Thursday, 29 November 2012

The Crisis Is Reaching A Turning Point

A couple of years ago I wrote about the bifurcations in the global economy, some of which are also mirrored within national economies.  Those bifurcations have not only continued, but have intensified.  On the one hand, China and other dynamic economies continue to grow at amazingly rapid rates.  China, despite attempts by the government to slow it down, and the effects of a global cyclical downturn, continues to grow at around 8%.  These economies have also built up huge reserves of cash, which they have lent out to economies in Europe, and North America, that have not been growing so rapidly.  Within national economies, large companies have also built up huge cash piles, and are able to utilise historically low interest rates to borrow even more, should they choose.  At the same time, hugely indebted smaller companies and individuals in these old economies now find it impossible to borrow, and in any case are trying to reduce their borrowing.

On the one hand, we have some extremely dynamic and profitable companies - much of the growth in the US, and in US employment has been in high value added production - and on the other we have a large number of "zombie" companies.  According to the FT recently, around 10% of firms in Britain are zombie companies.  That is they are companies that are essentially bust.  They are unable to generate sufficient income to repay the capital on their loans, and only manage to pay the interest, because of the low level of interest rates, and forebearance by the banks, afraid they might not get their money back at all!  If interest rates rise only slightly, or if things get only marginally worse, these zombie companies are likely to drop like flies, thereby exposing the zombie nature of the economy created by the Liberal-Tories.  If 10% of UK firms went bust, that means around 2 million people that would be added to the dole queue!!!

A similar situation exists in Europe, with a bifurcation between Northern Europe and Southern Europe, the latter also being extremely zombified, and only kept going by low interest rates, huge amounts of money printing, and state welfare from the North.  The chances of these zombies exploding is still quite significant.  Until Europe grasps the nettle, begins to establish a fiscally, politically as well as monetarily integrated state, its problems are likely to drag on.  That will also require, a significant fiscal stimulus, and directed invested to the periphery to stimulate real growth.  But, that remains essentially a political rather than economic crisis.

But, the signs are there that even without such a change, the strength of the Long Wave Boom, might just yet rescue these economies.  The US, which from 2008 has followed a policy of Keynesian fiscal expansion as well as Friedmanite Monetary stimulus, has continued to grow.  As I've pointed out before, for at least the last thirty years the global economy has had a three year cycle.  That cycle coincided with the 2008 Financial Meltdown, and a new slow down began towards the end of 2011.  It was due to end by the end of 2012, beginning 2013, and that looks like it is happening.

The US, whose growth and employment had been growing rapidly, once again slowed down at the beginning of the year.  Part of that was also due to Republicans in the US frustrating some of Obama's stimulus policies, as well as concern by sections of US Capital over political stalemate, and what the consequecne of that might be for the debt Ceiling, and the Fiscal Cliff.  But, the latest US growth figures show that its cyclical downturn has ended.  Not only have employment figures, as well as Consumer Confidence numbers improved in recent months, the latest data out today shows that the economy itself is growing again, quite rapidly.  The original figure for Q3 GDP was 2%, but the revised figure, out today, has raised that to 2.7%!!  That is a significant quickening in growth, and goes along with yet another improvment in the payroll numbers.

With the US again looking like the cyclical downturn is over, with China once again returning to stronger growth, and large areas of the world still experiencing rapid growth, it seems clear that not only is the Long Wave Boom still in place, but its strength is sufficient to override the particular problems of specific regions, such as Europe.  Of course, that could still be derailed.  If European politicans fail to address the political crisis, there, if Cameron's Government insists on pursuing austerity, and thereby leads to the onward march of the zombies, that could manifest itself in a huge crisis, which would necessarily ripple out into the global economy.

But, the more the US, China. and the other main drivers of the gloabl economy resume strong growth, the less likely that is.  That growth is itself likely to help deal with the question of US debt, along with some of it being inflated away.  It is also likely to lead to renewed growth in Germany, and otehr northern European economies, which will give them increased head room to deal with the problems of peripheral European debt.  Again some of that could be inflated away by an ECB engaging in the same kind of money printing that the Bank of England and Federal Reserve have done, which would also bring about a much needed lowering in the value of the Euro.

A couple of years ago, I also wrote that the political crisis in Europe could spark an economic crisis similar to the 1930's Depression, and its spark would be a collapse in property prices.  Again that still remains a possibility, but the EU authorities might have done just enough to buy enough time to resolve those political issues within the context of resumed growth.  Ironically, that is still likely to lead to a property price crash.  In the US, and Ireland, property prices fell by up to 75%, and that has resulted in the property market once again becoming affordable, bringing stability with it.  In Spain and the UK, although actual selling prices have fallen by around 30%, they have not yet corrected by anything like the figures for the US and Ireland, and have at least another 50% to fall - more like 70% from current asking prices.

Part of the reason these prices have not yet corrected, is like the situation with the zombie companies referred to earlier.  Borrowers unable to repay the Capital sum, are enjoying forbearance from banks afraid that if they foreclose they will spark a firesale the consequence of which will be they will never get their money back, and because large amounts of money printing and intervention have kept interest rates at unsustainably low levels.  In Spain that is ending.  Banks bad loan ratios have gone from around 0.5%, to over 10% in a matter of months, as they are forced to take a more realistic view of assets on their books, prior to any bail-out from the EU, which will expose the zombie nature of those banks.  Spanish banks are busy at the moment trying to dispose of those properties they have foreclosed on, ahead of the 6% increase in Spanish Property taxes, and ahead of the introduction of the Bad Bank.  That is bringing prices for these properties down considerably.  My wife spotted a nice villa in Northern Costa Blanca the other day being sold in a bank sale for just €20,000!  There were plenty of others at equally low prices.  That is also pressing down on all other prices.

But, if growth begins to return even fairly modestly, the massive Financial Repression, that has led to huge amounts of money being hoarded, or put into Bonds at ridiculously low Yields (some of them have even issued with a negative Coupon i.e. you are paying to lend out your money) will quickly end.  There are already signs that money is moving from Bonds into Equities.  Any sign that a deal on the Fiscal Cliff will be reached could see a massive move into US Equities, with an equally rapid move out of Bonds.  That means interest rates ill rise sharply over night.  That means the zombie companies, as well as the zombie mortgages will explode.  Borrowers will be unable to pay even the interest on their loans.  The zombie banks, that exist only on the back of the fiction of the value of their loans, and fiction of property prices will then implode.  They will be forced to foreclose on loans or be completely destroyed.  The irony of an economic recovery is that thousands of small businesses will go bust, and property prices will also collapse!


Anonymous said...

How would you respond to the counter-argument that house prices are highly unlikely to fall further because of the increasing number of homes owned outright by older people, who will seek to keep those homes within the family rather than selling them on the open market?

From Arse to Elbow: Ten Year Tenure Tips

Boffy said...

As I said previously, I bought my first house outright for cash when I was 23. I owned my last house outright, but sold it at the end of 2009 pretty much at the top of the market. I'm very glad I did! I have two kids who it could have been passed on to, but why would I pass on to them an asset, which by that time might have fallen to half or less of its 2009 price!

If I'm right, the £150,000 I received for that house, will in the not too distant future buy me a house currently priced at around £500,000 - £600,000. Even if I'm wrong, house prices continue to fall - according to Bloomberg today, even London house prices fell by 4% last month, and there is no chance of house prices rising, so all the risk reward at the moment runs with selling, and looking to buy later at significantly lower prices.

In my case, I have a further, reason, which is that I'm still thinking of buyiong a house in Spain when prices there have fully collapsed, and if and when the situation looks more stable.

The problem also with the idea of passing a house on, is that many older people have more than one child to pass it on to. They are not all going to live in the house. That then raises the question of how to value the house to divide up the estate. If I think that house prices are going to fall, and inherited a house at the moment, I would want to sell it rather than move into it, and pay other siblings what they consider to be their share, for all the reasons I've set out above.

Furthermore, do we really know how many people actually own their house outright with no encumbrances. People have been encouraged to engage in equity release scams, older peopple face losing their house or a good part of it to cover social care bills and so on. I also know lots of people of my age, who took out mortgage renewals to raise cash to keep spending. How many peopple have large credit card or other bills that have to be set against the property asset?

The proportion of housing that is mortgaged rather than owned outright I would estimate as around 2:1. But, in so far as the part that is owned outright continues to be lived in by current owners, or their children this has another effect - it reduces demand, as much as it reduces supply.

The important quantities here are the number of people demanding homes - not needing homes, but actually having the money to purchase them - and the number of people supplying them, either resale or new build. A walk down any road today will show that there is already a huge excess of supply over demand. Even the estate Agent data shows the number of properties on their books continuing to rise, and the length of time they are now on their books has steadily increased, to around a year.

We now have according to the Bank of England, the same percentage of people who have received some kind of forbearance on their mortgages as was the case at the height of the property crash of the 1990's. The only reason banks are not foreclosing on the same scale, is because to do so given the state of their own balance sheets would be to risk a firesale that would destroy their own assets.

Boffy said...


So, older people who own their home outright may decide to sit on it. I might have done the same had I not been intending moving to Spain, though I had been thinking about selling and moving into rented accommodation from around 2005, ahead of a property crash. But, it will not stop property prices crashing around them, as the houses that do come up for sale cannot be sold at current prices. After all, there ar4e and were probably a greater proprtion of homes in the US that were owned outright, possibly in Ireland too, and that is also no doubt true of Spain where houses have passed down through generations. But, property prices there have fallen by more than 50%. Finally, there is probably a smaller proportion of hosues owned outright in the UK today than there was in 1990 - because at that time many would have been bought by baby boomers, or their parents in the 1950's, 60's and 70's at a time when larger deposits were required, mortgages were repayment mortgages, and inflation had diminished capital sums so it was easier to pay them off - yet in a matter of months in 1990, prices fell 40%!