Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Thursday, August 18, 2005

China and the Housing Bubble

Given my insular existence in small-town midwestern Ontario, I have not experienced the current housing bubble first hand. I have read that housing prices in major cities (including Arlington, Virginia) have been rising rapidly, though. And I have also read that [many? some?] buyers are financing second home or first home purchases with easy-money mortgages at very low interest rates.

The question in many people's minds is, "If high housing prices are the result of low interest rates, then why are interest rates so low?"

The immediate source of supply of lendable funds that comes to mind for many is China. The trade imbalance between the U.S. and China has led to the holding of considerable U.S. debt by the Chinese central bank. This is the view of former Secretary of Labor under Clinton, Rober Reich:

Here’s where the China connection comes in. A major reason why mortgage rates have stayed low is that there’s a lot of money around. And much of that money has been coming from abroad. China and the rest of Asia have been putting their spare cash into America, in order to prop up the dollar and make it easier for them to export to us.

But that’s about t[o] change. We’ve been pressuring them to let their currency rise, and they’re getting the message. We don’t know yet how much they’ll let it rise. But the writing’s on the wall, in Chinese characters. And other Asian nations are following China’s lead.

You don’t have to be a zen master to see this means less Asian money flowing into the United States. Which in turn means long-term interest rates -- including mortgage rates -- will start to rise. It’s just supply and demand: less money around, and the cost of borrowing goes up.

As a result, the housing bubble bursts. I can’t give you an exact date. It depends how fast China and the rest of Asia unleash their currencies.

It looks to me as if the bubble will not exactly burst. Rather, it will slowly fizzle as prices stop rising so rapidly. This seems to be the view of The New Economist as well.

What puzzles me, though, is why mortgage lenders grant zero principal loans on the basis of such fragile collateral. It reminds me of the brokers in 1929 who lent far more money than was prudent for people to buy stocks on margin. I hope the two situations are not so closely analogous.
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