The US Fed’s move to launch its QE2 Lifeboat continues its policy of focusing on measures to boost liquidity. Yet as the blog has long argued, today’s problems are based on a lack of solvency not liquidity. Therefore it worries that the Fed’s efforts are likely to miss the mark, again.
The above slide, based on US government data, highlights this key issue. It shows that ‘real’ median US wages* (eg after adjusting for inflation), have hardly increased over the past 10 years. In fact, they are at almost the same level as at the end of 1979, when the data starts.
This confirms that the consumption binge of the Boom years between 2003 – 7 was based on borrowed money, rather than income growth. It also highlights that the continuing aftermath of this binge, the 35% drop in average US house prices, is a solvency problem. And it suggests that the current total of over 2 million homes in foreclosure is more likely to rise than fall.
One would have hoped that the Fed would have learnt from its previous mistakes, particularly after inflating the housing bubble with low interest rates in the early 2000s. This was done to counter the dot-com crash, but provided only temporary support for the economy.
Injecting $600bn of extra liquidity into the US economy will not change real incomes, and so it will not create new demand. Equally, by raising inflation concerns, it has already succeeded in raising long-term mortgage rates, the last thing that was required.
* Median wages give a clearer picture than average wages. These are distorted by the dramatic rise in incomes of the richest 1% of the population, from $800k to $1.8m between 1990 – 2007 in real US$, meaning that their share of total income rose from 12% to nearly 20%. Chemical demand depends on trends amongst the 99%, not the 1%.