By David Whitehead
Publisher, Business Insider Magazine
Note: This column was originally slated to run in the "Selling the South Bay" issue, which was published third quarter 2006. It was cut do to space considerations. Due the rapid decline of the dollar on the world maket in the weeks proceeding this posting, this column turned out to be more timely than I originally thought.
Most realtors are first and foremost sales professionals. And every successful professional knows that in order to close the deals, you need to keep your eye on the ball in front of you. The problem is that ball may be landing in the South Bay, but the batter that hit it deep into left field is across the sea in China. What does this mean for you as a local real estate professional? If you really understand what creates value in the home you are selling today, you might conclude foreign investment matters more in determining the price of a South Bay home than an ocean view on The Strand. At least it does if you take the long view.
During the long real estate boom that started in the mid ‘90s, China was simultaneously evolving into a global manufacturing powerhouse. To accomplish this, it first needed cash to feed its voracious economic engine, and, second, it also required an endless supply of affluent customers to buy its products. Not surprisingly, the United States turned out to be China’s best customers. To expedite this process, the Chinese deliberately pegged the Yuan at a very low exchange rate against the U.S. Dollar, making them hands down the most competitive outsourcers in the world.
Global corporations took full advantage of cheap offshore production resources to boost their profits. Meanwhile, American consumers—even those who lost their manufacturing jobs to China—weren’t shy about buying up the cheap goods that flooded the U.S. domestic market.
What did China gain? Foreign investment and cash for one thing; however, not nearly enough to fuel its rapid growth. In order to keep those appreciative American consumers consuming, China started investing heavily in U.S. Treasury bills, thereby giving then-Federal Reserve Chairman Alan Greenspan a powerful tool to keep both long- and short-term interest rates at record lows for years. This allowed him to expand the money supply much further than he could have otherwise without risking serious inflation.
To put the new economic scenario into perspective, during the late ‘80s when Greenspan didn’t have huge reserves of foreign cash to boost the domestic economy, some people blamed his policies for forcing President George Bush Senior to break his “read my lips” pledge on no new taxes, which in the wake of the early ‘90s recession, fated him as a one-term president.
Bill Clinton and George W. Bush haven’t had that problem. Throughout this boom period, China has invested heavily in U.S. Treasury bills. They are literally lending American consumers the very money they are using to buy Chinese products, although this is being done indirectly through the Federal Reserve.
China is not the first country to invest in U.S. Treasury Bills to keep its export market going. Japan did this during its manufacturing boon years. Japan is still the largest single holder of these securities, with $682 billion as of October 2005. China is the second-largest holder with $248 billion. China is catching up fast and the pace of that growth created an unprecedented economic dichotomy between what nation states produce and what they buy. The trade deficit with China alone represents over $202 billion of the astronomical $723.6 billion U.S. trade deficit reported in 2005.
Clearly, a global economy based on the same money flowing back and forth during an economic expansion wasn’t much different than paying past bills with new credit cards, so it eventually proved unsustainable. There hasn’t been a hard landing yet, however, China has halted its policy of pegging the Yuan against U.S. Dollar and now hedges it against a basket of foreign currencies, albeit still too low for the taste of Americans concerned about the across-the-board dismantling of domestic manufacturing. This in turn weakened the U.S. Dollar on the global market. With oil prices above $70-per-barrel and climbing, serious consumer inflation is now a real risk.
Chinese investment in the U.S. economy has artificially suppressed long-term interest rates at the Federal Reserve for several years. If it pulls back investing at current levels (which frankly would be in its long-term economic interests because it needs more diversity in its export policy), current Fed Chair Ben Bernarke will have to take more drastic action to stave off inflation than the 17 consecutive quarter -percent interest rate hikes we have seen until just recently.
Publisher, Business Insider Magazine
Note: This column was originally slated to run in the "Selling the South Bay" issue, which was published third quarter 2006. It was cut do to space considerations. Due the rapid decline of the dollar on the world maket in the weeks proceeding this posting, this column turned out to be more timely than I originally thought.
Most realtors are first and foremost sales professionals. And every successful professional knows that in order to close the deals, you need to keep your eye on the ball in front of you. The problem is that ball may be landing in the South Bay, but the batter that hit it deep into left field is across the sea in China. What does this mean for you as a local real estate professional? If you really understand what creates value in the home you are selling today, you might conclude foreign investment matters more in determining the price of a South Bay home than an ocean view on The Strand. At least it does if you take the long view.
During the long real estate boom that started in the mid ‘90s, China was simultaneously evolving into a global manufacturing powerhouse. To accomplish this, it first needed cash to feed its voracious economic engine, and, second, it also required an endless supply of affluent customers to buy its products. Not surprisingly, the United States turned out to be China’s best customers. To expedite this process, the Chinese deliberately pegged the Yuan at a very low exchange rate against the U.S. Dollar, making them hands down the most competitive outsourcers in the world.
Global corporations took full advantage of cheap offshore production resources to boost their profits. Meanwhile, American consumers—even those who lost their manufacturing jobs to China—weren’t shy about buying up the cheap goods that flooded the U.S. domestic market.
What did China gain? Foreign investment and cash for one thing; however, not nearly enough to fuel its rapid growth. In order to keep those appreciative American consumers consuming, China started investing heavily in U.S. Treasury bills, thereby giving then-Federal Reserve Chairman Alan Greenspan a powerful tool to keep both long- and short-term interest rates at record lows for years. This allowed him to expand the money supply much further than he could have otherwise without risking serious inflation.
To put the new economic scenario into perspective, during the late ‘80s when Greenspan didn’t have huge reserves of foreign cash to boost the domestic economy, some people blamed his policies for forcing President George Bush Senior to break his “read my lips” pledge on no new taxes, which in the wake of the early ‘90s recession, fated him as a one-term president.
Bill Clinton and George W. Bush haven’t had that problem. Throughout this boom period, China has invested heavily in U.S. Treasury bills. They are literally lending American consumers the very money they are using to buy Chinese products, although this is being done indirectly through the Federal Reserve.
China is not the first country to invest in U.S. Treasury Bills to keep its export market going. Japan did this during its manufacturing boon years. Japan is still the largest single holder of these securities, with $682 billion as of October 2005. China is the second-largest holder with $248 billion. China is catching up fast and the pace of that growth created an unprecedented economic dichotomy between what nation states produce and what they buy. The trade deficit with China alone represents over $202 billion of the astronomical $723.6 billion U.S. trade deficit reported in 2005.
Clearly, a global economy based on the same money flowing back and forth during an economic expansion wasn’t much different than paying past bills with new credit cards, so it eventually proved unsustainable. There hasn’t been a hard landing yet, however, China has halted its policy of pegging the Yuan against U.S. Dollar and now hedges it against a basket of foreign currencies, albeit still too low for the taste of Americans concerned about the across-the-board dismantling of domestic manufacturing. This in turn weakened the U.S. Dollar on the global market. With oil prices above $70-per-barrel and climbing, serious consumer inflation is now a real risk.
Chinese investment in the U.S. economy has artificially suppressed long-term interest rates at the Federal Reserve for several years. If it pulls back investing at current levels (which frankly would be in its long-term economic interests because it needs more diversity in its export policy), current Fed Chair Ben Bernarke will have to take more drastic action to stave off inflation than the 17 consecutive quarter -percent interest rate hikes we have seen until just recently.
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