Saturday, May 31, 2008

Housing Bubble vs. Tech Bubble Loss of Wealth in Dollar Denominated Terms

How much wealth has actually been destroyed in the current housing decline verse the 2001 tech burst? According to the Case Shiller Indices (the most accurate housing guage available) In 2006, the value of U.S. residential real estate totaled US$ 22.4 trillion. Since this recording the national pricing indices (based on 20 metropolitan areas) has decline 19.87%. This is a loss of asset valuation equal to $4.5 Trillion. To put this loss into perspective, according to the International Monetary Fund the U.S. Gross Domestic Product in 2007 was 13.8 Trillion. So is this decline in value a direct hit to the Net Worth of the United States. Absolutely. If the value of liabilities declined proportionally to asset price then the answer would be no, but they clearly do not. The United States has significantly overstated it's wealth. Sound familiar?

In 2001 the bubble was another significant overstatement of wealth. The Nasdaq Composite Index is a market capitalization weighted index of more than 5000 stocks. Comprising all Nasdaq-listed common stocks, it is the most commonly used index for tracking the Nasdaq. The Dow Jones Wilshire 5000 Total Market Index represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. No other index comes close to offering its comprehensiveness. For comparison, the NASDAQ listed securities compose 19% of the 5000 Total Market Index. The Market Capitalization of the Dow Jones Wilshire 5000 Full Cap was $16.7 Trillion as of April 30, 2008. Comparatively, the market cap at the end of Q1 in 2000 was approximately $16 trillion (only slightly smaller). However, between 2000 Q1 and Q1 2003 the index lost a stunning 43% of its valuation. In other words, $7.1 Trillion of wealth was lost. This stunning number includes the completeness of the crash. The 2001 bust was a U.S. equity based event and did not impact the real estate market (except for parts of tech specific markets, i.e. silicon valley). I assume this decline was not contagious because interest rates were so low at the time that demand for real property was accelerating.

The current collapse has a very different flavor. While the 2001 decline impacted large tech equity owners the current housing collapse impacts the average American consumer. This decline in wealth as it effects consumer spending is not particularly well known. The self propelling positive feedback cycle has not fully played itself out. There is potentially a 1/2 to $1 Trillion additional loss in the financial sector. Only $350 Billion of losses have been recognized on these balance sheets so far. What about the effect on the broader companies? Sears, Lowes, Home Depot, Microsoft, Alcoa, Catepillar, Merk, Wal-Mart, Disney, etc. The global firms do not seem to have much to fear. But remember, that the United States has the largest Gross Domestic Product in the world. A cyclical retraction of spending could take an enormous bite. U.S. Consumers are responsible for 2/3 to 3/4 of the U.S. GDP (that is approximately $9 to $12 trillion dollars of goods and services). The World's GDP was $54 Trillion in 2007. We're talking about 20%.

There is a strong offsetting effect of the US consumer pullback. Emerging market growth and the weakening U.S. dollar are the most prominent. The taste for leisure, life style, and technology is disseminating out of Western cultures into more agricultural and commodity based economies. A weak dollar makes the United State's taste for leisure, technology, and lifestyle a potentially cheap commodity. U.S. exports are booming. Ironically, emerging market demand, devalued currency, and outrageous commodity prices have created a golden age for the American farmer. Same goes for the steel industry, computer software, etc.

In another ironic twist, the Chinese peg their currency to the U.S. dollar. As the dollar declines because of mounting debt, cheap monetary policy, and a weakening economy, the Chinese are forced to keep the Yuan in step with the U.S. dollar. Allowing the Yuan to rise relative to the dollar would kill Chinese exports (the crux of their economy). The Chinese keep currencies pegged by buying dollar denominated T-bills. Their reserves (a word our culture is completely unfamiliar with) are pushed back into the U.S. financial system. As demand for T-bills is a must for the Chinese, prices are driven up and yields driven down. The United States' symbiotic relationship with the Chinese is largely responsible for the low interest rates obtained in the fixed income markets guessed it....30 year mortgages. Chinese reserves were approximately $1 Trillion last year.

No comments: