One of my main memories as a child living in Brooklyn's New Utrecht area was the large number of "empty lots" in our neighborhood. In those days, with few formal parks these unused spaces became our unofficial playgrounds. The block-sized parcels were an archaeological-site-in-formation with weathered, partly-built foundations, old concrete footings, rotting construction materials and piles of excavated soil, all evidences of a building boom gone cold. Here and there were leveled areas, perhaps planned as basement floors, a few of which were taken over by the old men in the area to serve as Bocci courts. In all of the parcels were found the high mounds of excavated red-brown Brooklyn earth, which in summer was covered in a growth of rank weeds. The old foundations and footings became our imaginary battlegrounds where my young friends and I transported ourselves to some of the famous WWII engagements our citizen-soldier fathers, sometimes hesitantly, spoke of. Undreamed of to us at the time, were that these "our empty lots" were the physical remains of a great economic downturn: the pre-Depression housing boom. Most of the abandoned parcels had been planned as sites for houses and stores and remained empty lots for nearly two decades. The growth on the red-dirt mounds progressed from weeds into patches of small trees, until finally, when I was well on into high school in the early '50s, construction finally resumed on some of the parcels. Thus lingered on the effects of the housing bubble of the Great Depression.
The great housing bubble of our times-2007-2008--the one I term the "Chinese Bubble" is a still collapsing. It has caused enormous pain and disruption to the middle class and changes in our economy and our society, with ramifications beyond mere house prices. And based on past events this housing bubble, like the one of the 1930s will likely take nearly a decade to run its course.
I read today in the news that housing prices are still falling in all areas of the nation. Prices of homes reached their peak in 2005 and since then have declined continuously, loosing on-average about one-third of their value. According to John Schoen, in a piece broadcast late last month ( Feb 22, 2012) on "The Bottom Line" (MSNBC), home sales are down below the "healthy level" by one and a half million units. Prices were down again in January by 2.2 % . Though the economy is showing some tentative signs of rebound, the housing market has not shown much change.
The reasons for this are several. First, there is apparently no-end to home bank-foreclosures, which have been steadily rising since 2009 and rose again in January to 35% of the market, from 32 % the previous month. Of course, as these distressed properties are offered for sale they tend to push prices down. The reason for the slow roll out of these homes, referred to as "delayed foreclosures", is that the banks are purposefully controlling the number of foreclosures and the homes they offer for sale so as not to depress their own market and decrease profits on the backlog of homes on which borrowers have defaulted and they have on the books. Put too many houses out for sale at once and the prices fall precipitously.
While the main cause of declining prices is the excess supply of foreclosed homes, there are other reasons for the low demand. According to MSNBCs Schoen, the fall of home prices has left some 12 million owners "underwater" and many of these are young-buyers who are stuck where they are, unable to sell their home for what's they paid for it and so unable to move up to a larger home.
The MSNBC piece also points out that another factor in the decline of house prices is the significant drop in formation of new households over this period. Prior to the Great Recession in 2007, new households were being formed at a rate of about one million a year. That pace has dropped by nearly one half to only about 600,000 new households each year. The reason is falling marriage rates, unemployment rates in the 18 to 34 year old cohort, and the fact that many of these Americans choose rather to double up with friends or remain at home with their parents, and are not buying a home. Then too many of these young people are unemployed or underemployed.
Thus we see the drastic results of the housing bubble: social disruption, economic deprivation, crowding, young-lives altered irrevocably for the worse, years of potential growth lost or wasted. And when will it end? I was born in 1940 while the last housing bubble of the 1930s was still deflating. It took nearly two decades for that cycle to come full circle.
But perhaps if we can establish why this last housing bubble occurred we and our policy makers in Washington might plan to avoid or ameliorate a similar event in the future. (But don't depend on it. Most of our economists, historians, and academics were well-versed in the history of the last Great Depression and subsequent housing bubble of the 1930-1950s. They were certainly capable of warning our banks, investors and government of the threat. But the long stretch of financial expansion in the late 20th century, fueled by low interest rates occasioned by Chinese monetary policies and FED policy, blinded most of those who were too young to have lived through the Great Depression. Myself, I did finally put together the image of the abandoned building lots in my boyhood home-town with the 1930s collapsed housing-bubble and failed economy which produced them. But, I could not sway my partners and business associates. Beside ignorance, greed and an inability to believe history, there were other more powerful causes too, in the form of low interest rates which encouraged excessive and unwise spending. In 2007 my business friends ignored and ridiculed my (doomsday) warnings, being held captive by the happy but erroneous thought that the old rules of "boom-and-bust" were banished by the "new economy" of cheap loans, high profits, controlled risk, bundled mortgages and hedge funds. They were so wrong. I only wish I could have been more persuasive.
But how did it happen? There are a few culprits. But one that hardly ever gets fingered is China. We often blame China for the trade deficit...but not the Great Recession of 2007 -2008 and the housing bubble I call the "Chinese Bubble".
Today China holds some one trillion dollars worth of US Treasury Bonds. Our balance of trade with China is almost all one-sided. The annual trade deficit has grown to about $300 billion annually. The Alliance for American Manufacturing claims that we have lost nearly three million jobs over the last decade. Where did those jobs go? To China. We get their junk goods. They get the jobs.
Here is how it all began and how China was a contributor to our our housing bubble and the continuing house-price decline.
Twenty-five years ago when we opened up trade with China we believed that our industries would profit enormously by selling anything--even shoestrings or toothbrushes to China's 1.3 billion individuals. But somehow that never happened. The Chinese had little money to spend, little desire to spend any they had, a great desire to save, and a possrful appetite for hard work. They turned the tables on us. Their government geared up to export products to expand their economy. They targeted us as one of their main export markets. The Chinese got the trade, we got nothing. They just store their money in our banks.
China has a huge population, and historically it is a potentially restive one. It's Communist government, which plans its economy in detail, has an imperative: keep everyone working and leave politics to the Party apparatchiks. Their plan for maximum employment, economic well being and internal peace and tranquility is called the Chinese model of "export driven economic growth". To maintain political control, the Communist Party simply has to keep every one employed--making things, many, many things and selling these products abroad. Their government is in fact as addicted to manufacturing and exporting, as ours is addicted to huge "defense" budgets, fighting unnecessary and expensive wars abroad, and running big deficits by spending more than we receive in taxes. We are in fact a form of binational duopoly, two very different countries but one hand-in-glove economic unit which controls large parts of the world economy.
But to keep everyone employed they must sell goods and to do so they must keep the prices of their products competitive on the open market. Their products must be cheaper, and nearly as good, as the products of other manufacturing nations. To achieve that goal the Chinese control their currency, pegging it to a value low enough to satisfy their goal. Today one Chinese yuan equals about 16 cents. That low value keeps Chinese goods looking very attractive to companies like Walmart and Target who buy them cheap and resell them at much higher but still competitive prices. This is one good reason why we have such a high trade imbalance with China. We buy their products but how can they buy ours? Imagine our "dollar" being worth only 16 cents when we attempt to buy something in a foreign country. We can not sell most of our our products there because they would be too expensive. The Chinese like it that way, and presumably many of our large businesses like it too. These concerns can maximize profits to shareholders by using cheap Chinese labor and avoiding certain taxes and labor laws they would be subject to were they to manufacture their products here. Of course, American labor, and American communities dependent upon those businesses lose out big time. But our government seems not to care and continues to shower tax benefits on these off shore companies. Why? Perhaps the reason is that these concerns may not pay as much taxes or generate benefits to their local communities, but they still make hefty political donations, which count greatly.
In China a typical firm produces its product for export to the US and other nations, not for the domestic market. A recent podcast on NPR described the finances of a large flooring company --(I'll call it) Jack Woo Floors Inc.--which produces plastic flooring for export. Plastic based flooring is rot-proof, termite proof, fire resistant and easily cleaned and polished. Woo Floors sell in bulk to large US firms. The US dealers pay the Woo Flooring Company in US dollars. But Jack Woo the proprietor can not use US currency to pay his employees' salaries, buy gasoline, rice, or vegetables at the market. Woo brings his bags of US currency to the Chinese Central Bank which accepts it and gives Jack Woo Chinese yuan in return. For every dollar Jack Woo, the flooring magnate, gives the Chinese Central Bank, he gets back 6.25 yuan or RMB. With all the companies in China doing business with the USA, large amounts of American dollars accumulate in the Chinese Central Bank. It must keep the dollars in some secure form. Just hoarding dollars (or other currencies) is not safe or wise, for they may lose value through inflation. What does the Chinese Central Bank (CCB) do with all those foreign funds? The best most secure investment in the world today is US Treasury bonds or "T bills". China's CCB converts much of its foreign cash into US treasury notes. To date, that amount is estimated at some $1 trillion dollars worth of T Bills (some estimate this as higher, more like $1.2 trillion dollars.) The Chinese earn interest on that investment to the tune of about an additional 74 million dollars a year.
What affect does Chinese addiction to export and our addiction to spending at home and abroad have on us here in the USA? For one thing we can buy many cheap products, fill our homes with inexpensive furniture and knick knacks. But it also has an effect on our our central bank--the FED and our economy. Since China is so ready to buy our T bills, because right now they are the safest and best place in the world to put their excess cash, our FED simply has to hold its hand out and accept money. No need to raise interest rates and attract bond buyers. China is right there each year with money in hand. Thus the FED can keep interest rates low because they have a regular customer in China (though US retirement funds, US investment companies, etc. also purchase large numbers of bonds). The US FED has been able to keep interest rates low due to China's need for T Bills as a result of its addiction for export sales.
Low interest rates makes borrowing cheap for the US government, to fund wars without raising taxes for example, but they have their impact here in the US too. It tends to encourage indebtedness and suppresses saving. Why save when you can purchase now and pay later with slightly inflated money? Low interest rates tended to fuel the housing bubble of 2007. With the low interest rates prevalent during the run up to 2007, any Tom, Dick, or Harriet could compete for a house in the open market, not using funds that they had saved, but with funds that a big bank was going to lend them. Thus not only were committed savers, the truly well-off or affluent competing for a property up for sale, but there were hosts of other people (it now turns out many were unqualified purchasers) who were using, not their own money, but a banks promise to lend them money at a low interest rate, competing for the same house. The result was that the prices of homes skyrocketed. That's how a bubble starts and is sustained. The low interest rates encouraged by business interests and business friendly Presidents as well as the steady annual purchases from China kept our interest rates low and tended to fuel the housing bubble. The house-related economy, the construction industry, Jack Woo's flooring, cheap Chinese furniture, and imported building materials all aided and abetted the process, and by 2005-2007 prices of properties were sky high and the peoples' debt burden was massive. That's when the end came.
Thus China's huge population and its need to keep its factories purring, its strategy of keeping the yuan cheap relative to other currencies, and its need to park its huge profits in safe US banks have kept US interest rates artificially low and contributed to the recent housing bubble here--the Chinese Bubble--and encouraged the rise of empty lots where houses might have been built.
Get the picture?
rjk
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