Saturday, November 1, 2008

"This led me to correctly predict that as the housing bust picked up steam in the U.S., the trade deficit would peak as a percent of GDP."

From Calculated Risk, an interesting chart:

"Perhaps we have seen a Virtuous Cycle as depicted in the following diagram:
Virtuous Cycle Click on graph for larger image in new window.Starting from the top ... lower interest rates have led to an increase in housing prices. And those higher housing prices have led to an ever increasing equity withdrawal by homeowners. ... it is reasonable to assume that a large percentage of this equity withdrawal has flowed to consumption, increasing both GDP and imports over the last few years. ... it appears mortgage equity withdrawal has been a meaningful contributor to the ever widening trade and current account deficits.

To finance the current account deficit, foreign Central Banks (CBs) have been investing heavily in dollar denominated securities. Some analysts have suggested that these investments have lowered interest rates by between 40 bps and 200 bps (Roubini and Setser: "Will the Bretton Woods 2 Regime Unravel Soon? The Risk of a Hard Landing in 2005-2006")

If these analysts are correct, and foreign CB intervention is lowering treasury yields, then this has also lowered mortgage interest rates ... and the cycle repeats. The result: a Virtuous Cycle with higher housing prices, more consumption and lower interest rates.

As a result of the rapidly increasing housing prices, we are now seeing significant speculation, excessive leverage and poor credit quality of new homebuyers; all the signs of an overheated market. ... What happens if the housing market cools down? "

It's very informative, and there's a counterclockwise one as well called the Vicious cycle.

It's truly informative as to the what and why, but not the who. Here's my comment:

Don the libertarian Democrat
writes:

Are there any human agents in these cycles, or is this like a mechanism? At what point do individual human decisions pass over from possible to inevitable in this schema, or do humans even matter? Or only the movement of money and other financial products?

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