Wednesday, June 27, 2012

Some Thoughts on Overseas Investing in U.S. Real Estate

Overseas investor buying of U.S. real estate is a consequence of trade deficits that have built up huge surpluses of U.S. dollars that must be recycled into dollar-denominated assets. Perhaps we should welcome the investment as both necessary and positive.

What few media pundits seem to grasp is that when our trade deficits transfer hundreds of billions of dollars to other nations, those dollars have to end up in dollar-denominated assets like bonds, stocks or real estate. Mish of Mish's Global Economic Analysis has tirelessly explained this dynamic many times: when U.S. dollars (USD) end up in another country as a result of our gargantuan trade deficits, the dollars don't just vanish into some other currency. One way or another, they have to flow into one dollar-denominated asset or another.

Many people have missed the difference between dollars used to settle accounts and dollars held as a result of trade deficits. Many of those emotionally wedded to the belief that the U.S. dollar is doomed gleefully grabbed onto the news that China and Japan will swap currencies directly (yen and yuan) rather than intermediate the trade with U.S. dollars. This was mistakenly seen as a nail in the coffin of the USD.

If I am in Japan and I have yuan due to trade with China, and I want to exchange those yuan for yen, I only need USD for about 10 seconds to intermediate the exchange. Cutting out the USD simply cut the exchange costs and lowered the daily trading volume of the USD.

This reduction in the transactions needed to exchange yuan for yen did nothing to change the dollars held by China or Japan as a result of their trade surpluses with the U.S.

This also didn't lower the amount of assets or credit (debt) denominated in USD. In other words, the effect on the value of the dollar is trivial.

No matter how many exchanges the USD sitting in overseas accounts are pushed through, they still end up in dollar-denominated assets somewhere. If China exchanges its surplus USD to Saudi Arabia in exchange for oil, the USD didn't vanish or become yuan: the USD were simply transferred to Saudi Arabia, which can either exchange them with another nation for goods or services, or they use the USD to buy dollar-denominated assets: bonds, stocks, U.S.-based companies, land in the U.S., etc.

Every time overseas holders of dollars start using their monumental stash of USD to buy real estate in the U.S., domestic pundits freak out and declare "X is buying America!" What the xenophobic pundits fail to understand is the overseas holders of USD have to buy something with their surplus dollars, and if they're sick and tired of buying negative-yield bonds (i.e. the bond yield is lower than inflation) then they have little other choice but to buy land, buildings and businesses in the U.S.

The largest overseas owners of U.S. assets have long been the Europeans, chiefly the English. Tremendous sums have been sunk into the relative safety and dynamism of the U.S. economy, going back to the 16th and 17th centuries.

"Foreign investment in the U.S. last year totaled $234 billion, a 14% jump over $205.8 billion in 2010, with around two-thirds of the cash coming from Europe."

There is an element of implicit racism at work when the cries of "we're being taken over" swell after the Japanese or Chinese make a signature purchase of U.S. assets: beneath the surface, the message is clear: it's OK for Caucasian Europeans to buy huge swaths of American land and built capital, but not OK for Asians to own the same percentage of assets.

Let me put this bluntly: if you don't want overseas investors to buy American assets, then stop running gigantic trade deficits with them. Once you transfer hundreds of billions of dollars a year, each and every year, to overseas accounts, the owners of those USD will have to buy something denominated in dollars. And since we presumably made those trades of our own free will to our own benefit, then it's hardly cricket to get all hot and bothered when those owners of USD seek the same thing we do: assets that return a higher yield at a lower risk.

That leads many holders of USD to U.S. real estate. As I outlined yesterday in Some Thoughts on Investing in the "Bottom" in Housing, rental properties offer attractive returns in a zero-interest rate world. Why are the Chinese investing in Toledo?

I have raised hackles by suggesting that the U.S. remains a very attractive "safe haven" for overseas holders of USD. The people who are emotionally attached to the "dollar will be destroyed" ideology are often equally attached to the notion that the U.S. is an internationally unattractive place to live/invest.

Yes, I share the concerns about the erosion of civil liberties and the extreme over-reach of the State and concentrations of private capital in the U.S. These are real and worrisome trends I have covered in depth for years.

But we need to see the U.S. through overseas eyes--for example, from a Chinese perspective. Since we have many close friends in China, Japan, Korea and Thailand, and have traveled extensively "on the ground" in these nations over the past 20 years, I have multiple first-hand reports of conditions and perceptions in Asia.

The first thing that is attractive about the U.S. is the wide open spaces--just look how much of the country is sparsely inhabited. Compared to places constantly teeming with people, the U.S. is wide-open. (Recall that the U.S. is Meiguo in Mandarin: Beautiful Country.)

Just another landscape in America, ho-hum....

The northern side of Mt. Rainier (Sunrise):

Also noteworthy is the air is generally amazingly clean in the U.S. Even smog-ridden Los Angeles is relatively clean compared to Chinese urban air quality.

Then there's the rule of law, which despite constant abuse still exists in the U.S. Your assets will not be expropriated at the whim of a senior Party official.

These same conditions also make Australia, New Zealand, Canada, Chile and Europe attractive places to invest surplus currency. The difference between all these places and the U.S. is of course the size of the currency holdings needing a home: the long-standing trade deficits with China have stockpiled hundreds of billions of USD in China. That alone powers a much greater interest in U.S. real estate.

Despite its bloated Plutocracy and numerous structural problems, the U.S. is exceedingly stable compared to other nations and remarkably dynamic compared to less-dynamic safe-havens such as Japan.

Lastly, there are enclaves serving dozens of nationalities in the "98% of us are immigrants" U.S. (92 languages have been identified among students of the Los Angeles Unified School District.) Your religious faith, class origins, caste and all the other social attributes than limit your social and financial mobility in much (if not most) of the world don't matter that much in cosmopolitan parts of America. In general, people here are too busy to care about your personal history: just get the job done and don't rip-off/exploit others, and you are good to go about your business.

Those with assets in China are feeling increasingly insecure. Even if your wealth was earned legitimately, as opposed to being skimmed via corruption or officially sanctioned theft, it doesn't matter: when the blowback to corruption and inequality arises, everyone with assets will be a target.

This is why everyone with significant assets in China is seeking an overseas passport, green card and a safe haven for their wealth. This is a longstanding trend that seems to be picking up momentum: Hedging their bets: Officials, looking for an exit strategy, send family and cash overseas (the Economist).
THE phrase “naked official”, or luo guan, was coined in 2008 by a bureaucrat and blogger in Anhui province, Zhou Peng’an, to describe officials who have moved their family abroad, often taking assets with them. Once there, they are beyond the clutches of the Communist Party in case anything, such as a corruption investigation, should befall the official, who is left back at home alone (hence “naked”). Mr Zhou says the issue has created a crisis of trust within the party, as officials lecture subordinates on patriotism and incorruptibility, but send their own families abroad. 
You do not have to be corrupt to be “naked”, however. Sending your family abroad is simply a state of maximum readiness. It does not suggest huge confidence in a stable Chinese future. Many wealthy businessmen have also been preparing exit strategies. One of the most common legitimate routes involves immigrant-investor programmes in America, Canada or Hong Kong, typically requiring an investment of up to $1m. Chinese nationals have rushed to apply for these. Three-quarters of applicants for America’s programme last year were Chinese. 
In 2011 the central bank published an estimate on its website, attributed to the Chinese Academy of Social Sciences, that up to 18,000 officials had fled the country between 1995 and 2008 with stolen assets totalling 800 billion yuan ($130 billion at today’s exchange rate). The bank then claimed the figures were inaccurate, and scrubbed them from its website. 
Officials who can afford to send their families abroad are usually the most powerful, and the most aware of China’s problems. Says Mr Li of Peking University, “They know better than anyone that the China model is not sustainable and that it’s a risk to everybody.”
In essence, investing a mere $1 million in U.S. business and promising to hire Americans will yield up a highly-valued green card. From an overseas point of view, wages in the U.S. are not that burdensome: Apple store employees, and millions of other workers, earn $11.25 an hour.

We have to put all this overseas investment in perspective. There are roughly $62 trillion in net assets in the U.S., and over $20 trillion in real estate. $200 billion or even $2 trillion isn't going to buy a dominant piece of the U.S. economy.

There are positives to overseas investors buying U.S. properties. Everyone who owns real estate wants their parcel to start rising in value, and the only way that can happen is for demand to exceed supply. The "creative destruction" of capitalism only works if owners who have failed to capitalize on assets move on and turn the assets over to those with capital and a desire to rework the assets into productive uses.

The irony is that the driver of overseas buying of real estate--trade deficits--could decline as oil prices slip and imports from China decline in recession. Those complaining about overseas buying may withdraw their complaints if the drivers of overseas investment dry up and the buyers vanish, leaving the U.S. real estate market vulnerable to another cascade down in valuations.
At that point, people may wish Chinese investors were still buying in Toledo. 

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