Thursday, January 12, 2006

The Importance of the Chinese to American Consumers

Over the past decade, U.S. consumption has risen from 65 percent to 70 percent of the nation’s output. This is a significant and remarkable change in just a few years. Two important factors have allowed the U.S. consumer to indulge in everything from spam to caviar.

First, low long-term interest rates and demographic changes have pushed houses prices upward at an almost record pace. This has provided the American consumer with “equity” upon which he/she has borrowed to support additional spending. Second, easy credit from financial institutions has allowed individuals and families to expand spending at a pace exceeding that of income for some time. As a result, the U.S. savings rate dropped into negative territory from a slightly positive rate.

But the Chinese, Japanese and South Koreans have been the true source of this gluttony (to borrow from Dante). By restricting consumption in their own countries, or over-saving, these three counties are depositing the reserves gained from large trade surpluses with the U.S., in long-term U.S. securities. For example, China's trade deficit with the U.S. was more than $200 billion to in 2005. The danger of this is that the Chinese, Japanese or South Koreans retreat from their purchases of U.S. long term debt and instead return the bounty from trade surpluses to their population thus stimulating consumption in their own country.

In the short term, this would mean higher long term interest rates just as the housing market appears to be cooling even with steady and low mortgage rates. Lower or even negative growth in housing prices would break one of the legs underpinning strong U.S. consumption. Furthermore, increasing optimism among Asian consumers, and reduced savings, would reduce the funds available for U.S. consumption even more.


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