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Mark Brady offers a worthwhile response [2] (see Comments) to this argument [3] made by Dan Griswold against those who lament the U.S. trade deficit. Mark says (in his comments to my earlier post [4] on Dan’s argument):
But what he [Griswold] doesn’t mention is that foreign investors buying U.S.
assets must, ceteris paribus, drive up the prices of those assets. It
would therefore be equally true to say that "If you are among the
American families looking to buy a house or an apartment, you can curse
the trade deficit and the offsetting foreign capital surplus for
driving up the price of homes."
Mark’s point is worthwhile because it’s important to look at the larger picture, as Mark does in his comment. I agree that the particular example — lower home-mortgage interest rates — isn’t ideal. Because the prices of homes might rise to offset the fall in real mortgage interest rates, the size of the benefit, if any, to American home buyers might be quite small or even nil.
But maybe not. Let’s look at an even larger picture. Even if the prices of homes rise to offset fully the lower real rate of mortgage interest, won’t the result be an initial increase in the profits of home-builders? And won’t these higher profits spur builders to build more homes than they would have built had the interest rate not fallen? If so, the full price that home buyers pay for homes will indeed be lower in the long-run even though the initial effect was to bid up the price of homes to offset the lower real rate of mortgage interest.
The previous paragraph points to a deeper truth that, I believe, is implicit in Dan’s argument: the capital stock is not fixed [5]. When savings increase, more capital is created. Some of this new capital might be in the form of new houses, but most of it surely is in the form of new or modernized factories, new office buildings, new and better IT equipment, more machinery per worker, more ships and trucks, more worker training, more R&D, new retail outlets — and on and on and on.
So as asset values rise because real rates of interest fall, more assets are created, increasing worker productivity, increasing total output, raising living standards regardless of the nationality of the persons doing the savings.