Wednesday, December 01, 2004

Real estate as trigger


Don’t forget until too late that the business of life is not business, but living.

B.C. Forbes
FX Trading

How low can it go—the dollar that is? “By as much as 50 per cent from its peak, in trade-weighted nominal terms, suggest two distinguished international economists, Maurice Obstfeld of the University of California, Berkeley and Kenneth Rogoff of Harvard.* Up to now, the fall has been just 17 per cent, on a broad trade-weighted basis (see chart). More, it seems, is on the way,” writes Martin Wolfe in yesterday’s edition of the Financial Times.

Source: Financial Times

Hmmm…so in order to bring about real change in the US deficit, by using the dollar to alter the terms of demand—through a lower price—another 33 per cent decline in the buck’s trade weighted value is needed…Yikes! That’s seems a bit extreme.

In other words, there has to be a significant shift in global demand patterns in order for the dollar as the key policy tool to work. And off the top of my head, the first thing that comes to mind, when thinking of ways US consumer demand will crater is two words--REAL ESTATE!

One of Mr. G’s emergency-Fed-Funds-rate-engineered-bubbles may be the key to driving US demand low enough to actually crank up the savings rate, thereby reducing US demand dependence on external financing of the buck—the theory goes!

“Moreover, there has been an important shift in the asset economy that took the US consumption dynamic to excess in recent years. The first wave came from the stock market, as household equity holdings surged from about 13% of total assets in 1991 to 35% at the peak in 2000. During the final stages of the equity bubble, individual stock portfolios supplanted real estate as the US household sector’s most important asset. By early 2000, residential property had fallen to less than 25% of total household sector assets, more than ten percentage points below the equity portion. It was only after the equity bubble popped that the asset economy took its most extraordinary twist. The increasingly wealth-dependent American consumer never skipped a beat. In large part, that was because the equity bubble immediately morphed into an even more powerful strain of asset appreciation -- a sustained burst of US house price appreciation that has continued to this very day. As a result, the real-estate share of total household assets rose back to 30% -- recapturing its role as the consumer’s leading asset class. According to Alan Greenspan, American households currently own some $14 trillion in real estate -- almost double their total equity holdings,” writes Morgan Stanley’s Stephen Roach.

American consumers have extracted an incredible amount of purchasing power from their homes and other real estate, according to Mr. Roach: “It wasn’t just the reduction in interest expenses, but the so-called cash-outs from rapidly appreciating housing assets enabled consumers to uncover a new and important source of incremental purchasing power. Freddie Mac puts the peak rate of equity extraction and second mortgages from residential property at $224 billion in 2003 -- almost 3% of the total value of home equity investments. Over the 2001-04, annual cash-outs appeared to average around 2% of aggregate home equity -- suggesting that households may have liquidated as much as 8% of their equity in real estate in order to fund current consumption.”

And here’s the rub. Despite the fact that global demand is in serious jeopardy—a la latest Japanese and European gloomy stats (Australian didn’t look so hot either)—US interest rates are rising. And rising rates, according to theory, should take a significant amount of air out of the last remaining bubble—real estate.

In the chart below…you can see the 30-yr bond price and the Housing Index show some degree of correlation. I think shows that real estate stocks are still juiced despite the change in the interest rate trend…

If air rushes from the real estate bubble, the forecasts of our two distinguished international economists may not look extreme for very long.

Jack Crooks


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