Whether in politics or in the media, words are increasingly used, not to convey facts or even allegations of facts, but simply to arouse emotions. Undefined words are a big handicap in logic, but they are a big plus in politics, where the goal is not clarity but victory — and the votes of gullible people count just as much as the votes of people who have common sense.—Thomas Sowell
In this issue
Phisix 7,250: Breakout on Shrinking Volume, Media Mounts Elaborate PR Campaign on the Property Sector, Why?
-Real Estate “Barber” Jones Lang LaSalle Sees ‘No Bubble’; But They Saw No US Bubble in 2007 Too!!!
-Rental Markets Indicate of Developing Price Strains, Global Property Guide Laments Manila’s Ghost Cities!
-Infrastructure, Construction and Property Boom? Where are the Jobs? Why the Price Deflation?
-Phisix 7,250: Gap Filling Breakout on Shrinking Volume, Peso Underperforms Asia
-China’s Government Sixth Interest Rate Cut: It’s NOT a Silver Bullet, It’s a Sign of Panic!
Phisix 7,250: Breakout on Shrinking Volume, Media’s Mounts Elaborate PR Campaign on the Property Sector, Why?
Real Estate “Barber” Jones Lang LaSalle Sees ‘No Bubble’; But They Saw No US Bubble in 2007 Too!!!
If you haven’t noticed, for the last two weeks, mainstream media has mounted what seems as an avalanche of “good news” or a full scale publicity relations campaign to promote the property sector.
Intriguingly, why the sudden media blitz? Have there been strains in the industry to have prompted for this? Has there been an upsurge in skepticism for media to defend the industry by citing ‘experts’, or in reality, insider opinions? Or has sales been stalling?
Well, Warren Buffett once remarked: Don’t ask a barber if you need a haircut.
Mr. Buffett’s “barber” parable was essentially directed at financial entities with hidden agendas or conflict of interests (agency problem).
The New York Times interpreted this quote as a “thinly veiled dig at Wall Street bankers and the perverse incentive system for corporate “advice”[1].
Industry insiders will tend to promote their interests than to candidly tell anyone of the real conditions.
Mr. Buffett’s don’t-ask-the-barber syndrome or the agency problem well applies to the Philippines today. This has been evident not only in the stock market but more importantly in the real estate industry.
The rabid denial of the real problems by projecting past into the future by industry insiders is a manifestation of don’t-ask-the-barber syndrome.
In defense of the industry, one of the last week’s articles cited a representative or an industry spokesperson who claims that because of statistical G-R-O-W-T-H, there is no bubble. In their dismissal of bubble concerns, the international real estate agency, the Jones Lang LaSalle (JLL) averred that properties represent “a connection between real income and the value of property”[2]
Really?
So what’s the connection between the sizeable downswing in the domestic formal statistical economy with skyrocketing properties? Or why has G-R-O-W-T-H rates of GDP and of property prices been substantially diverging? Or has the public’s income been growing in similar proportion to the spikes in land prices—25% in Makati CBD year on year and 10.3% in Ortigas during the 1Q—even when statistical GDP decelerated to 5%???? Through how and what means has property values been manifesting real income growth?
Also what explains the streaking slump of prices of everything else in the real economy—as seen through various to government measures: CPI*, general wholesale* and retail, construction materials wholesale and retail*, producers price index—to even money supply growth in the face of rocketing property prices and still double digit bank credit growth? The BSP** and bubble worshippers should reconcile on these divergences.
[*updated links]
[**The BSP explains in their 3Q inflation report that 2Q GDP was an outcome of “accelerated” consumer spending. Really now? Curiously, prices in the real economy have been collapsing. Unless the demand-supply (price-quantity) curve has been rendered obsolete and or dysfunctional, such sustained price collapse can only be explained as a consequence of a surfeit of supply—even when imports and manufacturing were in doldrums—or a slack in demand or both! Consumer spending growth, where?]
Anyway, property booms have not been signs of real economic booms but of speculative manic punts. Such speculative manias are manifestations of chronic monetary disorder that emerged out of financial repression policies. And speculative manias are representative of malinvestments. And malinvestments or the misallocation of resources are visible through the race to build capacity, based on expectations from an envisioned endless fountain of demand (which for bubble worshipers seem to fall from the heavens) that will only end in tears as theory and as history have always shown.
Some adverse repercussions from a property bubble I raised in 2013[3]:
Property bubbles will hurt both productive sectors and the consumers. Property bubbles increases input costs which reduces profits thereby rendering losses to marginal players but simultaneously rewarding the big players, thus property bubbles discourage small and medium scale entrepreneurship. Property bubbles can be seen as an insidious form of protectionism in favor of the politically privileged elites.
Property bubbles also reduces the disposable income of marginal fixed income earners who will have to pay more for rent and likewise reduces the affordability of housing for the general populace.
So instead of merely dealing with the economics, this time it would seem better to examine the track record of this (property) barber’s previous recommendations.
Question: Did JLL get to accurately identify the previous bubble before it blew up?
I know; past performance may not extrapolate to future outcomes. But past performance can give also us a clue on, not only on the methodology they employ, but also on the ethics practiced by firms or by individuals.
Flashback to the pre-Lehman US crisis.
At the climax of the stock market bubble even as US real estate has been on a descent, in August 2007, the company’s hotel arm predicted a $48 billion boom in hotel dealings for 2007[4]: (bold mine) U.S. hotel deal activity to June has already reached $32 billion, higher than we initially predicted. This represents more than half of the global volume of $56 billion for the same period,' said Kristina Paider, senior vice president of research and marketing for Jones Lang LaSalle Hotels. 'One half of the sales of this period were driven by REITs being taken private, and another third was private equity groups buying up real estate as well as management and brands, as seen with Blackstone's recent purchase of Hilton Hotels Corporation.' The 14th edition of Jones Lang LaSalle Hotels' Hotel Investor Sentiment Survey ('HISS') highlights investors' ongoing enthusiasm for the hotel sector. It shows that Americas' buyers outnumber sellers by 5:2. Investors indicated upscale hotels as their preferred asset type in 26 of the 29 surveyed markets. The survey also shows that 18.5% of respondents are now expecting to build hotel assets, indicating that investors are being pushed to consider development due to the shortage of available investment stock.
Unfortunately, one year after, or when the 2007 crisis was at its crux the same bullish firm admits[5]: (bold added) For the first nine months of 2008, hotel transaction volume was sluggish—especially in comparison to the rapid-fire buying and selling of 2007. Year-to-date through August 2007, total transaction volume was $36 billion, compared to year-to-date 2008 volume of $7.2 billion, according to Art Adler, CEO–The Americas of Jones Lang LaSalle Hotels. (By the way the title of the article sourced above had been spot on: “Transactions worse than most predicted”)
Bullish sentiment suddenly turned bearish. Yet the company had been caught blind or was totally clueless!
And it was not just about WRONLY predicting about the hotel industry’s ebullience, they were “Rah! Rah! Rah! Sis-boom-bah!” “no property bubble!” or “This time is different” or “bubble FOREVER!” on the US luxury property m market in 2007[6]: (bold mine)
“The triumph of the glamour cities turns conventional wisdom on its head—for quite a while, experts including Yale's Robert Shiller have been predicting that these cities, having been hyped the most, would likely fall farthest, fastest. The decoupling of national and local real-estate trends, which were once much more closely linked, reflects the lives of the new "superprime" property buyers themselves, roughly 50 percent of whom are expatriates, according to the global-property research firm Jones Lang LaSalle. While globalization has allowed money, but not necessarily people, to roam the world more freely, Cañas and his colleagues are an exception—they float on a cushion of international capital, largely immune to regional concerns, and are flush with cash…With so much money in so many more people's pockets, the demand for luxury housing in the most-sought-after cities has simply outstripped available supply, hence the eye-popping prices. This is especially true in the toniest quarters of these cities, where growth is often double or even triple the over-all city figures. "It's quite an interesting irony that these buyers are globally footloose," says Sue Foxley, head of residential-property research at Jones Lang LaSalle, "because there are probably only 100 streets around the world on their shopping list.
Awesome!
Demand for housing… outstripped available supply…rationalizations that sound familiar today?
What differentiates speculative demand from actual demand? Do they know?
Well in hindsight or in fait accompli, we all know how this turned out.
The Case Shiller New York Home price Index shows how New York as part of the glamour cities, which supposedly should have “decoupled” from real estate trends, were allegedly “immune to regional concerns”, were “flush with cash” and whose buyers were glorified as “new superprime buyers”, collapsed by about 25%, from its zenith in 2007 to 2010!
What happened to all the rationalizations or romanticization of the bubble?
Yet in the culmination of the crisis (October 2008) the company turned decidedly bearish on UK rental properties[7]: (bold added) Since early spring the world has, of course, gone much further to pot, reflected by the 1800-points drop in the FTSE 100 shares index. That has led rival property agents Jones Lang LaSalle to reach a much gloomier conclusion this month. They say rents for prime properties will fall by 22% by 2010, taking them down to £89.50 per square foot.
Unfortunately, UK’s rental markets turned in the opposite direction from their prognostication, as prime rents zoomed in 2010[8]: “Exacting lending criteria forcing many to rent rather than to buy – rents up over 12% in prime central London from a year ago as corporate letting market rebounds”. The chart above represented the overall rent in UK’s property market.
Such dismal performance in predicting markets’ inflection points reveal that the company seems more concerned about momentum chasing. And momentum chasing means banking or relying on recency bias (or anchoring), as well as, fickle crowd sentiment for their opinion, analysis and corresponding recommendations!
And they look like wonderful practitioners of Keynes’ sound banker principle: A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him
Tersely said, for entities that embrace the sound banker rule, they will NEVER see a bubble; even if the bubble stares at, and or even breathes or huffs and puffs on their faces. Such entities won’t see or know “irrational pricing”, as in pre-2008, because they are shills for irrationality!
After all, pardon the ad hominem, they wouldn’t want to bite the hand that feeds them. So they will go on with the ritual of incantations of an everlasting inflation boom based on selective ‘favorable’ statistics to frame their highly flawed no-bubble premises.
I wouldn’t count on this barber’s credibility.
Rental Markets Indicate of Developing Price Strains, Global Property Guide Laments Manila’s Ghost Cities!
On a similar vein, surprise (!) another article reveals that basic economic laws have been operating in the domestic real estate sector: “Increasing rents in established districts like Makati and Bonifacio Global City (BGC) has prompted a search for other office locations around Metro Manila as well as the provinces[9]”.
Although the article also was intended as another press release for the real estate industry, it unintentionally disclosed of what seems as developing strains from the ongoing price inflation.
The law of demand says that ceteris paribus or given all things constant “as the price of a product increases, quantity demanded falls”. So in application to the local property sector, this means that successive increases in rents has effectively been reducing demand for office locations at established districts like Makati and Bonifacio Global City. So tenant actions are simply manifestations that the law of demand works. Duh!
But another economic law in response to inflation seems also in operation.
Rising rents has impelled office consumers/tenants to resort to the substitution effect. The substitution effect which prods consumers to “replace more expensive items with less costly alternatives” can be seen above as…commercial tenants have been in “search for other office locations around Metro Manila…”!
So the law of demand and the substitution effect have been in motion!
The above anecdote affirms my arguments that severe property inflation in the establishment districts have been putting pressure on profits of BPOs and other office consumers/tenants to prompt them to look or scout for alternatives areas.
This is further evidence of how property bubbles discourage entrepreneurship or diminishes productive economic activities! Absurdly priced assets will reach its existential limits. Bubble exists because prices have been misaligned with real economic conditions in response to policy manipulation of the yield curve!
Yet the law of supply tells us that “an increase in price results in an increase in quantity supplied”.
Let us apply this fundamental economic law to current conditions.
Now the critical question is: given the reduced demand due to serial increases in rental prices which supposedly is being ventilated through the ‘substitution effect’, what will happen to the recent skyrocketing of property prices in the “established districts”? How will this affect the “increases in quantity supplied” or massive inventories built within those areas? Will there be a feedback mechanism between prices and the ongoing marginal shift in demand? If so, how will these affect profitability of developers and building operators? How will this also influence their capex plans? Moreover, how will this impact credit profiles, credit risks and general credit conditions?
Such news anecdote tells us that not only have the basic laws of economics been functional, importantly, economics 101 have been signaling escalating problems which is being glossed over, ignored or denied by the cheerleaders of the industry: Debt financed EXCESS capacity!
Yes, it is getting to be a lot more interesting!
To add to the string of pro-property hype, the popular international housing agency, Global Property Guide (GPG) in a confused article but meant to likewise tout on the domestic property sector also says G-R-O-W-T-H should sustain the upside momentum of prices of mostly the upscale property markets.
I say ‘confused’ because they bewail of “Manila’s Ghost Cities” or what they see as developing excess capacity on property markets serving the OFW driven ‘Barrio Fiesta’ middle class segment! They rightly point out that the middle class, powered by OFWs, doesn’t seem to have sufficient incomes to sustain demand from a huge inventory buildup by developers. So they warn of “Ghost cities”. It’s the second time they wrote about ‘Manila’s ghost cities’.
Ironically, in the same report, they say license-to-sell or permits to sell middle class housing spiked by 43% in 2Q 2015 from last year! Yet they see this as good news!
I guess that the GPG haven’t heard that growth rate of OFW remittances have fallen to less than 1% in two consecutive months, July and August (August was even a negative!). So what should happen to all inventories built for the OFW market?
Their ‘confusion’ not only stems from cheering one aspect which paradoxically they lament later, more importantly, they fail to see that one segment’s problem will eventually affect the other segments of the same sector that may also spillover to the other industries. For instance, some of the biggest developers cater to both high and mid end markets!
Furthermore, since properties are heavily financed by leverage or substantially rely on credit, one sector’s woes will the same contagion dynamics through the credit channel.
After all, the economy is complexly interfaced or interconnected.
More importantly, reliance on merely statistics to project demand can be a dicey proposition. The statistical economy is NOT the same as real economic activities. The statistical economy is supposed to represent estimates of actual performance. Because they are only estimates, they are subject to statistical deviation or errors.
Additionally, not only can statistical G-R-O-W-T-H be inflated to suit political goals of the incumbent leaders, statistical growth can be boosted from unproductive activities that will extract from future real economic activities or reduce the pool of real savings. (see my discussion on China’s interest rate cut)
Sound demand will arise from growth in incomes from real productive market based entrepreneurial activities, and not from speculation or yield chasing or from redistribution.
It must be stressed too that a growing population (demographic dividends) will amplify economic growth only when accompanied by income growth, again from the market based entrepreneurial activities.
And as noted above, current credit fueled demand for properties, which mostly have been about yield chasing speculations in response to financial repression policies, will prove to be unsustainable.
No less than the BSP’s own consumer loan data has exposed of the growing symptoms of malinvestments: the record jump in land prices in Makati and Ortigas in 1Q 2015 was concomitant with the swelling 1Q 2015 real estate NPLs! What happens more if property prices stop inflating or when credit expansion slows even more from the current rates???
Infrastructure, Construction and Property Boom? Where are the Jobs? Why the Price Deflation?
With the growth rate of OFW remittances substantially underperforming, I have noted last week of its possible ramifications on the race to build supply, the US dollar stock and the statistical GDP.
I said that if the September data won’t come up with 15.5% growth to retain the 5% quarterly growth, then the PSA-NSCB would have a hard time embellishing the fabled ‘consumer growth’ story via 3Q GDP. Of course, statistical ‘Sadako’ have always been the handy alternative.
Just a reminder, OFW remittances are not the same as BPO remittances. OFW remittances signify as money intended for final consumption. BPO remittances signify as gross business revenues for BPO firms. It would be a folly to believe that apples (OFWs) are similar to oranges (BPOs), because the distribution of spending will be different between them.
And another thing, I raised the issue that the recent attenuation of OFW remittances may be a function of weakening economic conditions of the Middle East. I used Saudi Arabia as example.
Well here are more circumstantial evidences. Last week, according to a report from Bloomberg, the Saudi Arabian government has reportedly been delaying payments to contractors for the “first time since 2009”. Companies working on Saudi’s infrastructure projects have been waiting for six months for payment! In addition, the IMF also has warned that the Saudi Arabian government may be headed for bankruptcy as she might run out of assets “needed to support spending within five years if the government maintains current policies”, from another Bloomberg report. All these have been indicative of the region’s dire economic straits to have likely reduced hiring on OFWs and wage growth of existing OFWs.
In the same report, I have also noted that government spending mostly through infrastructure reportedly zoomed in August.
Yet where is its alleged multiplier effect? Or has such activities percolated to the economy?
The online jobs market tells of little improvements.
Monster.com’s August Job data reveals of steep losses that continues to haunt the online job markets.
Year on year, Monster’s online hiring (left) was a huge negative 31%, but this represents a marginal improvement from July’s even deeper negative 36%.
Their data reveals that only two industries posted positive gains, particularly the IT, Telecom/ISP sector, which “witnessed the steepest growth at 10% year-over-year and the BFSI sector (banking, financial services and insurance) “which saw year-over-year growth of 2% after registering consecutive annual declines since March 2015”[10].
So the boom in the IT sector remains but the BFSI data could either be a dead cat’s bounce or a fledging recovery. I’d bet the former.
Meanwhile, Production/ Manufacturing, Automotive and Ancillary sector registered “the lowest activity since January 2015” accounting for “saw the steepest decline in online hiring activities with a year-over-year decline of -62%.”
It’s a curiosity, vehicles sales have been reported at record highs, so why the steepest decline in online job opening? Or have the auto industry been scaling back in anticipation of a slowdown?
And where o where has been the boom in construction jobs?
I also tabulate data of two other online firms every Thursday. I find that Monster’s data in consonant with the largest online job website, which is partly owned by a publicly listed holding company. I will call this firm “A”.
Nominal job opening numbers of “A” also zoomed in August but this failed to reach May highs (right window). The job numbers include overseas hiring. In the latter half of September until last week, online job openings plummeted again! Construction jobs also have plunged! Why?
Media says everything in the property and construction sector has been booming!
The third online job site I follow tells of a different story.
I call this firm online job “B”. For “B”, there was no August spike as nominal numbers demonstrate that online jobs continue to swoon! “B”’s numbers are incredible. Overall job openings have crashed by 54% from April! Construction jobs have similarly dived by an even more remarkable number: 66%!
All these job numbers seem to be in harmony with the ongoing slump in the government’s survey of retail prices of construction materials.
The following numbers are stunning!
Here is how the Philippine Statistics Authority sees it from a year on year basis[11]: (bold mine) On an annual basis, the Construction Materials Retail Price Index (CMRPI) in the National Capital Region (NCR) moved at its previous month’s rate of -0.4 percent. In September 2014, it grew by 1.3 percent. Negative annual rates were still posted in the indices of electrical materials at -1.5 percent; tinsmithry materials, -1.1 percent; and miscellaneous construction materials, -9.2 percent. Moreover, slower annual increments were noted in the corresponding indices of carpentry materials and masonry materials at 1.2 percent and 3.9 percent. A higher annual increase was however, registered in the indices of painting materials and related compounds and plumbing materials at 0.8 percent and 0.1 percent, respectively.
Now the month on month. Measured from a month ago level, the CMRPI in NCR declined by 0.2 percent in September. The indices of carpentry materials, masonry materials and tinsmithry materials dropped by 0.1 percent and miscellaneous construction materials, -3.1 percent. No movement was however recorded in the other commodity groups. Prices of nails, cement, corrugated GI sheets and steel bars went down during the month. The other construction materials group generally remained stable this month as they registered a zero growth.
The government’s price measure of wholesale construction materials[12] has even been worst!
Wholesale prices have been in DEFLATION for TEN straight MONTHS! And the scale price declines have been significant!
Hasn’t this been a striking irony? For a country supposedly undergoing a construction boom, the industry’s prices have been on a DEFLATIONARY cascade, whether year on year or month on month!
Just Incredible!
This comes even as banking loans to the construction sector have been on fire! While the rate of growth of banking loans to the construction sector has certainly subsided or has halved from the peak in 2013, they are still growing at 30% (32.5% y-o-y in August)!!! September data will be due next week.
Yet, where have all the money from banking loans been flowing to? Why the collapse in job openings whether general jobs or in construction jobs??? Why the persistent price deflation in construction materials since March (for retail) and since December 2014 (for wholesale)????!!!
The supply side is unlikely the major force behind this as imports and manufacturing have been sluggish for most of the year. Import growth rates have only rebounded in June and July.
This leaves demand.
But if demand has been stagnant then what’s the media's hubbub over infrastructure and property boom? Either media has been immeasurably exaggerating, or the government have been getting her data inaccurately from her surveys.
Additionally, to say falling prices have been a result of external influences signifies a bunch of hooey. One, as shown above, the industry’s falling prices, if accurate, has been widespread. Even those imported items, given the strong USD, have shown downside pressures!
Two, falling prices abroad will be theoretically counterbalanced by demand and supply in the domestic economic setting. Said differently, if demand has truly been robust, then falling prices abroad will be offset by increased demand here, hence price declines will hardly happen consistently or in a streak as seen above.
Yet, has money from the banking loans to the general economy, which growth rates have been MORE THAN DOUBLE than the GDP, been mostly channeled to debt repayment?
Are credit strains being reflected on domestic yield curve to impel for a massive flattening, despite the manipulations to force a steepening???
A recovery in BFSI jobs? The narrowing spreads shows a compression of net interest margins and eventually financial profit squeeze.
Or has most of credit expansion been directed to property (and stock market) speculation? And thus the downside momentum of statistical GDP, since speculative activities have become dominant or has replaced productive economic engagements.
These indicators run contrary to media hype!
Phisix 7,250: Gap Filling Breakout on Shrinking Volume, Peso Underperforms Asia
The Philippine Phisix stormed out of its consolidation mode to erase this year’s losses. This week’s astounding 2.56% gains emerged out of a very weak volume breakout.
This week’s gains has lifted year to date returns to .08%.
Friday’s afternoon headline from Wall Street Journal pretty much explains last week’s frantic pumps!
In stocks, the Philippine PSEi was one of the outperformers of the Asia (left). On the other hand, the peso one of the Asia’s underperforming currency last week (right).
Based on official close, the USD PHP soared by .85% to close at 46.44.
In other words, the falling peso has defied or has diverged from the bullish backdrop at the PSE. Add the narrowing bond yield spreads to such disharmony.
In the past the weak peso coincided with an equally feeble PSEi. Has the peso-PSEi correlations changed?
Yet this week’s breakout brings the 2013 the taper tantrum gap filling move in play.
As I have previously noted, the gaps from the two 6+% one day crashes in 2013 were both filled. Eventually both ended much lower than the lows established from the crash (right)
The new low signified as the staging point for the recovery.
Will history will rhyme or will this time be different?
Let me delve deeper on the PSE breadth.
This week’s rally has been broad based.
All sectors posted major gains with the service and industrial sector leading the pack or contributing to most of the index gains. The industrial sector had been spearheaded by energy issues and by URC, while the service sector was largely buoyed by PLDT.
Of the 30 PSEi issues, 27 advanced while 3 issues declined.
This week’s aggregate market breadth went in favor of advancers. Advancers led by a hefty margin of 82. But this margin came largely from two days of activities. On a daily basis decliners led by 3 days to two.
Yet in a display of the late cycle activities, many third tier or ‘basura’ issues have essentially run amuck or have shown wild volatilities that run in both directions (but with an upside bias).
Perhaps the most telling feature for this week’s action has been the breakout with strikingly THIN volume.
For the past two weeks, on a daily basis, nominal peso volume has mostly traded at Php 5-6 billion range (upper window). This comes even when the Phisix attempted to break past the previous resistance levels at 7,150.
Yet Friday’s October 23rd breakout came with volume even LESS than the other Friday’s October 16th volume when the PSEi closed marginally higher by .14% to 7,055!
Even more amazing has been that on an aggregate basis, daily volume (averaged weekly) accounted for the THIRD lowest for the year!
Breakout on diminishing volume! Just awesome!
Of course, what would the current boom look like without help from price fixers?
China’s Government Sixth Interest Rate Cut: It’s NOT a Silver Bullet, It’s a Sign of Panic!
The Chinese SIXTH interest rate cut won’t serve as a silver bullet.
Why? The Gavekal Team explains[13] (bold mine)
The measure is supposed to spur growth and make life a little easier on debt-ridden Chinese companies. In the immediate term it may give a slight boost to the economy, but there is no chance this measure, or others like it, will keep the Chinese economy from slowing much further in the years ahead. Let us explain.
The continued and dramatic slowing of the Chinese economy in the years ahead is baked in the cake. For the last decade Chinese growth has been fueled by investment in infrastructure (AKA fixed capital formation). In an effort to sustain a high level of growth massive and unprecedented investment in fixed capital was carried out and fixed investment has now become close to 50% of the Chinese economy. On the flip side, consumption as a percent of GDP has shrunk from about 46% of GDP to only 38% of GDP. Most emerging market countries run with fixed investment of around 30-35% of GDP and with consumption accounting for about 40-50% of GDP – exactly the opposite dynamic of the Chinese economy. China has run into a ceiling in terms of the percent of the economy accounted for by fixed investment and now fixed investment must shrink to levels more appropriate for China’s stage of economic development. This necessarily implies a slowing of the Chinese economy from what the government says is near 7% to something closer to 2-4%, and that is in the optimistic scenario in which consumption growth picks up the pace to mitigate the slowdown in investment.
This is why cuts in rates mean practically nothing for China’s long-term economic prospects. In the short-term rate cuts may postpone corporate bankruptcies by allowing companies to refinance debt at lower rates. Rate cuts may also make housing more affordable, on the margin. But these are cyclical boosts that act as tailwinds to China’s economic train. No amount of wind, save a hurricane, is going to keep the train from slowing.
It is important to reiterate that last week’s policy response accounts for the sixth action in just 11 months, as shown in the above chart (below window).
This goes to show that one policy measure have led to subsequent sets of similar policy actions. That’s aside from the other administrative responses (partly depicted below). This means that the previous series of rate cuts have failed in its objectives, hence, should signify as failure of government’s responses.
Importantly, to cram FOUR rate cuts in SIX months suggests that the PBOC has been in a panic mode. Why ramrod credit on her constituents whom have already been smothered by too much debt?
Obviously, the present policy response also represents the ‘doubling down’ of the same measures in the hope that at a certain level such monetary therapy would work its wonders. It’s a great example of doing the same thing over again and expecting different results from it. Someone once called this insanity.
Importantly too, with fixed investment now “close to 50% of the Chinese economy” such are manifestations of years of accrued unsustainable economic maladjustments (see upper window in chart).
The fixed investment boom emerged out of the government diktat. Part of this accounted for the thrust to shield the economy from the global financial crisis in 2008 through a massive $586 billion stimulus package. The fixed asset boom has principally been financed by credit expansion that piggybacked on the stimulus. The outcome has been to swell China’s banking assets to $28.84 trillion in 1Q 2015 (mostly through loans) which is almost double US banking assets at $15.545 trillion as of October 2015.
Such massive politically dictated investments, mostly channeled through local government units and their private sector representatives, have accounted for the immense ghost projects and the industrial capacity excesses.
In other words, the government’s fixed asset boom model can’t simply be sustained. More importantly, the $29 trillion of balance sheet expansion that has bankrolled such vast malinvestments will obviously see a day of reckoning.
Yet how effective was the initial actions? Or what has happened during the past year or when the rate cut was initiated last November?
The government have also deployed tens of USD billions (some acquired through credit) to shore up the stock market through mandated purchases by state owned firms and by some private brokerages. So whatever rally we are seeing today stands on the foundations of a sustained political lifeline support. Take away such lifeline, and we should see another bout of turmoil.
Second, those interest cuts seem to have succeeded in temporarily bolstering housing prices particularly in May to August. Unfortunately, according to the Bloomberg, such nationwide price growth has been weakening as “values in first-tier cities that have led the recovery are softening”. Yet loans to the property sector have been spiraling. Property loans have spiked by 20.9% year on year last September!
Third, the Chinese have been addicted to asset bubbles. With housing and stocks in stupor, corporate bonds have become the new objects of leveraged manic speculations. And leverage has been channeled through repos.
Reports the Bloomberg[14]: Where China's retail investors traded stock on margin, when it comes to corporate bonds investors appear to be using a different form of leverage known as repo. Repoing bonds allows investors to effectively pawn the assets in exchange for short-term loans that can be deployed into additional assets. According to HSBC, the daily volume of one-day repos on the Shanghai Stock Exchange has doubled since 2014, indicating investors are using that particular form of leverage to juice their returns. Meanwhile, structured products that allow investors in more junior tranches to leverage on the senior slices have also appeared, effectively allowing investments to be leveraged by as much as 10 times.
Sadly, the happy days from repo financed bond punts appear to have hit the proverbial wall as China’s repo markets have recently been showing signs of strains. Another Bloomberg article notes that[15]: “Chinese bankers say a debt-driven bond market rally is starting to show the same signs of overheating that preceded a collapse in equities. Repurchase transactions allowing investors to use existing note holdings as collateral to borrow money for one day doubled in the past year to a record 2.1 trillion yuan ($331 billion) on Tuesday. The cost of such funding in the interbank market has risen to 1.87 percent from a five-year low of 1 percent in May and has swung violently before, reaching 11.74 percent in June 2013. A similar contract on the Shanghai stock exchange climbed to 2.21 percent as equities rallied. Credit spreads near the narrowest in six years are being questioned after a state-owned steel trader missed a bond payment.”
These outflows have likewise prompted the government to devalue the yuan last August. The Chinese government have become so desperate to preserve the illusion of stability, by preventing the decline of its foreign reserves, for them to resort to the camouflage of foreign currency swaps.
The Bloomberg reports that “The People’s Bank of China and local lenders increased their holdings in onshore forwards to $67.9 billion in August, positions that would boost China’s currency against the dollar. The amount is five times more than the average in the first seven months, PBOC data show…Standard central-bank intervention to support a currency generally involves selling dollars and buying the home tender. In this case, China’s large state banks borrowed dollars in the swap market, sold the U.S. currency in the cash spot market and used forward contracts with the central bank to hedge those positions.”[16]
Given what seems as a sharply slowing economy in the face of a gargantuan debt burden, a feedback mechanism from the escalation of these two forces would be catastrophic.
So last week’s rates cuts have been intended to kill as many birds with one stone: namely, sustain the ‘animal spirits’ in the manifold domestic bubbles (property, stocks and bonds), postpone bankruptcies through the refinancing debt at lower rates, ensure the unbridled access to credit, flush the system with liquidity, fund government spending, stanch capital flight, keep the yuan and shibor steady or stable, support statistical G-R-O-W-T-H and HOPE that all these would bring about real economy growth. Of course, such hope would entail the diminishment of the risks of increased social instability which would jeopardize the reign of the incumbent leaders.
As for the shift to mythical consumption economy, it is important to understand that one can only consume what is produced. One cannot consume what is unavailable.
The lesson is consumption is a function of production. Alternatively this means consumption cannot just fall from heavens. Consumption has to be funded principally by income (or savings or credit—the latter represents future income) generated from production, and consumed on production outputs—as seen in available products and services.
So unless the Chinese government will be successful to replace the US dollar, with her currency, the yuan, as the world’s currency reserve for her to benefit from seigniorage profits, which should allow the Chinese political economy to go on a twin (budget and trade) deficits (Jacques Reuff’s ‘deficit without tears’), adapt financialization that would enable her to substitute production, and or, export production abroad, her constituents would need income for consumption. Where do you think such income will come from? From Sadako?
