No, we are not going to see double-digit interest rates in Real Estate any time soon. The economic and political environments today are far different from those of the early ‘80’s.
Two clients have posited this question to me, comparing the economic ravages resulting from the political situation of the 70’s and early ‘80’s with what arguably could happen today. Essentially their line of thought was that there are today so many affinities with back then, that a recurrence of the double-digit phenomenon is more than likely. Like in the ‘80’s, they contended, a new Chairman has taken control of the Federal Reserve System. The United States is involved once again in a military conflict that is dragging down the economy. America’s external debt is staggering. Employment, although not weak, is losing steam to outsourcing and there is today once again looming on the horizon the threat of stagflation caused by ever-increasing energy prices, further exacerbated by a possible military confrontation with Iran.
When Paul Volcker assumed the reins of the Fed in 1979, he indeed inherited an economy left pretty much in shambles largely by the policies, both domestic and foreign, of the Nixon Administration, the effects of which had reverberated heavily also throughout the Carter years. America had freshly ended the Vietnam nightmare, and had gone through a political oil embargo largely wanted by the Saudis and their Arab allies in retaliation for America’s open political, military and economic support for Israel, and for offering asylum to the deposed Shah of Iran, Mohammed Reza Pahlavi. The Cold War was the reality of the time, with Western Europe coming more and more under political pressure from the then USSR. And finally, a resurgent Ayatollah Ruhollah Khomeini (1900 – 1989) was set to transform Iran, a staunch US ally under the Shah, into an Islamic populist, theocratic and definitely anti-American republic - thus establishing the path of the Ayatollah’s policy towards the ‘Great Satan’, which ultimately pushed the United States to side with Saddam Hussein in the Iran-Iraqi conflict.
It was within this historic context, therefore, that Paul Volcker took command of the Fed and ended the stagflation that had plagued the United States by drastically limiting the growth of the money supply, abandoning the previous policy of targeting interest rates. As a direct and proximate consequence of a reduced pool of money, inflation peaked at 13.5% in 1981, before being successfully lowered to 3.2% by 1983, and has remained low ever since. The transition from Keynes-based policy to monetarist-based policy was a painful one, however, as it precipitated the significant recession the US economy experienced in the early 1980s, which included the highest unemployment levels since the Great Depression, as well as the highest interest rates ever. The unprecedented growth that the US economy subsequently has enjoyed over the next 25 years, however, has more than validated Volker's policies, which were continued by his successor at the Fed, Alan Greenspan.
By contrast, the world does not look nearly as ominous today.
With the advent of Reaganomics, the school of economics embracing the theory of supply-side took over. Supply-side economics is a school of macroeconomic thought, which emphasizes the importance of low taxation and of business incentives in encouraging economic growth, in the belief that businesses and individuals will use their improved terms of trade to create new businesses and expand old businesses, which in turn will increase productivity, employment, and general well-being. Specifically, supply-side economics emphasizes the importance of encouraging increases in supply and, thus, production of outputs, which result in lower prices in the marketplace and increased demand for products, thus spurring competition, increasing employment levels and generating the overall expansion of the economy.
The focus has somewhat changed after the end of Reaganomics and the advent of consumerism and globalization. The economic sensibility, sensitivity and reaction of consumers to the manipulation of interest rates has brought forth the consideration that Central banks have no handle on productivity and real economic growth, and that economy-wide recessions and booms reflect fluctuations in aggregate demand rather than in the economy's productive capacity. Thus, monetary policy is no longer viewed as a supply-side instrument but, rather, as a demand-side macroeconomics tool, at least so goes the rationale of the US Federal Reserve System and of the European Central Bank.
The impact of Reaganomics was magnified by one single event in the world’s political arena: the Soviet invasion of Afghanistan and the subsequent collapse of the Soviet Union. In December, 1979 Leonid Brehznev (1906 – 1982), the General Secretary of the Communist Party, had dispatched the 40th Army in support of the fledgling Marxist government of Hafizullah Amin. Although victorious at first, the 40th Army was dragged down in a 10-year all out war not only against the anti-Soviet Mujahideen but, factually, against the whole of Islam, which had declared a holy Jihad to combat the ‘atheist infidels’. The Mujahideen and their allies were openly and generously aided economically and militarily by the Reagan Administration (an event that the Pentagon has come to regret, in later years), and this fact was the single largest catalyst to America’s economic recovery as well as expansion, through appeasement with most of the Islamic world, which brought lower oil prices and that has lasted until today (with a few exceptions ... but, then, nobody is perfect).
It is impossible to talk about stagflation today. Stagflation is a term used to describe a period characteristic of high inflation combined with economic stagnation, high unemployment, and economic recession. It can hardly be said that there is economic stagnation and high inflation nowadays or, for that matter, widespread unemployment. In fact, both the United States and Canada are forecasting expanding economies for 2006 with an anticipated GDP of 2 percent and 2.5 percent respectively. Additionally, the political landscape today is totally different. In the era of globalization, gone are the times of major political confrontations and of more or less covert hostilities. The major economic powerhouses – North America, The Asian Tigers and the Euro Zone - have everything to lose and nothing to gain by antagonizing each others, as economic and financial interests are so intrinsically intertwined worldwide.
It is true, in my view, that in the forthcoming years the increase in energy costs, declines in both profitability and output of US major domestic industrial producers, such as the automobile and high-tech sectors, the increased reliance on imports manufactured by holders of US debt (Japan, China and India), the estimated shortfall of pension funds for an aging population, the uncertainty of value in stockmarkets and a progressive affordability crisis in real estate – all suggest that North America is entering a period of economic uncertainty which, however, greatly differs from the precepts of stagflation. Additionally, monetarist policies executed by Central Banks are now tried and tested, unlike the time when Paul Volcker took over, and there is no need for draconian measures to be enacted on the part of the Fed. In fact Ben Bernanke, the new Fed’s boss, has publicly made statements arguing in favor of a 2 percent inflation target over two years.
So, in conclusion, are we going to see double-digit interest rates any time soon? I strongly doubt it. We will see steady interest rates increases, somewhat limited in scope and spread out at intervals apart, so as to allow the economy to adjust.
But double-digit figures? Huh-huh ...
Luigi Frascati
Luigi Frascati is a Real Estate Agent based in Vancouver, British Columbia.
He holds a Bachelor Degree in Economics and maintains a weblog entitled the Real
Estate Chronicle at http://wwwrealestatechronicle.blogspot.com
where you can find the full collection of his articles. Luigi is associated with
the Sutton Group, the largest real estate organization in Canada, and is based
with Sutton-Centre Realty in Burnaby, BC.
Luigi is very proud to be an EzineArticles Platinum Expert Author. Your
rating at the footer of this Article is very much appreciated. Thank you.
Article Source: http://EzineArticles.com/?expert=Luigi_Frascati
