A Problem With The Great Monetary Experiment
A weekend topic on recent financial markets and the housing bubble. The Los Angeles Times. “Seven years ago when the housing bubble burst, it nearly took down Wall Street and the entire U.S. economy. This week, the concern was the reverse: That the prospect of an extended dive in the stock market, or even continued volatility, might spook buyers and sellers in Southern California’s housing market. Christian Lander put an offer on a Glendale house last week, before the stock market started falling. He’s proceeding as planned, because he’s investing for the long term and doesn’t want to react to fluctuations in the market. But Lander worries that other buyers may take a different view — because he’s a seller too, looking to unload his two-bedroom condo in Koreatown.”
“‘I am just hoping it won’t freak people out that this is a bad time to buy,’ he said.”
“George Pagano, a real estate agent with Immel Team Luxury Real Estate who specializes in coastal south Orange County, said his buyers are assuming that the stock drop-off is temporary and are not changing their intentions. But some sellers have been more willing to trim their asking prices from levels he considered unrealistic. This week, the owners of a five-bedroom house in Laguna Niguel reduced their asking price by $505,000, down to $3.9 million. ‘They are taking our advice to lower their expectations,’ he said.”
“Tom Berge Jr., president of the West San Gabriel Valley Assn. of Realtors, has had a different experience. He said three or four Chinese business owners looking to invest in homes have raised concerns to him over economic turmoil in China. But it wasn’t because they might no longer be able to afford local real estate. ‘Their fear is the government is going to limit the money that can freely move out of China,’ he said.”
Interest in New Zealand. “Last week I gave a presentation about the ‘big picture’ to a gathering of government officials in Wellington. I talked about China’s economy and financial market volatility, rather on-the-money topics given this week’s global stock-market meltdown! What’s unusual about this situation is that in the past large developing countries – and China is the largest – grew quickly and steadily. They provided a buffer during the business cycles of the developed world. The news out of China suggests that buffer is not as robust as it once was. It can’t keep acting as a sponge for the rest of the world’s economic over-spill.”
“New Zealand doesn’t seem particularly well-equipped to understand, prepare for and benefit from developments in China. Economists could do a much better job than they seem to be doing. We lack a good understanding of China. And that leads on to a second problem. We don’t understand how China affects us. There is a common pattern to the capital flows from China – the capital isn’t just flowing into stock markets and bank deposits in other countries (these are usually popular because they’re well regulated and it’s easy to cash up again) but into property.”
“As a country, we’ve been caught napping. We need to move beyond a focus on dairy prices and exports. What about unprecedented capital flows from China? Are the flows permanent or just hot money? Are we making the best use of the money? What are the social consequences of escalating house prices and how can we mitigate those?”
From Reuters. “The venerable Wall Street firm of Lehman Brothers went belly-up seven years ago. Since then, the Federal Reserve has engaged in an extensive monetary campaign involving near-zero interest rates combined with the central bank’s large-scale purchases of bonds. This experiment has delivered the weakest U.S. rebound on record while spreading what author Brendan Brown calls a ‘monetary plague’ into the furthest reaches of the global economy.”
“A recent study of historical periods of deflation by the Bank for International Settlements from 1870 to the present day finds only a weak connection between deflation and economic output. The BIS makes another important point: there appears to be a much stronger connection between a collapse in asset prices, in particular real estate busts, and economic growth than between deflation and output. The BIS argues that a bursting bubble produces a large immediate loss of wealth, albeit wealth of an illusory nature, while deflation simply redistributes a much smaller amount of wealth from debtors to creditors.”
“This points to a key problem with the Fed’s ‘Great Monetary Experiment,’ namely that it has inflated asset prices to unsustainable levels. Bernanke hoped that by making people feel richer, higher asset prices would induce them to spend more. After a run of good years, however, U.S. stocks have approached bubble valuation levels. Given the dollar’s role as the global reserve currency, Fed policy has also pushed down interest rates around the world, thus stoking real estate booms from Beijing to Vancouver.”
“In the wake of the global financial crisis, low U.S. rates also fueled a global carry trade, as yield-hungry investors poured into emerging market debt. At the same time, corporate borrowers in these developing nations availed themselves of low U.S. rates by borrowing in dollars, thus creating a potentially dangerous asset-liability mismatch.”
“The trouble is that asset prices – whether stocks, bonds or property, both in the United States and abroad – are now vulnerable to any future normalization of interest rates – just as the housing bubble and the subprime mortgage crisis followed from the Fed’s attempt to exit the Alan Greenspan easy-money era.”
The Indian Express. “Global markets were surprised by China’s devaluation of its currency, the renminbi, but they shouldn’t be. This is one of the inevitable outcomes of the bursting of its stockmarket bubble and Beijing’s lacklustre efforts to save the bubble as an engine of growth for a slacking economy. Besides losing face and wasting Chinese taxpayers’ money, the government has paid dearly for its misplaced faith in the power of the state.”
“It is unclear whether Chinese leaders realise this, but their expensive attempt to support a bubble has been a huge distraction from their real top priority — implementing difficult structural reforms to sustain Chinese economic growth. Instead of investing their time and energy in financial de-leveraging, squeezing out excess manufacturing capacity and reorienting the economy away from investment to consumption, Chinese leaders now find themselves helplessly watching the erratic gyrations of stock prices.”
“While the scale, timing and haste of Beijing’s operation may shock many, it does not come as a surprise to sceptics who have always doubted the CPC’s commitment to reforms. They have watched this bad movie many times before. Every time the party has to choose between wielding the power of the state or relying on market forces, it has consistently opted for the former. In this light, China’s decision to devalue its currency should not come as a surprise at all. As strong believers in the power of the state, Chinese leaders firmly believe they can fight the invisible hand. All it takes is strong political will. We can only hope that they will be proven wrong this time.”
