China Revaluation Impact on US Economy #1: Higher Mortgage Rates, Bye-bye Housing Boom
(7/21/2005)
China Revaluation Impact on US Economy #1: Higher Mortgage Rates, Bye-bye Housing Boom
China announced today they would increase the value of the yuan, also known as the renminbi (RMB), today from 8.3 per dollar to 8.1 per dollar, which amounts to just over 2%. From today forward they will also peg the yuan against a basket of currencies, rather than just the dollar, and allow daily fluctuations of +/- 0.3% per day.
One summary of this might be “Stand Back, They’re Revaluing!”. This 2% change is not big enough to do anything to import prices or trade. US companies can hire an engineer in China for $150 per month. The revaluation will raise the cost of that engineer by $3 per month.
The announcement is very important, however, in other ways. I will write a series of short pieces today outlining why this is important for US investors, workers, and consumers. Most of those impacts are negative.
This was a bad piece of policy making. If this were a movie, my title would be “Dumb and Dumber.” By pressuring China to revalue the yuan, we have unleashed a host of other demons. As my friend Robert Mundell showed long ago, currency policy and monetary policy are two sides of the same coin. It is not possible to act on one without impacting the other. Bob won a Nobel Prize for his work. Apparently, they don’t have a copy of it in Washington.
In this case, there will be a direct impact on the US housing market. China’s currency announcement today translates directly into higher mortgage rates for American home owners. And it accelerates the end of the great American Real Estate Boom by pushing home prices lower.
How? By forcing China to stop pegging to the dollar, we have put them out of the business of buying U.S. Treasury Bills. In May, foreign investors (chiefly The central banks of China and Japan) bought $60 billion of US securities. They are major buyers in the Treasury market.
Fewer buyers means lower prices and higher interest rates. Within minutes of today’s announcements US bond yields moved higher. The U.S. ten year bond yield increased by 12 basis points today to 4.27%; it was 4% 2 weeks ago. Mortgage rates are certain to follow.
Higher mortgage rates mean the end of rising home prices. Rate reductions were the driver for the 50% increase in US home prices and huge home building numbers over the past 2 years. Higher mortgage payments on adjustable rate mortgages–more than half of recent mortgage issues–mean less disposable income and fewer car buyers. Not good.
Essentially, today’s announcement amounts to a massive transfer of wealth, measured in home values and stock market values, from home owners to a small number of textile and other companies. I hope they have the good manners to send all of the home owners thank you notes.
I will write separately about implications for growth, stock prices, and currency markets. As you can tell, I am not a fan of today’s policy announcement.