Wednesday, November 19, 2008

Housing Starts and Consumer Prices Plunge, Deflation Looms

HousingWire reports Housing Starts Hit Rock Bottom, For Now

Same story, different month: single-family housing starts fell again in October, this time by 4.5 percent to a seasonally-adjusted rate 791,000, bringing new construction to its lowest level since just after World War II, the Commerce Department estimated Wednesday. Housing starts have now plunged 38 percent in the past year, and are down 70 percent from the peak of the market in early 2006, according to a MarketWatch report.

The Northeast led the way, posting a 31 percent drop from September to October. The Western region of the U.S., surprisingly, actually increased its housing starts by 7.5 percent in October, although starts remain 39.1 percent below year-ago levels, above the national average.

…But if there is a nugget of good news in the dismal housing data here, it’s this: housing starts need to fall, in order to allow home builders to work through vast amounts of unsold inventory. (The same logic, too, applies to completions). The worse the start data gets, the more pain it portends for the home building segment, but the closer it may move us towards righting the proverbial ship in the nation’s battered housing markets.

Bloomberg reports U.S. Economy: Consumer Prices Fall, Raising Deflation Danger

The consumer price index plunged 1 percent last month, the most since records began in 1947, the Labor Department said in Washington. Commerce Department figures showed housing starts tumbled to an annual rate of 791,000, indicating the industry’s contraction may extend into a fourth year.

Today’s CPI report signals deflation, or a prolonged price slide, may become another hazard facing Federal Reserve Chairman Ben S. Bernanke and President-elect Barack Obama. Deflation could worsen the economic downturn by making debts harder to pay off and countering the impact of Fed interest-rate cuts.

“The economy’s really just in horrific shape,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York. Fed officials will “take rates as low as they have to” to avoid “a deflation-type scenario, which now all of a sudden is very possible.”

…Excluding food and energy, so-called core prices unexpectedly fell for the first time since 1982.

“We are moving into an environment where prices are falling across the board,” David Resler, chief economist at Nomura Securities International Inc. in New York, said in an interview with Bloomberg Television. “That is going to continue. Deflation is spreading across the economy.”

For perspective on exactly what deflation brings, I highly recommend you read Abandon All Hope Once You Enter Deflation by Ambrose Evans-Pritchard

The curse of deflation is that it increases the burden of debts. Incomes fall: debts stay the same. This way lies suffocation. It was bad enough in the early 1930s when US farmers faced a Sisyphean Task trying to meet mortgage payments on their land as crop prices kept sliding. They suffered mass foreclosure and fled West, as recounted in John Steinbeck's Grapes of Wrath.

We forget, however, that overall borrowing was modest in the 1930s. The great credit bubble of the last 20 years has pushed debt levels in Britain, the US and other Western societies to unprecedented highs. UK household debt reached a record 165pc of personal income last year. This is almost 50pc higher than the burden at the onset of the recession in the early 1990s. Our sensitivity to debt deflation is therefore greater.

"It is going to be absolute murder in Britain if inflation turns negative," said Professor Peter Spencer from York University. "The big difference with past episodes is that we are now much more heavily indebted. Few people owned their own houses in 1930s. Debts were miniscule."

Deflation has other insidious traits. It causes shoppers to hold back. They wait for lower prices. Once this psychology gains a grip, it can gradually set off a self-feeding spiral that is hard to stop.