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Monday, December 06, 2004

Housing Price Bubble and Inflation in the US

Stephen Roach, Morgan Stanley's celebrated economist writes, December 1, 2004 could well go down in history as yet another important milestone for America’s bubble-prone economy.

According to the latest economic numbers released, house-price inflation over the past year has run at double-digit rates in 25 out of 50 states plus the District of Columbia. In six states -- Nevada, Hawaii, California, Rhode Island, Maryland, and Florida --- home prices increased by 20%, or more, over the past year. Housing is an asset class that is just as prone to excess as are stocks, bonds, currencies, or commodities. If it feels like a bubble, acts like a bubble, and looks like a bubble, it probably is one.

The concept of net national saving measures the saving left over to fund the net growth in productive capacity -- the sustenance of any economy’s long-term productivity and growth potential. On this basis, America’s net national saving rate fell to just 1.2% in the third quarter of 2004 -- down 0.9 percentage point from the already depressed second quarter reading and nearly back to the record low of 0.4% recorded in the first quarter of 2003. Lacking in domestic saving, the US must then import surplus saving from abroad in order to grow -- and to run massive current-account and trade deficits to attract that capital. In other words, a further sharp reduction in national saving is not exactly a desirable outcome for an already unbalanced US economy.

The key to this puzzle is to recognize that the housing bubble and the saving shortfall go hand in hand. The “asset economy” is a conceptual framework that brings these two seemingly disparate trends together. As seen through this lens, “rational” consumers take their income-based saving rates to zero only if asset-based saving provides an offset. As long as asset markets keep rising, that makes perfect sense. However, when asset markets correct, this decision can backfire. That was the case when the equity bubble popped in 2000 and could well be the case following the bursting of today’s rapidly expanding US housing bubble. That’s why the latest trends in house prices and saving are so disturbing. In my view, they underscore the distinct possibility that America’s asset economy is in the midst of yet another bubble-induced blow-off.

Bubbles have a way of feeding on each other -- ultimately compounding the problem and leading to an even more treacherous shakeout. That’s certainly the lesson from Japan and could well be the case in the United States. America’s housing bubble is now in the danger zone. So is its saving rate, current account deficit, and overhang of consumer indebtedness. It’s been a US-centric world for so long, that everyone takes it for granted. Yet global rebalancing poses challenges for all major countries in the world. Saving-short America will not be spared -- especially if it must now come to grips with the biggest asset bubble of them all.
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