Bubbles, bubbles everywhere. And not a stock to buy. Even emerging economy stocks are expensive, according to Nouriel Roubini, the New York University professor who is famous for calling the U.S. housing bubble and the global financial crisis. Roubini is now warning that even in the places of the world where things grow, you should be on your guard.
“In Brazil, like in many other emerging market economies,” he told Bloomberg, “there is now evidence of overheating of the economy…Expected and actual inflation is starting to rise, and that implies that over the next few quarters there has to be a tightening of monetary policy, gradually but progressively, in order to make sure that inflation expectations remain anchored.”
This is the monetary tightening we expect to pop the Chinese real estate bubble. That is our proposition, anyway. It could be wrong. Chinese GDP grew by 11.9% in the first quarter. “China is struggling to contain the threat of an overheating economy in the face of rising house prices, inflationary wage increases and a continuing surge in money supply,” reports the U.K.’s Telegraph.
The rest of the world is trying to figure out how to get rid of rotting bank collateral without destroying the banks in the process. Meanwhile, Chinese banks continue their lending boom on real estate assets. Money supply (M1) grew up by 31% from last year, according to Guo Shuqing, the chairman of China Construction Bank.
Remember, in 2009, Chinese banks lent out nearly US$1.5 trillion into the economy. The regulators in China have raised capital adequacy ratios at banks and introduced measures to try and drive speculators out of the real estate market. But it’s not like bank lending is drying up. Total loans outstanding in the Chinese economy are on pace to grow by 18% this year, with another US$1 trillion in loans to hit the books.
Yes. $1 trillion is less than $1.5 trillion. But it’s more than half a trillion, which is about the amount of yuan loans made out in 2008 – before China’s lending bubble went Nasdaq. As inflation is always and everywhere a monetary phenomenon, you don’t increase the money supply that much without unleashing inflation. And inflation is afoot in China.
Not in the stock market, though. The Shanghai Index is down 27% year-to-date. That may foreshadow the slowdown in the real economy to come. But in the meantime, Mr. Guo says that property prices have risen by 40% this year in some Chinese cities. “Property prices are definitely seeing something of a bubble,” but it differs from city to city.
Ah yes. All real estate is local. But all mortgage bubbles are national. This is true especially in markets – and we won’t name names – where most of the lending is concentrated in just a few issues. This tells you where lending risk resides in a financial system. In the U.S. subprime bubble, that risk was transferred from the loan originator to investors, via Wall Street’s securitisation machine.
Lately, the risk has migrated back on to the public balance sheet via the nationalisation of the U.S. mortgage market by Fannie Mae, Freddie Mac, and the FHA. The ultimate repository of U.S. housing risk is now the United States government. How’s that credit rating boys?
In Europe, the risk of bad loans made during the boom now calls the euro home. That is, the euro stands the most to lose from Europe’s version of a bad debt epidemic. But spare a thought for many of Europe’s banks. Overnight, the European Central Bank warned that euro-zone banks may have to write off as much as $238 billion in bad loans over the next eighteen months. In this case, for the most part, the bad collateral has nothing to do with mortgages. Instead, its deadbeat sovereign debt that will be rescheduled, marked down, or defaulted on.
But as bad as that loss figure is, and as much pressure as it would put on bank balance sheets, take a look at the chart below from International Monetary Fund’s Global Financial Stability Report published in April. It shows that global banks have nearly $5 trillion of debt maturing in the next 36 months. Can you see what this means?
The problem for the banks – and for sovereign governments – is that there borrowing needs exceed the capacity of global savers to fund. The alternatives are deleveraging for the private sector and debt monetisation for the public sector. In other words, the banks will have to reduce the amount of debt and new credit issued in the economy (which leads to lower real growth rates) and central banks will have to buy debt issued by governments who cannot fund their deficits in public bond markets.
We’ll get to the consequences of that in just one minute. But you can see the problem of borrowing short-term when interest rates are low. The maturity schedule of bank debt and public sector debt is biased toward very short terms, when rates are low. This creates big problems when you have long-term assets (like mortgages) at fixed interest rate, but you borrow short term at variable rates (which are rising).
Sure, it’s also an interesting case study in how centrally rigged interest rates – which distort the cost of capital – create huge misallocations of capital in the real economy that ruin plans and lives. But you can see what’s coming: a global contest for scarce capital.
In that fight, we’d expect smaller regional banks that are not politically connected to either fail or be swallowed up by larger ones that enjoy government backing (including loan guarantees). But the general trend is not good. It is the continued concentration of risk in a smaller number of large and complex organisations whose chief assets are someone else’s liabilities.
Now you may be thinking that in a world of fiat money, there can be no capital crisis. The central bank can print more money to buy government debt. How can there ever be scarcity when you own a printing press. Or a helicopter?
It’s a fair point. But it prompts this rejoinder: do you think the supply of gold and other precious metals will grow as fast as the supply of paper money and government debt in the coming years? Do you?
Australia’s banking sector will have to weather the storm like all the rest. But it too, borrows short term and must roll over a lot of debt. You can see now that Australian institutions are competing with other global banks and governments for savings and capital. That should push up the cost of capital for Aussie banks, even if the Reserve Bank of Australia sits pat and does nothing.
A higher cost of global capital probably wouldn’t be such a good thing for the Aussie market, we reckon. Housing finance fell last month, according to data from the Reserve Bank of Australia. And house prices have finally stopped rising on the ocean of credit, according to the RP Data Rismark Hedonic National Home Value Index.
Right then. Over the last 16 months national home prices have risen by an average of 12%. Late last week an IMF economist named Prakash Loungani said that house prices were still “well above historical values” in some places in the world, on a price-to-income basis. He included Australia in a list of those countries where prices are “misaligned” with incomes.
Naturally, his analysis was rubbished by Australian property analysts who say that property remains affordable here because interest rates are low. ANZ property analyst Paul Braddick said the price-to-income ratio is fundamentally flawed because it, “explicitly ignore a key component of the housing affordability equation – interest rates.”
Well. Hmm. It’s true that the amount of debt you can service is the key component of affordability. And the amount of debt to be serviced is a function of the interest rate. That’s true. But the total amount of debt required to get into a house is a function of prices. And relative to incomes, Australian house prices are nuts.
Besides, would you say that a drug addict is not an addict if he doesn’t have access to smack? Are Australian houses affordable because credit is accessible, for now? Determining the affordability of something based on your ability to borrow money seems a little dubious. This makes the Mona Lisa and Ferraris affordable too, provided you can find a banker to lend to you.
But obviously that’s rubbish. At an intuitive level, most people understand that affordability is not based on whether you can get the loan from the bank. It’s based on whether you can carry the loan without breaking the back of your financial plan. Obviously the banks and the real estate industry are keen to put you into debt. It’s good for their business. But it might not be good for your life…at least when prices are this high.
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