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Today's Commentary: 03.15.06
A Mote in Godıs Eye
A Look at the Fate of Economic Nationalism on Housing and the Economy

Several weeks back, I wrote a column about the potential trouble ahead for mortgage holders in this country. The continued creativity of financing and this year's first interest rate reset will find a half a trillion dollars worth of adjustable rate and zero down mortgages suddenly becoming far more expensive that originally financed.

But that is not what brought one reader's ire. It was the statement that I believed that housing would continue to appreciate in price over the next year and at a 5% rate. When the publisher of this column sent me this person's rebuttal, I wondered how I would respond.

As I thought about this reader's comments overnight, I came to the realization that, if given just what I knew at the time, I could make a convincing argument. However, more evidence lay ahead of my response, which ended up in a lengthy email that I assume went nowhere

Nicolas Cage, in a recent and forgettable movie called "Lord of War" responded to a question his father asked him about how he wanted to be remembered. Cage played an international arms dealer, and although no one, even his wife mentioned his lucrative occupation aloud, everyone seemed to know what his business was. His quick retort: "I donıt want to be remembered. If I am, then I will be dead."

Not so with writers. We want to be remembered. We want to create something that is worth considering long after we have moved on to other subjects. In my case, I want to be the mote in God's eye.

That deity is often the administration. During the Greenspan years, the Fed chairman was the target ­ and to a lesser degree, his legacy still is. But sometimes, the supreme being I want to distract with my questions and arguments is a reader.

Globalism is on your doorstep and most folks don't even realize it. That doorstep, unbeknownst to many people is dependent on an intricate web of financing that extends well beyond our borders. While we focus on the job's aspect of this phenomenon, we overlook some of the ways the world owns us. When we do, we often sound like belligerent children.

In Japan, a ripple of change is about to take place. For those who are blissfully unaware, Japan has been the place to borrow money for the international investment set. The Bank of Japan has been literally giving money away at near zero interest rates for years now.

The idea behind this country's central bank's loose money policy is simple. The Japanese economy had ground to a halt. The $4.7 trillion economy has been subject to falling prices and deflation that stopped any economic growth. Lower interest rates, the central bankers determined, would help stimulate growth and get the economy back on its feet. It took awhile but eventually they did convince their countrymen to begin to spend rather than save.

What the Bank of Japan failed to estimate was the amount of borrowed money that moved out of the country. Japanese investors, able to borrow money for next to nothing, seized the opportunity to buy. A good deal of what they purchased was Treasury notes.

By the end of 2004, Japanese investors had purchased almost $108 billion in foreign debt and property here in the US. The real money is coming from China and the Middle East where almost $1 trillion in investments have poured into this country in 2004. More on that further on.

For those of you interested this borrowing the Japanese currency and using that money to buy other investments is called the yen carry trade. Basically, if one government is paying you to borrow money and another has debt (essentially what investments in Treasuries are) to be bought, the difference between the two is profit. And to date, the least risky ­ at least so far ­ place to put that easy money has been here in the US.

While everyone seemed to cheer the GOP's sudden call to action over the security of our ports, few recognized the economic position we have put ourselves in.

While we can champion economic nationalism, we should be careful of the knee-jerk reaction that is possible as a result of those beliefs. Our trade deficit has, once again been record setting. That can only happen if we chose to buy more overseas that we export. But to buy those goods, we need cash. Obviously, we aren't generating enough cash from the sale of our goods, so we borrow. And those nice folks overseas, flush with dollars from the sale of those goods to us, lend us the money.

It is an arrangement that makes good economic sense ­ but only if you are a Soprano.

Many economists are unsure how these moves will all play itself out, but the flap of this butterfly's wings will be felt here by 2007, not this year.

Here's one scenario: Japan raises interest rates in a measured fashion. They want to be careful not to overheat their own economy and begin to cause unnecessary inflation. Remember, they have never had to do this before so historically, coming back from near zero interest rates is new territory for them and they are unsure how their economy will react.

If Japan becomes a new source of yield for the international community, the financial consequences could be globally devastating for us. A shift in investor mentality from the growing isolationism of the US markets, especially in real estate, could push many countries to look for better investments with equal risk. Prices in Japan will rise and the stock market there will appreciate. That has the Japanese worried.

In a maturing global investing environment, real estate is the next logical choice. Once you own as much of a country's debt as you deem substantial, the natural shift to more tangible assets is next. Push that money away from US markets through more intense scrutiny and interest rates will rise here to try an attract these investors back into the marketplace. Bond prices will fall as yields increase. This will cause mortgage rates to rise.

This will cause Ben Bernanke to begin to rethink his continued tightening policy on short term overnight rates, now predicted to reach 5% or more over the next six months. His problem is twofold. He cannot let the economy begin to slide even with the lagging effect of those rate hikes still not fully absorbed into the economy. And he cannot let the consumer back away from their continued economic support because of lack of spendable cash. There is little likelihood business will step up and begin to support an economy that is looking to stagnant under higher rates.

And that "spendable" cash will need to come from housing. That is where the 5% increase in prices comes in. While pockets of the country will see significant decreases in home appreciation, the fact remains that the housing market will not be allowed to slip too far. Homes need to be purchased, folks need to refinance, and this country needs to keep spending. Not the best scenario, but the one we have been dealt by the retired Chairman of the Fed.

In 2007, unless we change our attitudes on how and why we scrutinize every foreign purchase, overseas buyers may just be forced to look elsewhere. It is important to remember that investors need to know that whatever they buy will have a buyer when they want to sell. Economic nationalism will not assure these investors that will happen. It also flies in the face of all of our free trade talk.

As with many things, you cannot have it both ways. Either we face the economic fact that our spending has brought the world's investors to our doorstep, looking for whatever we have to sell these dollar rich countries or we close our doors and push them to other, more inviting places around the globe. The choice is amazingly simple.

These overseas investors are beginning to show a surprising tolerance for risk. So are Americans, who have shown that their zeal for emerging markets is growing as well.

So yes, remember me for having said that housing will appreciate. Also keep in mind that the warnings of slowing sales and higher inventories fly in the face of savvy homebuilders and historic low interest rates ­ still.

But also recall that those 5% price increases may come with far-flung consequences that you may not like. More trade deficits, a lackluster stock and bond market, and the potential for economic fallout that will portray us as a mere banana republic, all debt and nothing but the roof over our heads to show for it.

BlueMoney Report

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