by Calculated Risk on 2/21/2006 03:06:00 PM

From PIMCO: Chris Dialynas Discusses Causes and Implications of Low Interest Rates and the Yield Curve Conundrum

Here are his views on housing:

Q: If the global economy is awash in liquidity, wouldn’t that normally lead to inflation?

Dialynas: The inflation has occurred. The inflation is in the housing market. The inverse of the current account deficit has been debt creation, and debt has accumulated in the consumer side and federal component of the economy. So the inflation that we have realized in the U.S., the U.K., Australia and other current-account deficit countries, but also in some surplus countries like China with low-priced labor and undervalued exchange rates, has been huge price inflation in the real estate markets. Housing price inflation is, in essence, the externality of this global liquidity and fixed exchange rate regimes.

Housing price inflation has some very important longer-term implications. A housing bubble leads to more investment in housing, which contributes to current GDP growth. However, if that investment were in plant and equipment of equal magnitude then we would have a productive resource with which production could be utilized to repay the current account deficit. In the case of a housing bubble and construction boom, no such product is available. The economic prospects for the national economy will rise and fall with the housing market. A pop in the housing bubble may invoke a ruinous downward multiplier reduction in the U.S. economy while the debts remain. Ultimately, the houses themselves may need to be liquidated to settle debts with foreigners.

Ouch.