Economy isn't so appealing outside U.S.

September 23, 2007
Union Tribune

“Helicopter” Ben Bernanke lived up to his nickname last week when he slashed the Federal Reserve's key federal funds rate, pumping cheap money into the economy in the same way that a firefighting helicopter drops water onto a forest fire.

The fire that Bernanke hopes to put out is the Great American Mortgage Crisis, which has burned brighter and hotter than many economists had previously thought possible.

The people who cheered loudest over Bernanke's move were the Wall Street financiers who helped the mortgage crisis occur in the first place, doling out cheap money supplied by Bernanke's predecessor, Alan “Goldilocks” Greenspan.

But in the world beyond Wall Street's movers and shakers and CNBC's talking heads, the reaction was a bit different.

From the Persian Gulf to Beijing to Zurich, there is increasing skittishness about the health of the U.S. economy and the wisdom of our economic policies. Bernanke's kowtowing to the powers-that-be on Wall Street did nothing to allay those fears.

It is probably no coincidence that on the day after Bernanke's decision, rumors stirred that Saudi Arabia was considering changing the peg for its currency from the dollar to the euro – which ultimately could make gas a lot more expensive for Americans.

Already this summer, foreigners have been pulling back from U.S. investments. In July, foreigners sold a net $9.4 billion in U.S. Treasury bonds, one of the largest sell-offs on record. Foreign sales of dollars have pushed the value of the U.S. currency to its lowest point ever against the euro. The Canadian dollar, which used to trade for less than 70 U.S. cents, is now equal to the U.S. dollar and will probably soon surpass it.

Of course, Americans might be tempted to say, as they often do, “Goldangit! Who cares what them durned furriners think?”

The fact is that just as it required a lot of foreign money to get us into the economic mess we're now dealing with, it may require a lot of foreign money to pull us out. And if we treat them too cavalierly – or if we make our market too unprofitable – they might take their money and run. Which could make life difficult for all of us.

For good or for ill, our economy has become so intertwined with the global economy that it will be hard to quickly correct our current economic problems without massive infusions of foreign money.

And one place we could feel the pinch is our troubled housing market.

It's a quaint but very outdated concept to think that when you sign a mortgage in San Diego, it ends up in the vault of a U.S. bank or mortgage firm.

In general, mortgages tend to end up at Wall Street investment firms like Bear Stearns or Merrill Lynch. They, in turn, repackage the mortgages into bundles of loans that they sell to the banks or investment houses as far away as Beijing, Tokyo, Riyadh or Zurich. And those investors, in turn, count on generating a steady income from the monthly mortgage payments.

It's the Globalization of Debt, which on face value might seem more benign than, say, the Globalization of Lead-Painted Toys. But it has tied the fate of our real estate market, in part at least, to the investment decisions of foreign bankers. And in recent months, they haven't liked what they've seen.

This globalization was aided by “Goldilocks” Greenspan. (He's famed for his belief that the economy should not grow too hot or too cold, but just about right – although investment adviser Peter Schiff suggests that his Goldilocks Economy is really just another fairy tale.)

Following the Asian economic crisis of 1998, Greenspan and other central bankers created a virtual sea of liquidity in the world marketplace, printing money and lowering interest rates to prevent a worldwide recession.

The bankers accomplished their mission. But that surfeit of cash also helped inflate the late 1990s' stock market bubble, which subsequently went bust. And after the stock market imploded in 2000, Greenspan pumped in even more cash to help stave off a recession and instead gave us a housing bubble.

Wall Street firms, awash with cash, helped develop increasingly risky securities for foreign investors who were also awash with cash. Those investors, especially in a new market like China, may have had no idea what “no down, no doc ARMs” were. Instead, they probably had the idea that nobody goes broke buying U.S. real estate.

As of last year, foreigners held 45 percent of U.S. Treasury bills, 33 percent of U.S. corporate bonds and 19 percent of U.S. agency notes.

But the United States has been a notoriously bad investment in recent years, largely because of the lax monetary policies of the Fed. The U.S. dollar has plummeted to the extent that – if you judged our economy by the euro rather than the dollar – it is as if we have been in a recession for the past seven years. Judged by euros, the Dow Jones industrial average is still well below the highs it hit in 2000.

Ironically, last week's interest-rate slashing by the Federal Reserve, designed to keep the economy from falling into recession, may chase away so much foreign money that our economic problems will only grow worse. If you were a foreigner, why would you invest in a country where the combination of an anemic dollar and interest rates robs your investment of its value?

If we want foreign investments to help prevent an already dire situation from turning into a catastrophe, we might need to offer a little more than a rock-bottom interest rate. Otherwise one little helicopter might not be able to do much against a spreading conflagration.