March 6, 2016

A Zero-Interest Rate Liquidity Trap With No Easy Exit

A weekend topic on three opinion articles. ABC News in Australia. “When it comes to bubbles, Australian property ticks pretty much all the boxes. If there is a sharp correction in the eastern states it will have a devastating impact on our banks and economy, writes Ian Verrender.”

“As of December, mortgage debt over property issued by Australian banks and other authorised institutions has grown to just shy of an eye-watering $1.4 trillion. In 2008, when APRA first began compiling the statistics, it stood at just $638 billion. In the intervening years, not only has the number of mortgages ballooned, but the average size has grown as the property market has kicked into overdrive.”

“That doubling in Australian housing debt is remarkable and concerning, not just because of the short time frame and the fact it partly has occurred during a period of the lowest wages growth in history, but because a great slab of it has been struck at record low interest rates.”

“Throughout 2014, governor Glenn Stevens repeatedly brushed aside calls to impose controls to curb housing prices. But last year, in a sudden about face, he described Sydney housing as ‘crazy’ and within months, the banks were forced to restrict investment housing loans. The result? Investors, who accounted for 39 per cent of all new mortgages in June last year, now make up 36 per cent.”

“That measure was combined with a crackdown on the rorts surrounding foreign property purchases, where a flood of money out of China appeared to be pouring into established Australian housing. Foreign investment rules were not enforced, nor was any real data collected. So suddenly, the heat is ebbing from Sydney and Melbourne property prices.”

The Hong Kong Standard. “What’s happening in the mainland property market defies common sense. On the one hand, stockpiles of unsold new homes across the country are huge. On the other hand, home prices in first- tier cities like Shanghai and Shenzhen continue to soar to unprecedented levels. The phenomenon is strange, yet not difficult to understand if we look at what’s been occurring elsewhere around the mainland.”

“In less privileged cities, prices remain soft, with few signs of recovery. Ghost cities - new developments without residents - remain everywhere. These contrasting fates are inevitable, for smart money knows where to go. If political will can dictate where money flows, policymakers would have already solved the problems, so that the A-share bull market would still be alive, and the ghost cities would be vibrant with activity. The sad reality is things don’t always go according to plan.”

“It’s clear that the property bubble is continuing to build in major cities. To buy a flat, residents braved the winter cold to queue overnight in Shanghai. In Shenzhen, gangsters took up front positions in the queues, only to sell their positions later to buyers at, well, gangster rip-off rates. Such sights were common in Hong Kong prior to the bursting of the bubble in 1997.”

“However, central banker Zhou Xiaochuan has insisted mortgages are within safe levels despite the quantum price leaps. That may be the case officially - which can be deceptive - for it’s common for mainlanders to obtain secondary or even higher mortgages via a P2P platform, real-estate agents or finance firms. In some cases, a loan can be higher than a property’s price.”

“The bubble won’t burst as long as prices keep rising. The problem is that these activities aren’t supervised. After Beijing made it an objective to clear housing inventories, new lending hit a record high of 2.51 trillion yuan in January. It wouldn’t surprise me if a significant portion of that finds its way into places like Shenzhen to feed the bubble. By the way, congratulations if you own properties in Shenzhen, for it may be the time to lock in profits. But make sure you do so before the bubble bursts.”

Stephen Roach at the Asian Sentinel. “Seven years after the Great Recession, the world economy continues to struggle. After a wrenching financial crisis morphed quickly into a severe downturn in the global business cycle, the subsequent recovery has been unusually weak, lacking the vigor that normally insulates the world from subsequent shocks. With a multitude of shocks continuing to batter today’s troubled world, the probability of a relapse remains high. To a large extent, the world is mired in a Japanese-like secular stagnation.”

“The stage was set with a fractional increase of just 0.028 percent in world output, or GDP in 2009 – the weakest year in the global economy since the end of World War II. Students of global business cycles have long maintained that the world usually lapses into recession when global GDP growth pierces the 2 to 2.5 percent threshold. Relative to that standard, it’s not too hard to figure out why the 0.028 percent increase in 2009 is now known as the Great Recession.”

“Yet the economic situation is even worse when compared with the normal cruising speed for the global economy. Prior to the Great Recession, over the 1980 to 2008 period, world GDP growth averaged 3.5 percent. Relative to that trend, the shortfall in 2009 and its subsequent anemic rebound is all the more distressing. Looking at the six-year global recovery in its entirety, by 2015, the world had recouped only about half the 3.5 percentage point shortfall from the trend that opened in 2009 – marking the deepest and most protracted shortfall on record for the modern global economy.”

“Japan’s stagnation –now known as its lost decades – emerged in the early 1990s. Over the 1992 to 2015 period, Japanese real GDP growth has averaged just 0.8 percent – a stunning collapse when compared with the 7.25 percent growth trajectory of the preceding 45 years. At work have been the protracted aftershocks of a wrenching balance sheet recession following the bursting of two massive asset bubbles – equities and property – that led to the implosion of a highly leveraged keiretsu system of banks and corporations.”

“As Japan Inc. unraveled, Japanese policymakers resisted the restructuring and structural changes that might have spurred recovery. And the economy slid down the slippery slope of a ‘liquidity trap’ with zero interest rates and a massive overhang of debt. The purportedly Herculean efforts of Abenomics have not made a difference; real GDP growth has averaged just 0.7 percent over the 2013-2015 period since the ‘three arrows’ of Shinzō Abe were first fired, fractionally slower than the 0.8 percent trend in the preceding 21 years of Japan’s first two lost decades.”

“While no two economies are alike, telltale signs of the Japanese disease are evident in the United States and Europe. The American consumer felt the full force of a wrenching balance sheet recession during the Great Crisis of 2008-2009. Consumer spending had been artificially inflated by the confluence of massive property and credit bubbles. When they burst, the overly indebted, savings-short household sector plunged into an unprecedented balance sheet recession followed by an anemic recovery. Over the eight-year period, 2008-2015, growth in inflation-adjusted consumer expenditures has averaged just 1.5 percent – less than half the 3.6 percent pace of the preceding 12 years – as consumers opted for the balance sheet repair of deleveraging and saving over discretionary consumption. Like Japan, the United States now finds itself in a zero-interest rate liquidity trap with no easy exit.”

“And so it is for Europe, after its bubble-prone peripheral economies of Portugal, Ireland, Italy, Spain and Greece all imploded in the aftermath of the Great Crisis. Europe’s subsequent policy response – zero interest rates, quantitative easing and now negative policy rates – is a script right out of Japan’s playbook. And with worse results – average real GDP growth of just 0.1 percent in the euro area over 2008-15. Moreover, a lagging restructuring of the European banking sector is reminiscent of a similar phenomenon that afflicted the zombie banks of Japan.”

“With the major engines of the developed world sputtering, the rest of an interdependent world has been turned inside out. That’s especially true of the resource economies, both in the developed world like Australia and Canada, but also in the developing world – Russia, Venezuela and Brazil – and, of course, in the oil producers of the Middle East. Steeped in denial, resource economies were counting on the commodity super-cycle to persist indefinitely – the opposite of what has since transpired.”

“At the same time, other export-led developing economies are also struggling to stay afloat. China has felt the full force of the malaise in the developed world with a stunning downturn in its once omnipotent export sector. After exports peaked at 36 percent of GDP in 2006 – a seven-fold increase from the 5 percent portion of 1978 – its export share plunged to 23 percent in 2014 and even lower last year. With China’s contribution to global economic growth more than twice that of the combined contribution of the so-called advanced economies over the past decade, China’s export-led slowdown has played a key role in the downshift of world economic growth.”

“There is no quick fix for the globalization of secular stagnation. Japan is the template, and it’s well into its third lost decade. Yet there is still great denial elsewhere in the world over the main lessons of Japan. Policymakers and politicians – to say nothing of workers and their families – are paying a steep price for reckless economic management.”

Bits Bucket for March 6, 2016

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