from Follow the Money

An unbalanced economy gets more unbalanced

April 26, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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I look at the latest evidence that the US housing market continues to be red hot in the same light as I look at the latest evidence that Chinese exports continue to grow at an amazing pace.

I don’t see either as good news, at least not in any but the very short-run.

Calculated Risk and Macroblog have the details on the continued boom in US home sales.

I would much happier if the US real estate market was cooling down, and other sectors were taking up the slack and supporting the economy. Sectors like durable goods (oops).

Similarly, I would be a lot happier if there were signs that domestic consumption growth was taking over from exports (and real estate) as the motor behind China’s expansion. But if Chinese data are to be believed, the combination of rising investment and a rising current account surplus implies that Chinese consumption is falling as a share of GDP. That’s what it takes for domestic savings to be rising even faster than investment, leading China’s current account surplus to grow.

In the long-run, the more resources (capital and labor) that flow into housing and other non-tradables sector, the harder it will be to move resources out of those sectors and into the tradables sector when the US eventually is forced to adjust. DeLong’s model gets this right. Shifts across sectors are not frictionless.

Current growth by and large is coming from the sectors of the US economy (and sectors of the Chinese economy) that would need to slow in an orderly rebalancing story. My worry: the more dependent the US economy becomes on housing, and the more dependent the Chinese economy becomes on exports, the higher the risk the "landing" will be hard rather than soft. Remember, we in the US eventually will have to pay back all the external debt we are taking out now to fund budget deficits, housing investment and consumption -- or, at least, we will have to limit the pace that we add to our external debt. Over time, more and more of the current account deficit will reflect interest payments on our old external debt. That implies at some point in time the US will have to export about as much as it imports, not export about 2/3s of what we import.

On the other hand, the market (or perhaps the world’s central banks, who still make up a large share of the market -- more on this later) hardly seems to be putting much pressure on the US to change its ways right now ...

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