it is fully formed.
In my latest article for paid subscribers, “The Deeper Dive: The US Housing Market Has Frozen Over,” I explained how we are now seeing this worst-of-all risk happening in the existing home market where the more the Fed has tightened, the higher the price for existing homes has gone … like a rocket because of the Fed’s tightening. That is the unique dynamic I warned could emerge because of our present environment of shortages, including especially labor shortages. In this case, we see it playing out due to shortages in the housing market that the Fed caused with its huge mortgage-rate hikes. The article explains how the Fed caused it.
I’ll leave it to that “Deeper Dive” to explain the mechanics of all of that, but housing has become an example of something that will become the Fed’s Gordian knot for its entire inflation battle if it starts to happen in other sectors of the economy. For now, it is devastating only in the housing market, which has rapidly become most frozen (and peculiarly frozen) housing market in history — frozen at astronomically high prices that even dwarf the Housing Crisis of the Great Recession (even if adjusted for general CPI inflation since then).
Prices continue to rise on existing homes, even as the Fed tightens interest rates more … in fact BECAUSE the Fed is tightening more! That “Deeper Dive” also explains why that dynamic is not happening in new homes, just existing homes; but it also explains how the pressure for house prices to rise in the new-home market is forcing contractors to extreme measures just to stay in business and keep producing enough homes to avoid the acute shortage dynamic in new homes.
We have never seen this bizarre dynamic in any Fed tightening cycles in our lifetime (maybe ever); and, so far, it seems to be happening only in housing. It is possible the ice dam that is driving up housing prices could break in a few months. If it does, the break will likely be chaotic as one commentator, Melody Wright, explains in a Wealthion video below (linked in boldface). While Wright does not see the housing inventory problem quite the same way I do (though her focus is more on new housing where the story is a bit different), her alternate view on inventory is worth considering … at least for new homes. Either way, we have a Fed created problem, which will break chaotically when it does but is driving prices higher for now, the more the Fed tightens, or driving builders of new homes to increasingly desperate measures that they cannot sustain much longer (as Wright describes).
So, something has to give. She believes it will be a catastrophic collapse. So do I. We see eye to eye on is the chaos that will come when the totally frozen housing market breaks up, which Wright says will be a “category 5” storm in real-estate. I called it “chaos.” Another report in the real-estate section below says chaos is also coming in commercial real-estate, though it is not due to the same kind of freezing over of the existing home market I described in my “Deeper Dive” or that is described in the related story about the new housing market, but it is still Fed caused. Instead, it is due to prices falling and falling like the Fed wants them to … but doing so until they bust banks.
About two-thirds of the 919 respondents surveyed by Bloomberg believe that the US office market will only rebound after a severe collapse. An even greater majority says that US commercial real estate prices won’t hit bottom until the second half of 2024 or later.
For those who do not have access to “Deeper Dives” because they do not support my work, I did somewhat explain this dynamic during the following interview on GoldSeek Radio" as well, which is accessible to everyone:
I have not heard anyone else seeing or explaining this extreme risk, even though it could be the most important turn in the Fed’s inflation battle so far if the dynamic starts to happens in other sectors of the economy. It will certainly be devastating in housing. It already is, where housing has become so out of whack as to prove the dynamic is as distressing as I said it would be at the start of the year if it got started.
Nevertheless, the end of the dynamic in housing will be worse for sellers of existing homes because it means an all-out avalanche in prices as the ONLY way out, which as I indicated in the “Deeper Dive” will be a more severe repricing than we saw in The Great Recession because of the sheer scale of the bubble. (Of course, that will be great relief eventually for wannabe buyers who are now frozen completely out of the market, except that it will be chaotic for the entire economy, including wannabe buyers as we get there.) When ice dams break, they tend to do so chaotically.
Between that “Deeper Dive” and my own GoldSeek interview above, I hope you’ll be able to get a clear understanding of this bizarre dynamic that has frozen the housing market solid but, ironically, at scorchingly hot prices. As I say in the GoldSeek interview, if it happens in other sectors of the economy, the Fed won’t have a clue as to why this inversion in the normal cause-and-effect between interest hikes and prices is happening, so it will actually tighten harder to try to drive what it will see as stubbornly rising prices back down, causing them only to flare up worse than ever. It is very unlikely the Fed heads will understand the dynamic at play, having never faced this before.
I hope you’ll leave your comments or questions below about this serious risk after you’ve listened to the GoldSeek interview linked to above or read the “Deeper Dive” that explains it in greater detail and with data. It is also worth your time to listen to the Wealthion podcast, too, to get the full picture because this could become the point where the inflation fight goes critical if it spreads. Right now we are fortunate that it is happening in one sector only, at least so far as we can see. If you see otherwise, let us know that, too.
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