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Economics: Houses, Trade and Tariffs
New York: March 27, 2006
By John R. Stephenson

Last week the market witnessed something it hadn't seen for quite a while — a 10.5% drop in new home sales in the United States to a nine-year low. Increasingly, investors are beginning to worry that house prices, now well in bubble territory, might come crashing back to earth, taking the global economy down with it. The rationale? For the last fifty years, the U.S. consumer has been the engine of global economic growth. But while the American consuming public accounts for seventy percent of all U.S. economic activity, increasingly, Americans are going into hock to keep on consuming.

With wages flat and the savings rate negative, the party has continued because Americans have used the inflated values of their homes as an ATM machine. With a myriad of three and four bedroom ATMs dotting the landscape dispensing cash, Americans have chosen consumption over savings and investment. So much so, that last year, between 8 and 10 percent of all disposable income came from the home ATM.

The worry in investment land is that U.S. house prices will flatten or fall sharply, which will dampen consumption, possibly resulting in a global recession. So great is the worry, that housing has replaced the trade number as the most watched barometer of the world's overall investment health.

Lately, there has been a lot to worry about. In addition to the number of new homes sold dropping, the University of Michigan produces an index which measures the intention of people to buy a home in the near future. It just hit a fifteen year low. The reason is simple. Homes are less affordable, with first time home affordability index hitting a 20 year low. With houses less affordable, buyers are reluctant to spend.

Not only is housing overly pricey, but supply from developers and other sources is set to increase. Available housing supply might also be increasing as some $2 trillion of adjustable rate mortgages are up for a reset in their mortgage rates. With interest rates crawling higher, foreclosure might be a distinct possibility in the months and years to come. With prices nearing a top, intention to buy turning negative and housing supply increasing, are housing prices sustainable?

Who knows! But the smart money is starting to worry that prices can only start moving in one direction — down. If prices fall and consumers retrench, concern is mounting that in an increasingly interconnected world, global economic growth is about to slow.

This is all occurring at a time when the United States is importing some $3 billion of foreign capital inflows every day in order to prop-up the economy and to keep the consumer spending.

But unlike the trend in globalization that we witnessed in the 19th and 20th centuries when wealthy European nations funded the development of the Americas and Asia, today it is some of the poorest countries in the world (e.g. China) who are playing a critical role in propping up the lifestyle of the world's richest country. With capital flowing not from rich to poor nation but rather from poor to rich country, this is not the time to be playing politics with your banker. Yet that is precisely what is happening.

Never before has a country been as dependent on the kindness of strangers as the U.S. treasury has become on foreign capital inflows from Asia and Europe. But politics is politics and politicians with little else to offer have decided to up the ante for the global economic system by trying to dictate to the world the terms of investment in the United States.

So far we've seen the Dubai Ports World transaction get scuttled, the Chinese offer to buy Unocal rebuffed and now senators are floating legislation which would prevent cross-border acquisitions of U.S. companies by foreign-owned entities. To make matters worse, there is even talk of imposing punitive tariffs (some 27.5 percent) on Chinese exports to the U.S. The reason for the tariffs is the perception amongst certain senators that China is a currency manipulator which artificially pegs its currency at too low a rate against the U.S. dollar. Of course, if China wanted to quickly revalue its currency upwards against the dollar, one simple solution would be for it to dump billions of dollars of U.S. treasury bonds on the market.

While economists might fret at the approach taken by American politicians, it echoes an approach taken in France and the West in general. While previous waves of globalization have created huge dislocations in the manufacturing sector, the current round of globalization threatens a key political constituent — well paid white-collar workers. Today, factory workers only account for about 15% of total employment in the West but service sector workers account for close to 75% of the total workforce or five times the share attributable to manufacturing.

Services, once considered as non-tradables, have, with the advent of the Internet, suddenly become exposed to the new global world order. With the click of a mouse, once highly paid service sector work can be completed by an overseas army of highly educated and responsive knowledge workers. The result has been the start of the globalization of knowledge work. Services such as engineering, medicine, accounting, consulting and software programming once done locally are now up for grabs.

In the West, service sector jobs are the dominant form of work, generating most of the income and wielding the greatest political clout. Is it any wonder then that politicians have taken to protectionist measures to maintain the status quo and protect the almighty vote?

With housing stumbling, the personal savings rate negative and increasing trade frictions with a major trading partner and critical financier —could a slowing U.S. economy be far behind? For many market watchers the answer is "no".

But with growth around the globe increasingly coming from different corners, a slowing U.S. economy may not be the huge problem some think it is. While the U.S. still accounts for 26 percent of world GDP, increasingly countries such as Japan, China and even Germany have made huge strides in increasing internal consumption and economic growth. As other large economies begin to turn inward and start to trade with each other, the potential for their savings to be exported to a capital hungry U.S. decreases.

While things may slow in the U.S., all may not be lost. In spite of concerns about the health of the U.S. economy, the world has begun to move beyond a U.S. centric-model. With stronger domestic consumption trends in much of the world, the other large economies in the world are less and less reliant on the export-led growth to the U.S. to fuel their economic expansion.

For our money, we still believe that the best opportunities lie in the base metals and energy complex where strong demand from all over the world, coupled with struggling supply are conspiring to drive prices and equities higher.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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