Rossputin.com: Rational Thinking About Our World

Let's see if I can go a day without talking politics...here's some economics for you instead:

see "U.S. Current-Account Deficit Narrows to Two-Year Low" (Bloomberg News, 12/17/07)
http://www.bloomberg.com/apps/news?pid=20601109&sid=aFGRVkX98Hzw&refer=exclusive

Yesterday, the government reported that the Current Account Deficit, which is made up primarily of our balance of trade, fell to its lowest level in over two years and that "the figures so far this quarter suggest the trade balance may continue to improve. While the gap widened in October on record crude oil prices, the balance excluding oil was the smallest since 2004."

A couple important points to be made about this news:

First, although it may not always be as rapid as we'd like, markets tend to be self-correcting. In this case, a big current account deficit (along with other factors) cause the value of the dollar to weaken. As the dollar weakens, American goods and services become cheaper to foreigners (and their goods and services become more expensive to us), leading to a narrowing of the trade deficit, which in turn will lead to a stronger dollar, and so on.

Second, the trade deficit is not like the budget deficit, the latter of which represents excess government spending and therefore an increase in our debt and in the amount of tax the government will have to collect to cover their wastefulness. Instead, the trade deficit simply describes whether foreigners end up with more existing dollars or we end up with more of their currency. Whoever ends up with excess currency must then do something with it. With dollars, foreigners can buy oil or gold or invest in US financial or physical assets...or just by more of our stuff.

Quoting from the Bloomberg article:

Net exports added 1.37 percentage points to third-quarter U.S. growth, the most since 1996.

``For the first time in many years, the trade sector has been a positive contribution to the U.S. growth, as opposed to a negative contribution,'' Fed Chairman Ben S. Bernanke said in congressional testimony Nov. 8. ``I think going forward we'll see additional strength coming from foreign trade.''

The second piece of economic news is somewhat related. Again, from Bloomberg:
see "U.S. Housing Crash Deepens in 2008 After Record Drop" (Bloomberg News, 12/17/07)
http://www.bloomberg.com/apps/news?pid=20601109&sid=aFGRVkX98Hzw&refer=exclusive

Here's the beginning of that article:

For U.S. homeowners, builders, bankers and realtors, the crash of 2007 will only get worse in 2008.

Everyone from mortgage-finance company Fannie Mae to Lehman Brothers Holdings Inc. expects declines next year. Existing home sales will drop 12 percent and existing home prices will fall 4.5 percent, Washington-based Fannie Mae says. Lehman analysts estimate almost 1 million mortgage loans will default in 2008, up from about 300,000 this year.

``We're only halfway through the housing shock,'' said Ethan Harris, chief U.S. economist at New York-based Lehman, the fourth- biggest U.S. securities firm by market value. ``It's just a matter of time before the weakness spreads to the rest of the economy.''

The report notes that the credit crunch is now also effecting commercial real estate such as offices and shopping malls, so it's not only residential real estate that's having trouble.

How are these stories related?

Economists including my friend Brian Wesbury remind us that the increased GDP from higher exports will help to offset the "negative wealth effect" of declining real estate values. In other words, the weak dollar may either help us avoid a real estate-caused recession or at least allow any recession to be shorter and/or shallower than it otherwise might be.

This is not to argue that there's anything good about what's happening in real estate. Although I've predicted for several years on this blog that real estate was going to go through a protracted bear market, being right doesn't make me happy (not least because I now own a house). But despite what's going on with housing, all is not lost economically because free markets tend to be self-healing, even if the recovery process takes longer than we might wish.