by Calculated Risk on 1/24/2006 06:23:00 PM

Dr. Brad Setser excerpts from Robert Rubin's Wall Street Journal OpEd and adds some interesting commentary. Setser writes:

Thomas Palley is right: "Foreign flight" (a shock to the United States ability to borrow savings from abroad) is very different from "Consumer burnout" (a slowdown in US demand growth). In both the foreign flight and the consumer burnout scenarios, the US economy slows and the dollar falls. But in the foreign flight scenario, as Palley notes, the fall in the dollar and rise in US (market) interest rates triggers the US slowdown, while in the consumer burnout scenario, the US slump triggers dollar weakness. Foreign flight would combine dollar weakness with higher US (market) interest rates, consumer burnout combines dollar weakness with lower interest rates.

A housing market slowdown, and lower mortgage equity withdrawal, might lead to "consumer burnout". This is a potential problem right now for the US economy. But the addition of "foreign flight" might lead to a vicious cycle on the downside.

Click on diagram for larger image.

This diagram is from an earlier post. The diagram depicts a virtuous cycle that might have been occurring over the last few years. Lower interest rates leads to higher housing prices and this leads to more equity withdrawal, higher consumption and more imports. Flush with cash, foreign CBs invest in dollar denominated bonds leading to lower interest rates ... and the cycle repeats.


Unfortunately, as the second diagram depicts, this has the potential to become a vicious cycle as housing slows. As Dr. Setser concludes:

But as US rates start to fall, foreign investors lose interest in lending even more to the US. Rather than adding $1 trillion or so to their portfolio of dollar denominated bonds at 4.5%, they want to add only say $600 billion or so ... Reduced foreign demand for US dollar assets ends up pushing US interest rates up.

At least those interest rates that are set in the market. The Fed's response to consumer burnout could trigger foreign flight.

That is a bad scenario. It implies that the US economy wouldn't benefit from some of the stabilizers that normally buffer the US from really bad (economic) outcomes.

Of course, this was my top economic prediction for 2006:

I think long rates will start to rise when the Fed starts cutting the Fed Funds rate.

This will be Bernanke's "conundrum"! As the economy slows, this will reduce the trade deficit and also lower the amount of foreign dollars willing to invest in the US - the start of a possible vicious cycle.

Also, see Dr. Kash's post today: Will the Fed Overshoot?

by Calculated Risk on 1/23/2006 08:48:00 PM

From a Financial Times article: Prospect of housing downturn casts pall over US economy

The ratio between average income and the costs associated with buying a home has risen to record levels. "Strong price growth momentum has resulted in very high prices relative to incomes across the country," says Ian Morris, chief US economist at HSBC.
...
Mr Morris says a "bubble zone" has been created where house prices are overvalued by 35-40 per cent, equivalent to $6,000bn. Although this bubble could take time to deflate, Mr Morris warns that "the consequences of a punctured housing bubble could be traumatic". Even a soft landing of zero house price growth, he says, will dry up the mortgage equity withdrawal that has fuelled consumer purchasing. Consumer spending makes up two-thirds of the US economy.

So could a bursting of the housing bubble pull the US economy into recession?

Mr Morris says yes. "If this adjustment can be managed over many years, the economy can avoid recession. If the process is squeezed into a shorter time-frame instead, then recession is probable."

The article offers other views too. The data later this week might be interesting.

by Calculated Risk on 1/23/2006 05:16:00 PM

On Angry Bear, I reported the newest Bush Approval (actually disapproval) ratings.

Now Gallup reports: Many States Shift Democratic During 2005


Click on map for larger image.

Note: Gallup doesn't normally interview in Hawaii and Alaska. I added both states.

This shift is probably due to the dissatisfaction with Bush's policies. It will be interesting to see if this translates to Democrat victories later this year.

by Calculated Risk on 1/22/2006 10:24:00 PM

In Monday's WaPo: As U.S. Economy Has Thrived, So Has Debt

"The jury is out on his legacy in large part because of the debt" and the trade deficit, said Stephen S. Roach, chief economist at Morgan Stanley. "You will not be able to truly judge his accomplishments until we see how this plays out in the post-Greenspan era."

The article offers these examples:

· U.S. household debt hit a record $11.4 trillion in last year's third quarter, which ended Sept. 30, after shooting up at the fastest rate since 1985, according to Fed data.

· U.S. households spent a record 13.75 percent of their after-tax, or disposable, income on servicing their debts in the third quarter, the Fed reported.

· The trade deficit for last year is estimated to have swollen to another record high, above $700 billion, increasing America's indebtedness to foreigners.

The debt binge has definitely contributed significantly to the current recovery. The big question is what happens next?

by Calculated Risk on 1/22/2006 06:00:00 PM

The Ports of Long Beach and Los Angeles reported a seasonal decrease in import traffic for December.

Import traffic at the Port of Long Beach decreased 12.7% compared to November and was 1.2% less than December 2004. A total of 266 thousand loaded cargo containers came into the Port of Long Beach, compared to 305 thousand in November. The record is 313 thousand set in August 2005.

The Port of Los Angeles import traffic decreased 1.2% in December compared to November, but imports were up 16% from December 2004. Imports were 321 thousand containers. The record for the Port of Los Angeles was set in October with 368.5 thousand import containers.

For Long Beach, outbound traffic was down 3% to 104 thousand containers. At Los Angeles, outbound traffic was steady at 98 thousand containers.

The quantity of containers says nothing about the content value, but provides a rough guide on imports from China and the rest of Asia. Given these numbers, I expect imports from Asia to be lower in December than in November.

by Calculated Risk on 1/22/2006 01:03:00 AM

First, it is fairly clear, as pgl notes, that Iran is not currently an imminent threat to the US. But what about the economic issues with the "Iranian Oil Bourse"?

Dr. Hamilton has a nice post addressing that issue: Strange ideas about the Iranian oil bourse

I agree with Dr. Hamilton, but I'm afraid the actual economic impact (or lack of economic impact) doesn't really matter. What matters is what Bush / Cheney think. Although the Bourse is inconsequential, an attack on Iran could have significant economic implications.

In my economic predictions for 2006, I included this caveat:

So, without trying to predict natural disasters, a pandemic or human stupidity (terrorism, bombing Iran, etc.), ...

And for some reason I'm reminded of the fictional character Forrest Gump's quip: "Stupid is as stupid does." Lets hope the US is not stupid this time, otherwise $68/barrel WTI oil might look cheap, and my 2006 economic predictions wildly wrong.

by Calculated Risk on 1/20/2006 11:42:00 PM

Morgan Stanley's Chief Economist Stephen Roach writes: The Irony of Complacency

So far, so good, for an unbalanced world -- the sky has yet to fall.

... suffice it to say, were it not for another year of solid support from US consumer demand -- our latest estimates put real consumption growth at an impressive 3.5% in 2005 -- the rest of a largely externally dependent world would have been in big trouble.

What did it take for the American consumer to deliver yet again? ... With America’s internal income-generating capacity continuing to lag, US consumers once again tapped the home equity till to draw support from the Asset Economy. According to Federal Reserve estimates, equity extraction by US households topped $600 billion in 2005 -- more than enough to compensate for the shortfall of earned labor income. Comforted by this asset-based injection of purchasing power, consumers had little compunction in stretching traditional income-based constraints to the max. The personal saving rate fell deeper into negative territory that at any point since 1933, and outstanding household sector indebtedness -- as well as debt service burdens -- hit new record highs.

So much for what happened in 2005. The big question for the outlook -- and quite possibly the most important macro issue for world financial markets in 2006 -- is whether the American consumer can keep on delivering. My answer is an unequivocal “no.”

Roach is always interesting reading.

by Calculated Risk on 1/20/2006 10:44:00 AM

More on MEW, IBD reports:

As of the third quarter ... the home equity-piggy bank still looked bright and shiny.

Estimated gross equity extractions rose 10% from the previous quarter to a seasonally adjusted $990.6 billion, according to an update provided to Investor's Business Daily of a September Federal Reserve study on mortgage originations.

Extractions include money left over after a homeowner sells his home and pays off his mortgage, cash-out refinancings and home equity loans. It takes into account equity gains used for the down payment of a subsequent home purchase by excluding the buyer's estimated down payment.

Consumers had also dug more wealth out of their homes in the second quarter, with equity withdrawals rising 27% to an estimated $904.4 billion after falling for two prior quarters, said the Fed.

For the first nine months of last year, equity extraction totaled $2.6 trillion vs. $2.4 trillion for the same period of 2004 and over double withdrawals during all of 2000.

NOTE: This estimate of equity extraction is lower than my estimate of $289.5 Billion ($1.16 Trillion annual rate) for Q3. See GDP Growth: With and Without Mortgage Extraction). The difference is the FED's approach excludes buyer's estimated down payment for a subsequent home.

Goldman Sachs is concerned going forward:

... with sales and prices slipping at the end of 2005 and refinancing less attractive, economists have started to place bets on when the country's favorite piggy bank will finally start to crack. If and when that happens, consumers may have to cut back, slowing overall economic growth.

"We expect mortgage-equity withdrawals to decline and therefore not just stop supporting growth in spending and but actually act as a drag on spending," said Goldman Sachs economist Ed McKelvey.

That drag could happen mid-year, he said.

by Calculated Risk on 1/19/2006 02:51:00 PM

DataQuick reports: Decline in Bay Area home sales, prices

Home sales in the nine-county Bay Area declined on a year-over-year basis for the ninth month in a row in December as prices eased back from their November peak, a real estate information service reported.

A total of 9,347 new and resale houses and condos were sold in the region last month. That was down 3.8 percent from 9,717 for November, and down 15.5 percent from 11,068 for December last year ...

"Demand still seems to be there, but the sense of urgency seems to be a thing of the past. We don't expect the market to tumble, but we do expect price increases to level off between now and spring," said Marshall Prentice, DataQuick president.

The median price paid for a Bay Area home was $609,000 last month. That was down 2.6 percent from November's record high of $625,000, and up 14.3 percent from $533,000 for December a year ago. The annual price increase was the lowest since prices rose 13.1 percent to $474,000 in March 2004.

by Calculated Risk on 1/18/2006 05:11:00 PM

In my earlier post I plotted the weekly Mortgage Bankers Association (MBA) Market and Purchase indices since last June. It appears that the purchase activity has weakened a little over the last 6 months.


Click on graph for larger image.

The graph on the right is of the Purchase Index for the 3rd week in January for each of the last 9 years.

This clearly shows that purchase activity is still at a very high level according to the MBA.