Sunday, March 18, 2007

Thank the Chinese and the Arabs for Your High House Prices

What I find interesting is that, presumably, people that are much higher ranked than me, with much higher offices and fancier cars are paid the big time bookoo bucks to know more than I do.
Which I find interesting because usually I'm explaining to them that one cannot just look at the US and expect to find the reason why we had this housing bubble form. Sure they say, "well, interest rates are at historic lows." I even remember somebody saying, "we don't have to worry about interest rates because the Federal Reserve will lower interest rates to keep the economy going" because he didn't know that the Federal Reserve only controls the Federal Funds Rate, not the 30 year conventional mortgage rate. None of them know there's an international component to the housing bubble formula. None of them know the relationship China (and to a lesser extent) Arab nations have with our housing prices.

The short of it is that China and various Arab nations have effectively muted the "crowding out effect." Meaning, traditionally if the government ran large deficits (which it has under Bush Jr.) this meant the US government would have to borrow money from the markets to finance its expenditures, leaving less money to be loaned out to the private sector. This drove up interest rates as the supply of loanable dollars shrank. Normally this would then put a dampening effect on housing prices as people would not be able to borrow as much money at such high interest rates and therefore demand for housing would go down.

However, this assumes the US operates completely on its own, innoculated from the rest of the world....which it doesn't.

China, flush with cash from selling all of its wares to us, and Middle Eastern nations flush with cash from selling all of their oil to us (at very high prices) have been taking their proceeds and buying a larger and larger share of US government debt. This means the government doesn't have to come to US citizens to borrow the money and ensures the debt markets are flush with loanable dollars keeping interest rates at historic lows despite large government deficits.

Of course, the problem is what if China and the Arab nations get their fill of US government bonds and decide to stop loaning the US trillions of dollars? This would drive up interest rates and then put further downward pressure on our already deflating housing market.
Good thing they haven't started doing that!...Or have they?


Anonymous said...

I think there's another significant factor that you haven't mentioned, which is increased productivity from China and India and the role that Wal-Mart has played in delivering lower prices to a lot of American consumers and the impact that has on the Fed's interest rate policies.

Those factors push prices down, so to keep the CPI stable the Fed lowers rates to increase the money supply. Some of the new money floats around and prevents the prices of a lot of things from falling much, while some of it ends up flowing into an idiotic speculative housing bubble.

There's a lot of random crap hitting in exactly the wrong direction at the same time. I'm betting we'll see a recession within two years.

Robert D. Brown III said...

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Anonymous said...

In reality, don't we have George "I make LBJ look like a fiscal conservative" Bush to thank here?

Anonymous said...

"presumably, people that are much higher ranked than me, with much higher offices and fancier cars are paid the big time bookoo bucks to know more than I do."

What makes you think any of these people know more than you? Is Northwest Airlines not a classic example? The only thing that the past couple of CEOs know more than your average guy is how to secure bailouts curtesy of the taxpayers of MN while leaving with huge bonuses and pensions!!