The Proud Duck
Tuesday, July 26, 2005
On NRO Financial, John Tamny explains why he doesn't think the American current-account deficit is a problem.
My response, e-mailed to him:
"Dear Mr. Tamny,
Interesting article in today's National Review Online. I think you may be overlooking one of the negative consequences of large American trade deficits -- the effect on the American housing market.
You wrote, correctly, that "all trade logically must balance," and noted that dollars flowing out of the country to buy cheap Chinese goods generally come back in the form of investment, driven by "foreigners' insatiable appetite for U.S. equities and land, along with our public and private debt."
Foreign investment in American equities is generally a good thing: It supplies American companies with money to use for capital investment, ideally making American business more productive. But foreign investment in American land -- directly, through purchases, and indirectly, through purchases of mortgage-backed securities -- is different. That's because a house, unlike a security, has characteristics both of an asset and of a consumer good. And houses are generally not fungible; people are often reluctant or unable to relocate, and have to pay what the market demands. For various reasons, renting a house is not a perfect substitute for ownership.
Those Americans who desire to own homes primarily as consumer goods -- i.e. to live in them -- are being forced to compete with investors armed with funds either directly brought from overseas, or raised thanks to extraordinarily cheap credit that foreign dollar holdings have enabled. The result is that in many markets, the costs of homeownership dramatically exceed the cost of renting equivalent housing, home affordability is near record lows, and unusually large numbers of purchasers are only able to buy using exotic mortgage interests that are only viable as long as housing prices continue to appreciate dramatically.
In other words, foreign money has tended to squeeze out the marginal home consumer-buyer by increasing the degree to which housing is an investment vehicle rather than a consumer good. In southern California, it is virtually impossible for even a relatively well-off household (like mine) to afford a home even in a marginal area without resorting to a death-or-glory negative-amortization option ARM -- because people using those risky vehicles are bidding up prices on the same houses conservative purchasers are in the market for. These risky loans are often bundled into mortgage-backed securities and sold off to those dollar-flush foreign investors you discussed, minimizing the risks to the loan originators but not to the borrowers themselves.
In short, foreign dollar holdings are forcing American homebuyers to expose themselves to significantly greater risk than buying a home used to entail -- because the housing market has been transformed largely into an investment market, with correspondingly increased risk. It's made the American Dream into the American Gamble.
On the one hand, cheap foreign manufacturing provides me with the opportunity to buy my daughter a Barbie for a few bucks less than it would have cost to make her in America. The flip side of cheap foreign manufacturing is a trade imbalance that returns dollars to America in the form of investment, which lately has flowed less into productive sectors of the economy and more into inflating the cost of an essential consumer good/asset hybrid.
Two bucks off the price of a Barbie in exchange for tripling the cost of an ordinary suburban house in seven years. Not what I'd call a fair trade."
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