Real Estate Chronicle

Over the past few years, there has been a strong expansion of the global economy. Indeed, the rate of expansion has exceeded the growth rate of global potential output. This strong growth has led to higher prices for many of the primary commodities that North America produces. In turn, this has meant an improvement in terms of trade and rising national incomes in both countries.

This global growth has been rooted primarily in the economic strength of the United States and, by reflection, of Canada. Specifically with regard to the U.S. economy, growth has come from strong household demand, while net national savings have been negative. By comparison, in emerging Asia household demand has been weak, while net national savings have been very high. These forces have contributed to the global current account imbalances that have now become an important macroeconomic concern.

These global imbalances are caused by the large and persistent U.S. current account deficit, which is mirrored by current account surpluses in Asia and in many oil-exporting countries. And these imbalances have grown to the point where the United States needs to attract 70 percent of the world's capital flows to finance its current account deficit - clearly an unsustainable situation.

Additionally, following events such as the Asian and Russian financial crises of the late 1990s and the bursting of the tech bubble earlier this decade, Central Banks around the world have injected a lot of liquidity into the global economy. Clearly, this liquidity has helped to encourage the strong growth in North America of recent years. But now, Central Banks are in the process of removing some of it. The interest rate increases seen to date, and the prospects for more increases to come, have been associated with the slowdown in real estate and a somewhat increased volatility in financial markets, as investors adjust their expectations about future growth. Moreover, the recent revamp of that very old Middle East conflict and the expectations of many analysts of further, substantial increases in the price of crude certainly do not help.

This withdrawal of liquidity is completely appropriate, given that the global economy is now likely not too far away from the limits of its capacity. Thus, it seems very likely that global growth will slow to a more sustainable pace. Ideally, this would take place in a relatively smooth way. But there are a number of risks surrounding this scenario, and there is a possibility that global growth will slow more sharply than desired, to the detriment of the economies in North America. The most important risk has to do with the way global imbalances are ultimately resolved.

There are a couple of concerns here. First, in order to reduce its current account deficit to sustainable levels, the U.S. economy needs to reduce its domestic demand. But as U.S. demand and American consumerism have been a key support for the global economy, it is crucial that other major players boost their domestic demand to pick up the slack. Specifically, it is important that China and the economies of emerging Asia take steps to reduce their savings by strengthening household demand. It is also important that demand in Europe and Japan continue to strengthen, to help global economic growth smoothly 'rotate' away from the United States without global demand slowing too much or too quickly.

Second, it is crucial that real estate and investment markets remain confident that policy-makers are serious about putting the right policies in place to allow for an orderly resolution of imbalances. As long as they have this confidence, markets are likely to continue to function smoothly. The alternative is an increased risk of investment and financial instability in North America, and such instability could then spill over into trade in goods and services, leading to a dramatic decline in global growth.

luigi@dccnet.com