from Follow the Money

Is Alan Greenspan encouraging moral hazard in … China?

August 24, 2005 3:10 pm (EST)

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Listen to one Chinese fund manager in this morning's Wall Street Journal

"Mr. Zhu (who helps manage US dollar investments for the Bank of China) expresses confidence in the US dollar and the health of the US home market.  Housing is so vital to the US economy, Mr. Zhu and some of his counterparts at other Chinese banks reason, that US authorities will prevent a bust."

Sounds like Chinese fund managers believe in the Greenspan (Hubbard? Lindsey? Bernanke?) put ...

Actually, Greeenspan's successor can lower short-term rates to try to put a floor under the US housing markets, but cannot do that and also put a floor under the dollar.   The Chinese are betting that the US won't let the housing market falter -- and that China's central bank will prop up the dollar even more than it does now should US rates fall.

I certainly agree with the basic conclusion of the Wall Street Journal article.  Foreign demand for mortgage backed securities (MBS) has picked up recently, and some of that demand no doubt comes directly from central banks.  Still, foreigners hold a far smaller share of the total stock of MBS market (6%, according to the Journal, at the end of 2004) than of the Treasury market.  I wonder what share of the MBS market is held by US banks - and US hedge funds - plying the carry trade.  See Edward Chancellor's Wall Street Journal oped (another good piece on the oped page.  Add in Makin's piece from last week ... are there subtle signs of improvement and openness to a broader set of opinions?).  Hedge funds are certainly big in credit derivatives; I am not sure about their role in the MBS market.   But with a shrinking two year to ten year spread in the Treasury market, making money off the carry trade may require taking a bit more risk.

I also suspect Mr. Zhu would be on to something.  If interest rates ever were really to rise, I would not be surprised if (some) homeowners - if one can call folks with big debt and little equity homeowners - started to demand, loudly, protection from higher rates.   And i suspect politicians here in the US would take notice.  Florida likes to flip condos -- and it is a swing state.

Most cries of protection recently have come from sectors facing increased foreign competition, and therefore seeking protection from imports.  But those complaining about imports really are seeking protection from economic shocks - or just economic changes - that are adverse to their interest.  Over the past twenty-five years, as the trade deficit has expanded and imports have risen relative to US GDP, those sectors that compete with imports have been under consistent pressure.   But over the past twenty years or so, as interest rates have marched downward as part of the "great disinflation,"  interest-sensitive sectors have had a pretty nice run. 

But in a scenario where the US starts to adjust (saves more, consumes less, imports less, exports more), the relative fortune of different sectors would change.  Cries for protection might emerge from strange sources.

For a slightly different take on all this, one that emphasizes how foreign demand for US debt (a product of the global savings glut) almost forces the US to spend and invest, check out Macroblog.

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