Everything seems in order as we kick off another week of reckoning. Japan’s national debt just exceeded 1 quadrillion yen for the first time as everyone celebrates the success of ‘Abenomics’. China’s economy is apparently stabilising/bottoming/rebounding as fixed asset investment growth continues unabated. And Australia heads slowly towards its first recession in over two decades as our ‘leaders’ engage in a meaningless and choreographed pre-election debate.
Yes, the absurdity continues in this mad financial world. Even Christopher Joye is writing Daily Reckoning-esque commentary. In the Weekend Financial Review, Joye lamented the role played by governments and central banks in doing everything possible to subvert the business cycle.
‘We appear willing to do almost anything to avoid a correction, which we’ve not had since 1991. Instead of the new ideas and reinvigoration that slumps stimulate, we’ve opted for doubling government debt from $250 billion in 2007 to $500 billion.
‘We are capitalists during the good times and statists when adversity arrives. Ride the man made wave for as long as it lasts. But don’t accept the popular meme that if governments pull the plug you are inevitably doomed.’
Joye is saying that just because most economies are on life support, don’t expect them to die (and darkness to descend) when the plug is pulled. We would certainly agree with that — in the long run. But we’d also point out that once governments or central banks DO pull the plug, you are going to see some pain inflicted.
We’ve written about this before. It has to do with ‘economic structure’. When policies incentivise a certain industry, either intentionally or unintentionally, the structure of the economy grows around those incentives.
In China, the central government incentivises local governments to achieve high rates of economic growth. The incentive is that they can rise up through the communist party ranks and lavish family and friends with riches.
The intended consequence of these incentives are strong economic growth, employment and rising incomes. The unintended consequences is vast overcapacity…in housing, steel making, cement, shipbuilding and probably numerous other industries. Oh, and a ginormous credit boom.
Goldman Sachs reckons China could face losses of up to US$3 trillion as the boom turns to bust. That guess is as good, or as bad, as any. What’s clear is that China has misallocated a vast amount of its surplus wealth.
Due to the magic of double entry accounting and pegged exchange rates, China’s ‘wealth’ has two sides to it. One is its vast hoard of US Treasuries and other reserve assets like euro bonds, which amount to around US$3.2 trillion. That’s the asset side of the ledger. On the liability side are commercial bank reserves. These are effectively yuan-denominated bank deposits created by the Peoples Bank of China to prevent the yuan from appreciating against the US dollar and other major currencies. The PBoC does this in order to keep the export sector competitive.
So instead of the saved wealth from China’s trade surpluses manifesting in a stronger currency (which would benefit all households by increasing their purchasing power) it has instead been ‘captured’ by the banking system and used to fund China’s property boom.
China came out with a bunch of economic data late last week which led some analysts to conclude that the economy is bottoming. We disagree. Recent stimulus measures simply gave the old growth model another nudge. Fixed asset investment (mostly property construction) continues to grow at a 20%+ rate.
It continues to grow much faster than consumption, meaning that as a share of GDP, investment is getting bigger, not smaller. It’s the same old story. China acknowledges the need to rebalance but it’s not sure how to do so without triggering a crisis.
It plays the game of trying to gently tap on the accelerator at the first sign of slowing growth, even though that’s what they need for healthy economy over the longer term. As Christopher Joye pointed out above, we’re not necessarily doomed if China pulls its support from the credit market. But it will be a painful couple of years as the economy’s structure changes.
And likewise for Australia. As a first derivative economy of the China boom, we have benefitted hugely. It has changed the structure of our economy immensely. As the booms recedes, or busts, it’s going to change it again.
What many people are betting on is that it won’t alter the structure of the property market. With official rates at record lows, the media is in unison in proclaiming a renewed property boom. (So many booms to deal with!)
Let’s ignore the fact the interest rates are at historic lows because the economy is so dependent on easy money and is extremely fragile. We’ll ignore the fact that national income will really struggle to grow in a China rebalancing environment, and that unemployment will rise as the economy’s structure changes.
The bottom line? It’s time to buy property because property is going up again. Call us foolishly stubborn, but that’s never been a smart reason to buy any asset. Not unless you’re trading it and hoping someone will come along and buy it off you for more than you paid.
Which has been a smart strategy for years now. It’s turned the ‘bigger fool theory’ on its head because the bigger fools are the bears like us who have stood on the sidelines watching the madness for years.
So in the bulls’ eyes we can’t get any dumber. But we’ll give it a shot anyway…
We think this latest emergency interest rate, media hyped, reduced supply-induced ‘boom’ is a blow-off top in a near 20 year bull market. Like all major market tops, people are anaesthetised to value and just want to get in at any price. We think that’s exactly what you’re seeing now.
There you go…
for The Markets and Money Australia
What if the property bulls are right? Economist Phillip J Anderson believes we’re at the beginning of a 14 year boom in property prices. To find out more, visit the Remembering The Future Facebook Page.
From the Archives…
Treasurer Bowen: Australian Economy in Crisis
9-08-2013 – Nick Hubble
Bonner For Fed Chairman Over Larry Summers
8-08-2013 – Bill Bonner
Interest Rate Troubles and a House Price Bubble
7-08-2013 – Nick Hubble
Australia’s Shadow Banking Sector is Collapsing
6-08-2013 – Nick Hubble
Diesel Goes to Caulfield and Callum to the Alfred
5-08-2013 – Nick Hubble