There is much evidence of a property bubble in China. For example, developers are paying $1,000 to $1,500 per sf for undeveloped land in Bejing and Shanghai. Further, as a centrally managed economy there is likely to be a significant mis-allocation of resources and corruption.
That said, it is far easier to overcome bad economic decisions in a rapidly growing economy. Time and growth are your friends.
Further, China’s leaders appear to be reasonably astute in managing nascent bubbles before they turn into economic catastrophes. They have raised bank reserve requirements, down payment requirements and mortgage interest rates particularly on properties acquired for investment purposes. While these actions may not forestall a bubble collapse, they will provide a cushion to protect the system in the event one occurs. It will be far easier to work out of bad property transactions when 40% of the purchase price was upfront cash, the initial mortgage term was 10 – 15 years and banks are holding $1 of capital in reserve for every $6 to $7 in loans. (Compare this to our scenario of 100%+ debt financing, 30 year mortgages, 30 to 1 reserve ratios, off balance sheet accounting mechanisms and derivative bets that can serve to magnify rather than cushion the effects of a bubble collapse.)
Does China have bubble worries? Yes. Will the collapse in the real estate bubble devastate China’s economy? Who really knows, but at least the Chinese government recognizes the risks and is stringing up the safety nets to cushion a fall if one comes.
Saturday, March 27, 2010
Thursday, March 25, 2010
Should Home Owners Get a Bail Out?
Should Home Owners Get a Bail Out? As long as one assumes that we are going through a difficult albeit reasonably typical economic cycle where the forces of greed and excess are purged, irrational behavior punished and prudent behavior rewarded then perhaps the answer is no.
Without doubt the government programs that help homeowners are also serving to bail-out banks. In doing so these programs create a moral hazard that discourages self-discipline within the financial sector.
Perhaps I give them too much credit, but from my perspective the financial industry is the most culpable party in the housing market/foreclosure episode. They created the financial products that enticed homeowners and consumers to engage in reckless behavior. They succeeded in compromising the rating agencies by playing one against the other and by offering enticing fees on mortgage backed security offerings. They succeeded in changing our laws and regulations – effectively eliminating interest rate ceilings, reserve requirements, regulation and oversight. It is wrong from both a free market and in my mind a moral perspective to bail out these firms. To do so promotes all sorts of inappropriate behaviors that will do great harm in the long term.
However, if the economy is not undergoing a severe but never the less typical business cycle, but rather is and continues to be on the precipice of an economic collapse, then these government homeowner programs are perhaps a distasteful but necessary medicine. Chemotherapy for the cancer patient.
Whether or not this is the case depends on the economic consequences. What would be the consequences if the government stepped away and allowed market forces to dictate housing prices, foreclosure levels and banking costs/failures? Would the actions of efficient markets and creative destruction serve to quickly reprice assets, clean out excessive inventories of housing stock and purge the system of irresponsible banking practices so that the economy can once again grow? Or are the excesses of such a great magnitude that the market would excessively over correct on housing prices, force large numbers of responsible homeowners into foreclosure and bankrupt the responsible/well managed banks?
Here is my definition of the difference between a recession and a depression. A recession results in the destruction of poorly managed or inefficient assets (aka “creative destruction”) which is good but a depression results in permanent destruction of the very creative assets that are needed for long term economic prosperity, which is bad.
If the government were to “stand down” on housing and the result was still a recession, then this would be the correct action to take for long term economic growth. However if it resulted in a depression, the consequences might be permanent damage to the economy that would impede long term growth. I personally am not yet confident enough in the long term economic prospects to agree with pulling the plug on these programs.
Until it is more certain that we are not at risk of economic collapse, I would rather see meaningful financial reform to prevent future excesses, honest accounting to identify the failed banks, allowing them to be taken over and unwound, and a continuation of homeowner programs as a measure to avoid permanent long term economic destruction.
Without doubt the government programs that help homeowners are also serving to bail-out banks. In doing so these programs create a moral hazard that discourages self-discipline within the financial sector.
Perhaps I give them too much credit, but from my perspective the financial industry is the most culpable party in the housing market/foreclosure episode. They created the financial products that enticed homeowners and consumers to engage in reckless behavior. They succeeded in compromising the rating agencies by playing one against the other and by offering enticing fees on mortgage backed security offerings. They succeeded in changing our laws and regulations – effectively eliminating interest rate ceilings, reserve requirements, regulation and oversight. It is wrong from both a free market and in my mind a moral perspective to bail out these firms. To do so promotes all sorts of inappropriate behaviors that will do great harm in the long term.
However, if the economy is not undergoing a severe but never the less typical business cycle, but rather is and continues to be on the precipice of an economic collapse, then these government homeowner programs are perhaps a distasteful but necessary medicine. Chemotherapy for the cancer patient.
Whether or not this is the case depends on the economic consequences. What would be the consequences if the government stepped away and allowed market forces to dictate housing prices, foreclosure levels and banking costs/failures? Would the actions of efficient markets and creative destruction serve to quickly reprice assets, clean out excessive inventories of housing stock and purge the system of irresponsible banking practices so that the economy can once again grow? Or are the excesses of such a great magnitude that the market would excessively over correct on housing prices, force large numbers of responsible homeowners into foreclosure and bankrupt the responsible/well managed banks?
Here is my definition of the difference between a recession and a depression. A recession results in the destruction of poorly managed or inefficient assets (aka “creative destruction”) which is good but a depression results in permanent destruction of the very creative assets that are needed for long term economic prosperity, which is bad.
If the government were to “stand down” on housing and the result was still a recession, then this would be the correct action to take for long term economic growth. However if it resulted in a depression, the consequences might be permanent damage to the economy that would impede long term growth. I personally am not yet confident enough in the long term economic prospects to agree with pulling the plug on these programs.
Until it is more certain that we are not at risk of economic collapse, I would rather see meaningful financial reform to prevent future excesses, honest accounting to identify the failed banks, allowing them to be taken over and unwound, and a continuation of homeowner programs as a measure to avoid permanent long term economic destruction.
Monday, March 1, 2010
Why Would Anyone Invest in Retail Stocks?
Reasons why I cannot see investing in retail stocks.
1) Aging population - the Baby Boomers are now hitting age 65. It is a fact that old folks buy less of everything except for health care and booze.
2) Population growth is slowing - A good part of past population growth was immigration. However in the past year, 1 million illegal immigrants returned home and legal immigration is down as well. The traditional industries such as construction are far from hitting bottom. These shoppers are not coming back.
3) Household debt - It is at record highs. Consumers must now pay off the purchases they made during the "good times" rather than buy more stuff today or in the foreseeable future.
4) Credit card interest rates - "Zombie" banks (pretty much all of them) have raised interest rates to as much as 30% as well as hiking many of their fees. While American consumers have a hard time fighting off their desire for immediate gratification, slowly they are realizing that buying goods with credit cards is a bad deal. Even for those who will never get it, the compounded interest costs at higher rates of interest will eat up available credit limits rather quickly.
5) Job losses and labor market participation - Not only is unemployment at 10% but another 5% or so have just given up. There is little indication that these jobs will be coming back for a very long time. In fact we have yet to reach the point where job losses will stop. No work, no purchases.
6) Future tax increases - We all know that we cannot continually run $1.5 trillion dollar deficits. Taxes will have to be raised or government jobs & purchases cut. Either way, there will be less spent on retail. Many are discussing a VAT tax which basically a national sales taxe. Further, most or all of the Bush Era tax cuts will be allowed to expire and when they do, so will discretionary income levels.
7) Higher import costs for Chinese goods. Believe it or not, China is experiencing a labor shortage at its coastal factories. Wages are expected to rise at least 10% after the Spring Holiday (which just ended). Further, in spite of their rhetoric against it, China is actively considering increasing the value of their currency, perhaps with a 5% jump and then many smaller increases there after. Thus the cost of many of the goods sold by retailers will be higher and profit margins lower (unless they raise prices, but this will reduce total sales).
8) Discretionary income is falling - Due to globalization and the "Great Recession", employees are not able to demand higher wages and thus "real wages" are not keeping up with inflation. Most consumers have a number of fixed costs that go up with inflation or cannot be adjusted. Thus lower wages means lower discretionary income means fewer purchases.
9) Oil and gas prices may continue to rise - Gasoline is a major cost for many consumers. China, the rest of Asia, India, Brazil and even Russia are rebounding out of recession and the pick up in their economies and increased auto sales are resulting in strong demand and higher prices for oil. Every additional dollar spent to fill up the tank means one less dollar available to buy stuff. Higher gasoline prices are likely to become a permanent fixture even if demand in the USA falls off.
So my question to you is, "How can retailers grow rapidly, let alone grow at all, when faced with these headwinds over the next few years and perhaps beyond?
So what are your counter arguments?
What am I missing?
1) Aging population - the Baby Boomers are now hitting age 65. It is a fact that old folks buy less of everything except for health care and booze.
2) Population growth is slowing - A good part of past population growth was immigration. However in the past year, 1 million illegal immigrants returned home and legal immigration is down as well. The traditional industries such as construction are far from hitting bottom. These shoppers are not coming back.
3) Household debt - It is at record highs. Consumers must now pay off the purchases they made during the "good times" rather than buy more stuff today or in the foreseeable future.
4) Credit card interest rates - "Zombie" banks (pretty much all of them) have raised interest rates to as much as 30% as well as hiking many of their fees. While American consumers have a hard time fighting off their desire for immediate gratification, slowly they are realizing that buying goods with credit cards is a bad deal. Even for those who will never get it, the compounded interest costs at higher rates of interest will eat up available credit limits rather quickly.
5) Job losses and labor market participation - Not only is unemployment at 10% but another 5% or so have just given up. There is little indication that these jobs will be coming back for a very long time. In fact we have yet to reach the point where job losses will stop. No work, no purchases.
6) Future tax increases - We all know that we cannot continually run $1.5 trillion dollar deficits. Taxes will have to be raised or government jobs & purchases cut. Either way, there will be less spent on retail. Many are discussing a VAT tax which basically a national sales taxe. Further, most or all of the Bush Era tax cuts will be allowed to expire and when they do, so will discretionary income levels.
7) Higher import costs for Chinese goods. Believe it or not, China is experiencing a labor shortage at its coastal factories. Wages are expected to rise at least 10% after the Spring Holiday (which just ended). Further, in spite of their rhetoric against it, China is actively considering increasing the value of their currency, perhaps with a 5% jump and then many smaller increases there after. Thus the cost of many of the goods sold by retailers will be higher and profit margins lower (unless they raise prices, but this will reduce total sales).
8) Discretionary income is falling - Due to globalization and the "Great Recession", employees are not able to demand higher wages and thus "real wages" are not keeping up with inflation. Most consumers have a number of fixed costs that go up with inflation or cannot be adjusted. Thus lower wages means lower discretionary income means fewer purchases.
9) Oil and gas prices may continue to rise - Gasoline is a major cost for many consumers. China, the rest of Asia, India, Brazil and even Russia are rebounding out of recession and the pick up in their economies and increased auto sales are resulting in strong demand and higher prices for oil. Every additional dollar spent to fill up the tank means one less dollar available to buy stuff. Higher gasoline prices are likely to become a permanent fixture even if demand in the USA falls off.
So my question to you is, "How can retailers grow rapidly, let alone grow at all, when faced with these headwinds over the next few years and perhaps beyond?
So what are your counter arguments?
What am I missing?
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