Sometimes a walloping dose of disconfirming information is good medicine. I would like to flatter myself in thinking that I will be sharing some of that sour treatment today. I leave you to judge. We are surely going to look at the interplay of China, our once precious greenback (the dollar) and housing markets. It remains beyond the scope of polite conversation to mention the role of China in US housing price support, interest rate reduction and dollar support. It is into this dark corner of our present situation that this work delves.
As you know and I have repeated -- ad nauseam -- housing prices are falling and so are US dollars. This would have happened sooner, faster and farther were it not for the large and growing demand for US housing and dollars coming from the People's Republic of China. Yes, I meant to say that. No, I am neither an advocate, nor a critic, of this reality. I desire merely to sketch how it has been working, that it has been working and that there are real risks involved.
We like to buy things from China, often from American transnational firms making things in China. China likes to buy things from us. They buy a lot less from us then we buy from them -- it is crucial to understand that "them" includes our businesses operating in China. How much more do we buy from China? In 2006 we bought $232.6 billion more from them. In 2007, through October, we have bought $213.5 billion more than we sold. This put us on track to send $275-$280billion more to China than they have to send to us across 2007. That is a lot.
How do we do that? We borrow, like all people that spend more than they earn. Who do we borrow from? Those who spend less than they earn. Who might that be? China, among others, loans to America so we can continue to buy more from them then we sell to them. This is now a huge, everyday reality. We are locked into mutual dependence. We rely on growing mountains of very inexpensive stuff and the credit to buy it. They rely on our demand and eventual repayment of loans. Much Chinese economic growth is built on America's growing appetite for imports of goods and credit.
So far, you have heard it all before. Here comes the new stuff. China has built up vast reserves, mostly of dollars. It presently has reserves -- depending on how inclusively they are measured -- in the $1.5trillions range. Now that is a lot. They are building reserves at a rapid clip, somewhere over $300 billion per year. These reserves are being lent back into the US economy to keep our demand strong for what they have to sell. We see that by looking at the rapid and massive acquisition of American assets by China. Our most recent comprehensive data is 18 months old. As of June 30, 2006 China had purchased $700 billion in US long-term assets. A huge and growing category of purchase has been the agency bond. These are bonds made of loans -- often home mortgage loans -- sold to government sponsored enterprises, or agencies, like Fannie Mae and Freddie Mac. In other words, they are US mortgages. How big is this? Don't take my lowly word for it, let's hear from HUD Secretary Jackson:
One statistic in the financial marketplace bares this out most of all: In 2002, the total Chinese investment in U.S. agency mortgage-backed securities was just over $100 million. By June 2006, this number had grown to over $107 billion -- a nearly 1,000-fold increase in less than 5 years.
-- Alfonso Jackson US HUD Secretary May 23, 2007.
Another way to see this: China is helping to create the substantial demand for American mortgages. This is not a story that has already ended and refers to the past. This is ongoing. Mainland China was a net long term Agency bond purchaser of $2.5 billion in July 2007, $2.7 billion in August 2007 and $8 billion in September 2007. To recycle vast hordes of dollars building up from booming exports and massive US investment in China, the Chinese are buying huge quantities of US mortgages. This creates demand for the US dollar and keeps the greenback from falling further and faster. It also creates demand for American home mortgages. This makes it easier and cheaper than it would otherwise be to get a mortgage loan. This offers some support to our house prices. As far as we can tell, the Chinese have continued to buy mortgages even as our housing market has been in growing trouble.
I am not arguing that this is done to help. It is done to get Americans the massive quantity of credit that they require to keep buying. It is done to sustain an export and economic growth boom that has and continues to dazzle. This is done to sustain American consumption in order to sustain Chinese production. This is a pillar of the international economy as it presently stands -- or teeters, as the case may be.
In a brave new world of globalized product and capital markets, interdependence makes for strange bedfellows. It is essential to know what is going on and to play "follow the money." It is wise to know who is propping you up -- whatever their ultimate motivation. If this arrangements breaks down, the Chinese will lose very important markets for their goods and capital. Americans will lose support for house prices, mortgages and the dollar. Vast financial loss and upheaval could result from any sudden change in this relationship -- especially in these days of weak and falling US house prices and Dollars.
Food for thought as you sit in China's investment house and ponder your future and theirs.