A balanced yet booming market.

Author:Zandi, Mark M.
Position::Positive effects of the Asian financial crisis on consumer demand and the housing market of US - Cover Report: Market Research/Housing Policy - Cover Story
 
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Just a few housing markets are overpriced, even though housing prices nationally are rising at a hefty 6 percent pace. Good economic fundamentals appear to be sustaining the price gains, but a coming slowdown in demand suggests the danger of overbuilding ahead.

The nation's economy has suddenly turned Schizophrenic. After expanding by a robust 4 percent last year and more than 5 percent during this year's first quarter, the economy's growth slowed to slightly more than 1 percent in the just ended second quarter.

At the heart of the economy's schizophrenia is the Asian economic crisis. The contracting Asian economy and the soaring U.S. dollar are badly undermining the nation's trade balance. The nation's real trade deficit likely rose to more than $250 billion in the second quarter, a deterioration of $100 billion over just one year. This alone has shaved nearly 1 1/2 percentage points from real GDP growth. Collapsing trade with Pacific Asia is responsible for more than two-thirds of the total increase in the deficit. Due to Asia's ongoing travails, an even larger deficit should be expected in the trade balance in the coming year.

The weakening trade balance has damaged the nation's manufacturing and agricultural base. based on recent industrial production, factory orders, pricing and purchasing managers' reports, it is apparent that manufacturing activity is contracting for the first time in more than two years. Farm incomes are also reeling from falling Asian demand and prices.

While manufacturing and agriculture have been flattened by the impact of the Asian crisis, so far U.S. domestic demand has been lifted by the crisis. Consumer demand for everything from apparel to housing to vacations and vehicles is soaring. Real consumer spending is currently expanding at its fastest pace in a decade.

The Asian crisis is supporting consumer demand as the global flight-to quality into U.S. financial markets has prompted a dramatic decline in U.S. long-term interest rates. Long-term rates have fallen by nearly one percentage point since this time last year. That foreign buying of U.S. bonds is largely responsible for the lower rates is evident from the surge in foreign ownership of Treasury bonds. According to the U.S. Treasury, foreigners now own nearly 40 percent of the $3.4 trillion in federal debt that is privately held. That is nearly double the ownership by foreigners from as recently as 1994.

The sharp decline in interest rates has supported consumer spending in innumerable ways. Lower mortgage rates are supporting record housing activity and prompting an unprecedented mortgage refinancing boom. Strong housing demand is in turn lifting sales of household appliances and furnishings, while refinance activity is reducing household debt payments and providing more cash to households that are increasing their mortgage balance in the refinancing.

Lower bond yields are also supporting U.S. equity prices, despite weaker corporate earnings prospects. Soaring equity prices, until recently, have benefited consumers through the wealth effect. All told, the lower rates resulting from the Asian crisis have contributed approximately half a percentage point to GDP growth during the past year.

The falling import and energy prices and weaker agricultural prices that have resulted from the Asian crisis are also inducing stronger consumer demand. Import prices are down nearly 4 percent from one year ago, consumer energy prices are off close to 6 percent, and food prices are up only 2 percent. Weaker prices for these goods have performed much like a tax cut for consumers, adding approximately one-half percentage point to overall growth.

The net impact of the Asian crisis on the U.S. economy to date has thus likely been a wash. A wider trade deficit has cut growth by 1 percent over the past year, while lower interest rates, import, energy and agricultural prices have added 1 percent to growth. However, the impact of the Asian crisis will turn decidedly negative during the coming year. The trade balance will deteriorate further, while the boost from lower rates and prices will wane. Just how much the economy slows in the coming months will depend on the degree to which the lost employment and incomes in manufacturing and agriculture affect consumer demand and thus the rest of the economy.

That the Asian crisis is affecting the broader economy should be evident first in the nation's housing market. As mentioned, housing, at least so far, has been a beneficiary of the Asian crisis as mortgage rates have plunged. Housing demand is also sensitive, however, to changes in employment and income growth and, perhaps more importantly, to consumer confidence. The Asian crisis will have a more serious impact on the broad U.S. economy if it dampens currently lofty consumer and business confidence.

A soaring housing market

So far there is no indication that the housing market is experiencing any ill effect from events overseas. The housing market is soaring. New and existing home sales are on track to easily hit a record of more than 5.5 million sales this year. House prices are rising quickly as a result. National house prices are rising at a 6 percent year-over-year pace, the strongest sustained growth since the mid-1980s.

Prices are also rising strongly from coast to coast. Nearly every area covered by the National Association of Realtors (NAR) is experiencing price gains that are greater than the rate of inflation, and only a handful of areas are experiencing price declines [ILLUSTRATION FOR FIGURE 1 OMITTED]. An increasing number of areas are experiencing double-digit price gains, including much of California and significant parts of the Northeast and Midwest.

The soaring homeownership rate is also indicative of housing's strength. More...

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