EScroogeJr (< 20)

Impending destruction of the US Economy

December 14, 2007 – Comments (4)

Morgan Housel has launched his attach against the US economy: 

http://www.fool.com/investing/general/2007/12/11/the-impending-destruction-of-the-us-economy-part-1.aspx?source=ihpdspmra0000001

His argument is very simple: If we increase rates, we lose all our housing equity, and if we lower rates, we lose our foreign investors who have been financing our spending, ergo, we're up (censored) creek without a paddle. Simple and convincing.

Every time you hear an argument that simple and that convincing, you should ask yourself what it is that you're not being told. 

The housing part of Housel's argumentcould not be more true. In fact, I have repeatedly stated my belief that the billion crying voices of homeowners, lenders, brokers and investors make it all but impossible for the Fed to raise interest rates even by 0.25%. So the rates can either stay the same or go lower. Once they go down and do their job of inflating house prices, they can't go up. Let us agree with Housel on this point.

Now, the other part: foreign investors. Housel is right to point out that the dollar has become an unattractive currency. But before we sign the dollar's obituary, let us ask ourselves what are the other currencies that Housel considers attractive.

The euro? I'm sorry to bring you bad news, but Europe is even closer to a recession than we are. Why? Because with the euro costing $1.5, you can't produce anything in Europe and sell it to America. And vice versa, there is no way to protect your domestic market from American imports (to say nothing of China).  The only way for Europe to avoid a recession is to lower its own interest rates and devalue the euro. After all, our two economies are very similar, and the same forces that compel us to devalue the dollar are equally felt by the European central bank. The same is true for the British pound, and to make matters worse, the housing bubble in England is every bit as nasty as here. 1/3 of the British population say they would like to leave the country to escape their mortgage payments. What else? The yen? It's the same old story: the moment the yen gets any higher against the dollar, Japan slips into depression that brings the yen back to its current value. Chinese yuan? This is the only currency that can and will appreciate against the dollar, but it won't happen too fast, the Chinese central bank will control the process. Anyway, the Chinese are financing us because they need to export their surplus capital, and that need will not go away, so it's not a competition of $ against yuan, but rather a competition of $ against the other currencies. Of the remaining currencies, only Latin American currencies hold any promise, but then again, once these countries get an influx of capital, they are going to develop their own housing bubbles which then will need to be maintained by lower rates and currency devaluation (this has already happened to Russia and the Ukraine, and now their central banks are printing money like there's no tomorrow). To summarize, when you look at America separately, it does seem that the dolar has to plummet, but then, once you remember that you can only fall relative to something, this leaves you wondering what is that other currency the dollar is going to plummet against becuase all the other countries are either in the same stage of the cycle or on the way there.

Plus, even if foreign capital did leave the US, how would that damage the economy? What is this capital doing here anyway? Toyota is one exception when foreign capital builds car factories in America, increasing the industrial output, but it is the exception that confirms the rule. For the most part, this capital was invested in American CDOs of all varieties and flavors. If it leaves, well, nothing will change for those few extant Americans who are still producing real things. And as for the mortgage lenders, they will cry at first, and then Bernanke will turn on his printing press and replace the lost foreign capital that buys mortgage securities with the same amount of capital, only produced domestically. And the mortgage lenders will smile and live happily ever after. Because regardless of the global situation, with printing presses working and with Bernanke's hand on the helm, capital is the one thing that America can always produce cost-effectively.