American demand for homes & world economies


A country’s currency is the first to get hit when its economy goes into a recession. A slowing US economy, therefore would affect the dollar whose value against other currencies will diminish and investors would not buy assets denominated in the depreciating currency. It will also reduce the value of the foreign exchange reserves of many developing countries and make their dollar-invoiced exports less profitable.

When demand for houses slows down, it is the first sign that consumers are putting off their purchases because they cannot afford them. The booming Japanese economy worked as a growth engine for the world until 1989, just before its housing market came crashing through the roof.

It was the beginning of a long recession that hobbled the country’s economy for more than a decade. Real estate prices in Japan fell for 15 straight years. Home prices there have never touched the high watermark of the mid-80s again.

American home owners took advantage of a low interest rate regime that prevailed until June 2004—when the Federal Reserve began raising key interest rates to rein in run away prices—to refinance their mortgages with cheap money that increased their equity and reduced monthly installments. When house prices shot up, owners borrowed against them to buy other goods and services, a transaction called leveraging.

Leveraging increases the indebtedness of customers and can take a turn for the worse when the economy slows down bringing in its wake production cuts at factories resulting in reduced hiring and job cuts. Incomes begin to fall and borrowers’ ability to repay loans gets impaired. Shortly, widespread personal financial crunch begins affecting demand for goods and services.

The International Monetary Fund’s (IMF) world Economic Outlook 2006 says: “A slowing US housing market would have important implications for the world economy given that the US economy has been a key engine of global growth in recent years. Should US growth and imports slow, trading partners particularly significant exporters of consumption goods to the US would be adversely affected. Through its likely impact on household saving and residential investment a slowing in the rate of house price appreciation in the US would contribute to a needed rebalancing of global growth and a reduction in existing current account imbalances.�

What the IMF means is that if demand for houses continues to slacken in the US, it could be an indicator that the American economy is slowing. American, which is the largest trading partner for many countries such as India and China, is a sort of pivot for the world economy. China and India export the most to the US. Its voracious consumption of goods and services ensures that hundreds of factories in developing countries continue to run at full steam. For example, US’s largest retailer Wal-Mart imports cheap Chinese goods worth over $15 billion a year. If Wal-Mart were to abruptly stop its orders, many Chinese industries would have to cut production affecting thousands of jobs and livelihoods that have come to depend on them.

The IMF says that over the past 25 years, the correlation between output growth in the US and the rest of the world has been 0.5 which effectively means that over the years global growth has increasingly got linked to the US.

Plummeting demand would then force traders to cut back on imports, which in turn, would hit other countries whose exporters depend on the US for revenues. As globalization is now fairly rooted and world economies are more integrated, recessions in key economies such as the US quickly spread to others—a pattern economists describe s the domino effect.

Low cost of production has helped many Asian economies such as India and China to emerge as the leading suppliers of products and services to developed nations, increasing the mutual dependence. Emerging Asia, contributes nearly half of the growth in global output.

A slowdown in US growth now could seriously affect the fortunes of the world economy, which the IMF estimates, will grow at about 5%, thanks to China’s blistering growth of over 10% and India’s more modest 8%. The huge surpluses in the trade accounts of a few countries and the gaping hole in the US current account need to converge to rebalance the global economic equation. That can happen only if demand for goods and services picks up elsewhere in the world to even out the slack in the US.