One by one the world's legendary deflationists are taking one look at the following chart of the global money supply (as shown most recently by DB's Jim Reid) and after seeing the clear determination of central banks to spark a global inflationary conflagration, are quietly (and not so quietly) capitulating.
One month ago it was SocGen's Albert Edwards, who after calling for a deflationary Ice Age for over two decades, finally threw in the towel and conceded that "we are transitioning from The Ice Age to The Great Melt" as "massive monetary stimulus is combining with frenzied fiscal pump-priming in an attempt to paper over the current slump."
At roughly the same time, "the world's most bearish hedge fund manager", Horseman Global's Russell Clark reached a similar conclusion writing that "all the reasons that made me believe in deflation for nearly 10 years, do not really exist anymore. China looks okay to me, and potentially very good. Commodity supply is getting cut at a rate I have never seen before. The US dollar is strong but will likely weaken from here. And it is clear to me Western governments will only ever attempt fiscal austerity as a last resort, not a first. The conditions for both good and bad inflation are now in place."
And now, it is the turn of another iconic deflationist, Russell Napier, who in the latest Solid Ground article on his Electronic Research Interchange (ERIC) writes that "we are living through another deflation shock but [he] believes that by 2021 inflation will be at or near 4%."
Why the historic shift in monetary perceptions? Because similar to Albert Edwards' conclusion that MMT, i.e., Helicopter Money, is a gamechanger, Napier writes that "what has just happened is that the control of the supply of money has permanently left the hands of central bankers - the silent revolution." As a result, "the supply of money will now be set, for the foreseeable future, by democratically elected politicians seeking re-election." His conclusion: "it is time to embrace the silent revolution and the return of inflation long before such permanency is confirmed."
What does this mean for asset prices? According to Napier, "a trading opportunity does now exist in European equities in particular. With the impact of bank credit guarantees not yet fully positively impacting broad money growth, we can expect Eurozone broad money growth to go even higher. Eurozone M3 is already growing at 8.9% year on year and in just a few months will likely exceed its peak of 2007."
An even more dramatic picture emerges in the US (see top chart), where Napier highlights the surge in M2 which is now the biggest since the Great Depression:
In short, money creation is shifting away from central banks and is being handed off to governments. And that, in a word, will have catastrophic consequences:
This explosion in money supply will eventually have an impact on interest rates with Napier's best guess is that "ten year bond yields will have to be forced to settle between 2% and 3%. This level comes from working backwards from the highest rate of inflation that governments might dare target to bring escalating debt-to-GDP ratios under control. At levels of annual inflation above 6% there is a growing risk that the velocity of money could shift markedly higher and the prospects of controlling inflation thus reduce."
The take home here, is that Napier expects inflation to approach 4% by 2020 with velocity of money troughing soon and then surging to 1.4x.
Does the coming surge in inflation mean buy stocks hand over fist? Yes... and no: as Napier explains, "at this stage it is probably best to hold equities as the market begins to discount the silent revolution and, with a lag, inflation itself begins to rise. Should you hold them for the entire journey to 4%? The Solid Ground is skeptical that the rise in equities will last for the duration of inflation's journey to 4%."
But what if rates are simply capped a la Japan or the US ca. 1943, with the help of Yield Curve Control? Surely such a disconnect between the yield curve and inflation expectations would be beneficial for stocks? Here, too, Napier pours cold water:
... at some stage in the reflation the government will have to move to cap yields in the knowledge that it is probably too risky to allow inflation to rise above 6%. Many investors seem to believe that this combination of a capped yield curve and rising inflation will be positive for equity prices. That will depend upon what savings institutions are selling in order to fund their compelled purchases of government debt. The most likely asset for liquidation will be equities and, as yields are to be capped possibly for decades, that liquidation could be prolonged.
Needless to say this is clearly at odds with prevailing convention wisdom that yield curve control would "unleash a mindblowing stock rally." And incidentally Napier seems to agree with this, at least in the short-term:
Time will tell whether that is a good or a bad guess but for now inflation is low, long-term inflation expectations are ridiculously low and equities will benefit from the change in inflationary expectations that are still before us.
While there is much more in the full report below, here are his conclusion:
And so, without further ado, here is Russell Napier and his latest ERI-C note:
Equities & The Rise of Inflation: How Much Inflation Before Repression? (07/07/20)
In 1Q 2009 The Solid Ground called for the bottom of the bear market in equities and then went on to recommend that investors should hold US equities until inflation reached around 4.0%. This proved to be good advice for those who followed it but unfortunately your analyst was not one of them! By 2011 The Solid Ground saw problems ahead for the global banking system in boosting credit growth and thus, with the likelihood that broad money growth would remain anemic, inflation would decline and deflation was likely. Inflation did peak just below 4% in 2011 and by early 2015 the US was indeed reporting mild deflation. The problem was that the journey of inflation from close to 4% back to just below zero was not negative for US equities. Only in the latter period of that journey, when inflation went below 1% and corporate earnings declined, did the S&P500 index decline. The original advice from mid-2009 - hold US equities until inflation nears 4%, even if you think it will subside from that level back towards zero - was the best advice. Now we are living through another deflation shock but The Solid Ground believes that by 2021 inflation will be at or near 4%. Can your analyst take his own advice this time and learn to stop worrying and love the early reflation?
In the 4Q 2019 report (Inflation, Disinflation & Deflation: Their Impact on Equities & Problems for Europe) The Solid Ground revisited the advice from mid-2009 and concluded that those who believed in rising inflation should buy European equities. While that quarterly report forecast a deflation shock, it was clear that European equities would be a major beneficiary of rising inflation if that forecast proved to be wrong. Since the publication of the 4Q report we have had a deflation shock, with probably some expected deflation to come, and equity prices and inflation break-evens on Indexed Linked Bonds (ILBs) have moved sharply lower. If European financial markets were pricing in prolonged low inflation in December 2019, they are pricing in even lower inflation now. So if The Solid Ground is correct in expecting inflation, even in the Eurozone, to near 4% by next year, there must be an opportunity to profit from a rise in European equity prices?
A trading opportunity does now exist in European equities in particular. With the impact of bank credit guarantees not yet fully positively impacting broad money growth, we can expect Eurozone broad money growth to go even higher. Eurozone M3 is already growing at 8.9% year on year and in just a few months will likely exceed its peak of 2007. Most investors your analyst has spoken to in the past few weeks then expect bank loan growth and money supply growth to subside, as emergency lending ends, and this brief surge in broad money growth to become an historical aberration with almost no impact on inflation. While that is possible, The Solid Ground believes it is not probable as politicians fully recognize the possibilities of commercial bank balance sheet control and launch a series of new initiatives, probably focused on guarantees on loans for green initiatives. The more the duration of this guaranteed lending extends, the more investors will come to realize that there is nothing temporary regarding governments use of commercial banks balance sheets to create credit and in the process to create money. Already the Spanish government's bank credit guarantee programme has been extended from EUR100bn to EUR150bn. While cautious investors will want to wait to see the permanency in the bank credit guarantee policy, your analyst suggests it is time to embrace the silent revolution and the return of inflation long before such permanency is confirmed.
It is now probable that deflation will be reported across the developed world. It might also be somewhat irrelevant for investors. If The Solid Ground is correct what has just happened is that the control of the supply of money has permanently left the hands of central bankers - the silent revolution. The supply of money will now be set, for the foreseeable future, by democratically elected politicians seeking re-election. Imagine two economies, identical in every way, except that in one an independent central banker seeks to control the supply of money while in another a democratically elected government directly determines the supply of money through commercial bank balance sheet control. Would these two economies have the same level of long-term interest rates? The Solid Ground's answer to that question is that they would not and it is because they would not that long-term interest rates should now rise - even if the near term outlook is for deflation. The 2Q 2020 report (The Birth of the Age of Inflation: Why It Is Now and What to Own) shows just how governments have seized control of money creation and thus your analyst believes that financial markets will soon be pricing in this silent revolution long before the inevitable inflation, governments so crave, has actually been created.
So at this stage it is probably best to hold equities as the market begins to discount the silent revolution and, with a lag, inflation itself begins to rise. Should you hold them for the entire journey to 4%? The Solid Ground is skeptical that the rise in equities will last for the duration of inflation's journey to 4%. The key reason for that skepticism is that it seems highly unlikely that governments will accept the likely long-term interest rates that would probably follow if inflation reached 4%. With total debt-to-GDP ratios just below record highs before the COVID-19 crisis, they are now spiraling even higher - in both the government and private sectors. These record high debt levels risk crushing any reflation if the cost of interest rises dramatically in any recovery. The Solid Ground has long forecast that no such rise in interest rates will be permitted — see Capital Management in An Age of Repression: A Handbook (3Q 2016). So when might government action begin to stop such a rise in interest rates and what does it mean for equity prices?
Judging what level of long-term interest rates will be deemed unacceptable by policy makers is one of the most difficult calls in investment. It is probable that policy makers do not currently know the answer to that question themselves. They might not know the answer until there are negative economic impacts from higher long-term interest rates and only then might repressive action be triggered. Your analyst's best guess is that ten year bond yields will have to be forced to settle between 2% and 3%. This level comes from working backwards from the highest rate of inflation that governments might dare target to bring escalating debt-to-GDP ratios under control. At levels of annual inflation above 6% there is a growing risk that the velocity of money could shift markedly higher and the prospects of controlling inflation thus reduce. Perhaps some governments might flirt with higher levels and of course there is always the risk of over-shooting any economic target, whether of a government or a central banker. However if we conclude that governments will not want to risk inflation rising above 6%, what level of long-term interest rates would they need to pull off a successful financial repression? Perhaps they could allow long-term interest rates to reach 3% but as the success of a repression is based primarily upon the gap between inflation and interest rates, any smaller gap might just slow the process of inflating away debts by too much. These are very clearly back of an envelope calculations but they suggest that even if inflation is permitted to rise as high as 6%, investors should expect aggressive moves to repress long-term interest rates once they are even as low as 2% to 3%. Allowing interest rates to rise to higher levels risks too slow a de-leveraging or a need for a rate of inflation that is too destabilizing.
In the last newsletter (The Silent Revolution: How To Inflate Away Debt... With More Debt) The Solid Ground explained why central bankers would not be able to control long-term interest rates in a world of rising inflation expectations. Such a cap on interest rates would only be possible by forcing savings institutions to buy government debt at the targeted yields. So at some stage in the reflation the government will have to move to cap yields in the knowledge that it is probably too risky to allow inflation to rise above 6%. Many investors seem to believe that this combination of a capped yield curve and rising inflation will be positive for equity prices. That will depend upon what savings institutions are selling in order to fund their compelled purchases of government debt. The most likely asset for liquidation will be equities and, as yields are to be capped possibly for decades, that liquidation could be prolonged.
The conclusion from all of the above is that equities will benefit on the road to higher inflation. That will occur even if deflation happens first as markets begin to discount the impact from the shift in the powers of money creation from central bankers to governments. However the move to cap interest rates between 2% and 3% may well come before inflation hits 4%. As one would normally expect long-term interest rates to be above the rate of inflation, a forced purchase of government bonds by savings institutions is likely before inflation reaches 4%. If the move to force savings institutions to cap yields occurs before inflation reaches 4%, then the mass liquidation of equity portfolios by those institutions also begins before inflation hits 4%. That does not suggest that equity prices can rise ever higher into the financial repression and the liquidation may be met by high equity issuance in a period when non-bank debt availability will be significantly curtailed (see The Silent Revolution: How To Inflate Away Debt... With More Debt).
Is your analyst guilty of once again ignoring his own advice? Perhaps, but tactically the advice is the same. Equities can be held as long as the markets continue to discount higher rates of inflation and only when the move to the forced purchase of government debt securities is likely is that upward movement in equities likely to end. We cannot be sure when that will be but should receive some warning on the timing as higher longer term interest rates begin to impinge on the economic recovery. Your analyst, seeing this move as part of a much longer financial repression, would be surprised if long-term interest rates were allowed to rise above the 2% to 3% level, given the implications for the acceptable rate of inflation. Time will tell whether that is a good or a bad guess but for now inflation is low, long-term inflation expectations are ridiculously low and equities will benefit from the change in inflationary expectations that are still before us.
COVID Lockdown Protests Erupt In Beijing, Xinjiang After Deadly Fire
COVID Lockdown Protests Erupt In Beijing, Xinjiang After Deadly Fire
Protests have erupted in Beijing and the far western Xinjiang region…
Protests have erupted in Beijing and the far western Xinjiang region over COVID-19 lockdowns and a deadly fire on Thursday in a high-rise building in Urumqi that killed 10 people (with some reports putting the number as high as 40).
Crowds took to the street in Urumqi, the capitol of Xinjiang, with protesters chanting "End the lockdown!" while pumping their fists in the air, following the circulation of videos of the fire on Chinese social media on Friday night.
2/ one significant trigger for the protest was a deadly fire in a resident building.— 巴丢草 Bad ї ucao (@badiucao) November 25, 2022
dozens people died due to lockdown setting stopped fire fighters and fire engines coming inside the block. pic.twitter.com/26soQld816
Protest videos show people in a plaza singing China's national anthem - particularly the line: "Rise up, those who refuse to be slaves!" Others shouted that they did not want lockdowns. In the northern Beijing district of Tiantongyuan, residents tore down signs and took to the streets.
3/ protestors from Urumqi were singing China‘s national anthem while waving a flag.— 巴丢草 Bad ї ucao (@badiucao) November 25, 2022
Quite common in China’s protest，we call it ‘举着红旗反红旗‘ wave the flag while against it.
Its a self-protraction meaning ’ i am against a policy not the nation/CCP‘. pic.twitter.com/XqworKWUnb
北京天通苑北一区— 李老师不是你老师 (@whyyoutouzhele) November 26, 2022
Reuters verified that the footage was published from Urumqi, where many of its 4 million residents have been under some of the country's longest lockdowns, barred from leaving their homes for as long as 100 days.
In the capital of Beijing 2,700 km (1,678 miles) away, some residents under lockdown staged small-scale protests or confronted their local officials over movement restrictions placed on them, with some successfully pressuring them into lifting them ahead of a schedule. -Reuters
According to an early Saturday news conference by Urumqi officials, COVID measures did not hamper escape and rescue during the fire, but Chinese social media wasn't buying it.
"The Urumqi fire got everyone in the country upset," said Beijing resident Sean Li.
【新疆的朋友私信发我的，不敢在朋友圈里发，会被派出所抓，求您推广，让大家知道，他们根本没办法逃生】 pic.twitter.com/rUV8QoEwz9— 方舟子 (@fangshimin) November 26, 2022
6/ Video of ‘anti zero-covid-lockdown protest’ from Urumqi,Xinjiang, China after 100+ days lockdown— 巴丢草 Bad ї ucao (@badiucao) November 25, 2022
Many people took videos and post on social media inside of China.
All the little screens in the video is a spark of fire and life pic.twitter.com/yUVxpduq4i
According to Reuters;
A planned lockdown for his compound "Berlin Aiyue" was called off on Friday after residents protested to their local leader and convinced him to cancel it, negotiations that were captured by a video posted on social media.
The residents had caught wind of the plan after seeing workers putting barriers on their gates. "That tragedy could have happened to any of us," he said.
By Saturday evening, at least ten other compounds lifted lockdown before the announced end-date after residents complained, according to a Reuters tally of social media posts by residents.
This anti-lockdown protest in the suburbs of Beijing can be geolocated to the South Gate of the Tiantongyuan North #1 Community. From the inside looking out.— Nathan Ruser (@Nrg8000) November 26, 2022
At 40.0731, 116.4109https://t.co/PjkDqEeeMO https://t.co/GzGJfHp7Lk pic.twitter.com/yBzA6y8j4s
On Nov 23, when a fire broke out in #Urumqi , people’s doors were locked from outside. Fire truck couldn’t get closer either( see my previous tweet). The latest figure says 44 were burnt to death, including a 3 y/o kid. That’s one of the reasons for today’s protests. pic.twitter.com/s4E0JHk4wQ— Jennifer Zeng 曾錚 (@jenniferzeng97) November 25, 2022
US Jobs and Eurozone CPI Highlight the Week Ahead
Two high-frequency economic reports stand out in the week ahead: The US November employment report and the preliminary eurozone CPI. The Federal Reserve…
Two high-frequency economic reports stand out in the week ahead: The US November employment report and the preliminary eurozone CPI. The Federal Reserve has deftly distanced itself from any one employment report. As a result, it would take a significant miss of the median forecast (Bloomberg survey) to alter market expectations for a 50 bp hike when the FOMC meeting concludes on December 14.
Economists are looking for around a 200k increase in US non-farm payrolls after 261k in October. In the first ten months of the year, the US has created 4.07 mln jobs. This is down from 5.51 mln in the Jan-Oct period last week but a strong performance by nearly any other comparison. In the same period before the pandemic, the US created about 1.52 mln jobs. Non-farm payrolls rose by an average of 150k in 2018 and 2019. It is averaging more than twice that now.
Average hourly earnings have increased in importance now with greater sensitivity to inflation and fears among policymakers that it could get embedded into wage expectations. The year-over-year increase in average hourly earnings peaked in March (when the Fed began hiking rates) at 5.6%. It has fallen or been unchanged since and fell to 4.7% in October. Economists expect the pace to have slowed to 4.6%. The 4% rate, seen as more consistent with the Fed's goals, assumes 2% productivity, which has been difficult to sustain outside crises (around the Great Financial Crisis and Covid) since the middle of 2004.
The ECB is a different kettle of fish. Nearly all the voting members at the Fed that have spoken, including the leading hawks, seem to accept a downshifting from 75 bp to 50 bp. However, at the ECB, there appears to be a genuine debate. It hiked rates by 75 bp at the last two meetings after starting the normalization process with a half-point move in July. As a result, the month-over-month headline inflation surged by 1.2% in September and 1.5% in October. The year-over-year rate stood at 10.7% in October, 300 bp above the US. On the other hand, core inflation was 5% above a year ago in the eurozone compared with 6.3% in the US. The median forecast in Bloomberg's survey sees the headline rate easing to 10.4%, with the core rate unchanged.
This is leading some, like the Austrian central bank governor Holzmann to suggest that unless there is a sharp fall in the November report, he would be inclined to support another 75 bp hike when the ECB meets on December 15. The preliminary estimate of November CPI will be released on November 30, but the final reading will not be available until the day after the ECB's meeting. That said, revisions tend to be minor. While Holzmann is perceived to be one of the more hawkish members of the ECB, the more dovish contingent seems to be pushing for a slowing the pace to 50 bp. It is a bit too simple to make it into a North-South dispute. The ECB's chief economist, Lane, from Ireland, is in the 50-bp camp. The swaps market sees a little more than a 30% chance of a 75 bp hike next month. Countering the elevated price pressures is recognizing that the eurozone is slipping into a recession. Still, officials say it will likely be short and shallow, arguably giving them more latitude to adjust rates.
To be sure, the US also reports inflation. The Fed's targeted measure, the PCE deflator for October, will be released the day before the employment report. But, in this cycle, in terms of the Fed's reaction function, it seems to have been downgraded, and the thunder stolen by the CPI. Indeed, when Fed Chair Powell explained why the Fed hiked by 75 bp instead of 50 bp in June as it had led the market to believe, he cited CPI and the preliminary University of Michigan consumer inflation expectation survey (which was later revised lower). While the methodologies and basket of the PCE deflator are different than CPI, the former is expected to confirm the broad developments of the latter. A 0.3% rising in the headline PCE deflator will see the year-over-year pace slip below 6% for the first time since last November. It peaked at 7.0% in the middle of the year. The core rate is stickier and may have eased to 5% after edging up in both August and September.
The US economic calendar is packed in the days ahead. The S&P CoreLogic Case-Shiller house prices 20-city index are expected to have fallen for the third consecutive month (September). That has not happened for a decade. The FHFA house price index is broadly similar. It fell by 0.6% in July and 0.7% in August. The median forecast (Bloomberg survey) is for a 1.3% decline in September. If accurate, it would be the largest monthly decline since November 2008. The October goods trade balance and inventory are inputs into GDP forecasts. There continues to be a significant gap between the Atlanta Fed's GDPNow tracker (4.3%) and the median estimates in Bloomberg's survey (0.5%).
The JOLTS (Job Opening and Labor Turnover Survey) has become a popular metric in this cycle and has often been cited by Fed officials. It peaked in March at nearly 11.86 mln. It has erratically trended lower and stood slightly below 10.72 mln in September. It is forecast to have softened in October. The low for the year was set in August at 10.28 mln. In the three downturns since 2000, the peak in JOLTS has come well before a recession, and the bottom after the recession has ended.
While the cost-of-living squeeze is impacting consumption, the supply chains are normalizing, which is a powerful tailwind. This is at least partly the story in the auto sector. US auto sales reached 14.9 mln (SAAR) in October, the best since January and almost 15% from October 2021. In fact, in the three months through October, US auto sales are running 8.8% above the same three-month period a year ago. Still, US auto sales have averaged 13.73 mln through October, nearly 11% lower, at an annualized pace in the first ten months of 2021. Still, S&P Global Mobility analysis warns of softer November figures (14.1 mln). However, if the projection is accurate, it would be about 9.6% more than in November 2021.
There was some optimism that after the 20th Party Congress, China's Xi would have the authority and inclination to pivot on Covid, property, and foreign relations. Yet, Chinese and international medical experts have warned that China is woefully unprepared to relax its Covid policy regarding inoculation rates and medical infrastructure. The surge in cases has seen restrictions imposed on an area responsible for more than a fifth of the country's GDP. China's composite PMI has been falling since the year's peak at 54.1 in June. It fell below the 50 boom/bust level in October for the first time since May, and Q4 GDP appears to be slowing from the 3.9% quarter-over-quarter jump in Q3 after the 2.7% contraction in Q2. The world's second-largest economy may be growing around a third of the pace in Q4, with risks to the downside. The median forecast (in Bloomberg's survey) is for Q1 23 growth of 0.9%.
Aid to the property market may help stabilize the sector in the short term. Iron ore prices surged by more than 27% at the end of October through November 18 amid the optimism. However, this seemed anticipatory in nature as many of the new measures are slowly rolling out. Many observers share our doubts that the excesses of a couple of decades have been absorbed or alleviated. News that separate from the list of 16 measures to support the property market announced earlier this month, the PBOC is considering a CNY200 bln (~$28 bln) of interest-free loans to commercial banks through the end of Q1 to induce them to provide matching funds for stalled property markets, seems to be a subtle recognition that more efforts are needed. While new supply has stalled, we are concerned that the more significant issue is effective demand.
Japan, the world's third-largest economy, unexpectedly contracted (-1.2% annualized rate) in Q3 but appears to be rebounding, likely aided by the new support measures (JPY39 trillion or ~$275 bln). Japan reports October employment figures. The unemployment rate has been 2.5%-2.6% since March. Japan has been successful in boosting the labor force participation rate. It was at 61.8% in early 2020 before Covid and has been at 62.9%-63.0% for four months through September. This is the highest since at least 2001. Retail sales, reported in terms of value (nominal prices), rose 1.3% and 1.5% in August and September, respectively. Another strong report would not be surprising. Government travel subsidies were widened in October.
Japanese businesses were pessimistic about the outlook for industrial output in October. They anticipate a 0.4% decline after production fell 1.6% in September. The auto sector is a source of pessimism. Supply chain disruptions were cited for the dour outlooks of Toyota and Honda. Foreign demand is weakening, and Japanese exports are slowing. Japan's preliminary November manufacturing PMI slipped below the 50 boom/bust level to 49.4, its lowest in two years.
Australia reported October retail sales and some housing data, but the newly introduced monthly CPI may have the most significance. The market is not sure that the Reserve Bank of Australia will hike rates at the December 6 meeting. The futures market has a little better than a 60% chance of a quarter-point hike. The cash rate is at 2.85%. In September, CPI made a new cyclical high of 7.3%. The trimmed mean measure stood at 5.4%, which was also a new high. We would subjectively put the odds higher than the market for a quarter-point hike. The next RBA meeting is on February 9, which seems too long for Governor Lowe to make good on his anti-inflation commitment.
Canada reports Q3 GDP and the November jobs. The Canadian economy is downshifting after enjoying 3.1% and 3.3% annual growth rates in Q1 and Q2, respectively. The pace is likely to be a little less than half in Q3 and appears to be slowing down more here in Q4. The median forecast (Bloomberg's survey) is for the Canadian economy contract in the first two quarters of next year. Canada created an impressive 119k full-time positions in October. Adjusted for the size of the economy, this would be as if the US created 1.3 mln jobs. In four of the past five quarters, Canadian job growth has been concentrated in one month. As one would expect, the following month has been a marked slowdown, and twice there were outright declines in full-time positions. After hiking by 100 bp in July, the Bank of Canada slowed its pace to 75 bp in September and 50 bp in October. The central bank meets on December 7, and the swaps market seems comfortable with a quarter-point hike.
Lastly, we turn to the Taiwanese local elections on November 26. The key is the mayoral contest in Taipei. It is seen as the most likely path of the presidency when Tsai-Ing's term ends in 2024. The great-grandson of Chiang Kai-shek is the candidate for the KMT, which wants closer ties to Beijing but rejects claims it is "pro-China." The DPP candidate is the health minister and architect of the country's Covid policy. The Deputy Mayor of Taipei is running as an independent candidate, but it looks like a two-person contest. Despite the US and Chinese defense officials agreeing to improve their practically non-existent dialogue, there is unlikely to be a meeting of the minds about Taiwan. Changes in the constellation of domestic political forces within Taiwan seem to be the most likely component that may change what appears to be an inexorable deteriorating situation. Both Beijing and Washington have good reason to believe the other is trying to change the status quo.
Disclaimerrecession unemployment pandemic subsidies fomc fed federal reserve congress governor recession gdp unemployment japan canada china
China’s Housing Crisis: What Investors Need to Know
China’s economy has grown from near irrelevance to the second largest in the world in less than half a century. Perhaps more incredible than its meteoric…
China’s economy has grown from near irrelevance to the second largest in the world in less than half a century. Perhaps more incredible than its meteoric rise is the fact that it’s done so without any kind of significant economic contraction. Nearly fifty years of consistently positive GDP growth is practically sorcery in the eyes of the west, as our more democratized and less managed economies seldom manage to go a single decade without at least some kind of bust, let alone five.
The assumed impossibility of eternally uninterrupted economic growth has raised more and more eyebrows and elicited more and more dire predictions about China’s economy as time has passed. Surely the ruling Chinese Communist Party can’t stave off the fundamental economic forces indefinitely. Surely the other shoe is going to drop soon, and all will be right with the world.
It has to. Right?
We’re supposed to be living in a post-Soviet world. A world where the question of managed versus free economies is long-settled fact. But if the CCP is able to keep China’s economy—an economy encompassing the interests of over a billion people—from experiencing so much as a recession, that settled fact starts to look more like an open question with each passing quarter.
The current situation facing China’s real estate market is the latest and perhaps most convincing sign that China has finally reached a tipping point. A generation’s worth of breakneck growth, urbanization, and unintended consequences may be coming to a head.
China’s housing market is currently the biggest asset class in the world, with a notional value of nearly $60 trillion, more than the entire capitalization of the stock market. About one third of China’s economic activity involves the real estate sector (compared to 15 to 18% of the American economy), a staggering figure that becomes even more so when combined with the fact that housing accounts for about 70% of Chinese household wealth.
The reasons for the outsized role that housing and real estate play in China’s economy are complex and numerous, though they all trace their roots back to the CCP.
The current real estate crisis began shortly after China relaxed its rules on private home sales back in 1998. This change in policy roughly coincided with the explosive economic growth that’s characterized much of the past decades, much of which relied on the importation of cheap labor from the Chinese countryside into rapidly growing metro areas. Over 480 million Chinese moved from the country to the city in pursuit of better economic opportunities, and real estate developers were only too happy to provide the accommodations that the newly urbanized Chinese both needed and could suddenly afford.
Real estate developers and construction firms weren’t the only ones to profit from the unprecedented mass urbanization. Regional governments—many of which relied heavily on land sales for revenue—encouraged as much development as possible, and the seemingly endless demand for housing gave yield-starved Chinese investors a place to park their capital. Developers soon found themselves unable to keep up with the pace of demand and began to take on massive amounts of debt, much of it in dollar-denominated offshore bonds, and even started selling properties in developments that hadn’t even begun construction.
China’s government took notice of all this rampant speculation and took what it saw as reasonable steps to mitigate the threat of the collapse of the real estate market. It imposed new financing restrictions for developers based on their liabilities, debt, and cash holdings, as well as imposed new rules for banks to limit the amount of mortgage lending. Some developers, including the giant China Evergrande Group, were pushed into default by these new restrictions and were forced to put ongoing projects on hold while they sorted out their balance sheets.
Quirks in China’s real estate system meant that the newly paused or canceled projects were more than just the developers’ problems. Chinese homebuyers who had gotten mortgages and purchased unbuilt properties suddenly found themselves on the hook for properties that may never be completed, and many were understandably upset. More and more people began to protest the situation by refusing to pay their mortgages until upwards of $295 billion worth of loans were affected before the CCP started interfering with data collection on the subject. So far China’s government has been unsuccessful in trying to get the situation under control, though they are stepping up support for distressed developers and providing some special loans to help ensure certain projects are completed.
How Will China’s Housing Collapse Affect the World?
The current crisis has severe implications for the wider China economy, some of which are already being felt. S&P Global Ratings has claimed that around 20% of the Chinese developers it rates are at risk of going under, and that falling land sales have impacted local governmental revenues to the point that 30% of local governments may have to cut spending by the end of the year. Nonperforming real estate loans held by state-owned banks increased by a full 1% in 2021, a figure that is sure to grow as more recent data is made available. There is every reason to believe that the real estate market will suffer in the short to medium-term.
Harvard professor Kenneth Rogoff estimates that a drop of 20% in real estate-related investments could cut 5 to 10% out of China’s GDP, and that the subsequent drops in real estate and construction employment could create significant instability in China’s job market. Or, more broadly: “On the medium term, China faces a multitude of challenges, ranging from extremely adverse demographics to slowing productivity…Until now, the housing boom has been sustained by a broad economic boom that now faces steep headwinds.”
The intentionally opaque workings of China’s government make it difficult to predict exactly how the current crisis will play out. It is, however, possible to extrapolate the kind of impact the crisis may have on the global economy if China’s real estate market continues to deteriorate. The first and most obvious consequence of a serious slowdown in China’s economy will be felt by companies with significant exposure to China. Firms like Wynn Resorts, Apple, Tesla, and Disney would all suffer from the ensuing loss of revenue from China’s market, as would firms like Qorvo, Boeing, Caterpillar, and any other firms that rely on supplies from or sales to China.
In terms of Chinese companies, the ratings agency Fitch identified three main sectors that would be most vulnerable to a slowdown in the real estate market: Asset management companies, engineering and construction firms, and steel producers. Fitch also believes that small and regional banks would be most vulnerable to continuing difficulties—particularly if the trend of homebuyers refusing to make mortgage payments on properties that may not ever be built continues—though this may have little impact on the global economy beyond the consequences of a slowdown in China’s economy at large.
As dire as things may seem, however, it is important to remember that China’s government is acutely aware of the risks its economy faces from the current crisis. Pundits, analysts, and observers alike have been warning about an imminent collapse in China for years now, yet the closest we’ve seen was a self-imposed downturn that resulted from the government’s draconian attempts to eradicate COVID-19 within their borders. There is little reason to assume that China’s government’s control over their economy has slipped to any significant degree. Anathema as it may seem to western sensibilities, China’s government still possesses the tools, the will, and the monopoly on violence it needs to prevent the real estate market from destroying their economy as a whole.
The best response, for now, is to maintain the course. It may be a good idea to close positions concerning firms with significant exposure to China’s economy, but treat all other investments the same way you would when facing any other kind of economic headwinds. If the economies of Europe and the United States made it through the 2008 housing crisis, chances are China’s economy will weather this storm as well.
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China’s Housing Crisis: What Investors Need to Know
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