It's Not a Credit Crisis, It's a Solvency Crisis

I read this story in the Financial Times a few days ago and I keep coming back to it ...

Hold tight, the central banks have no plan

This has been the year when many deeply held beliefs have been challenged. One such belief was that central banks have the toolkit to sort out any conceivable economic or financial crisis.

Last week’s co-ordinated liquidity action by five central banks taught us that this is not the case. The idea was that a co-ordinated response would reassure the markets, but it had the opposite effect. It turned out that market participants are not infinitely stupid. They know by now that this is not a liquidity crisis at its core. If it had been, it would be over by now.

It is a fully fledged solvency crisis that has arisen because two giant and interlinked bubbles burst simultaneously – one in property, one in credit – leaving banks and investors on the brink of bankruptcy, some hanging on by their fingertips. Yet there is nothing the central banks are offering at this stage to alleviate a solvency crisis.

Go read the whole thing.

And this brings me to my point. I've said in the past week that the market is wrong if it thinks the Fed is going to stop cutting interest rates because of rising inflation. The Fed may stop cutting interest rates, but I think the folks in Washington don't want to stop inflation. Inflation is the only way they can get America out of the housing crisis.

Here in Florida, homes that were selling for $500,000 a year ago are selling for under $400,000 now. If Joe and Jill Consumer take that kind of hit, they're going to scream bloody murder.

But let's say you get inflation of 8% per year. Then the price people are willing to pay for that house has artificially inflated back to $500,000 in just three years.

You don't think inflation will run at 8%? Okay, let's say 5%. Then it will take you five years to get back to the original price of the home.

You could make a case that the powers that be in Washington are trying to encourage enough inflation in the economy generally that home prices will start inflating by 5% a year. That way, homeowners who sell their houses will feel they haven't lost money, even though, thanks to inflation, they really have.

It's just a theory, but one I'm comfortable with.

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