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Mark's Market Blog

12-4-10: Real estate bubbles in the US and China

By Mark Lawrence

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Korea isn't at war. Ireland accepted their "bailout," bailing out UK, German, and French banks on the backs of Irish taxpayers. The jobs market continues to "improve," that is we're losing jobs less fast. Bernanke continues to spend money with the express intention of moving the markets upwards. Never fight the Fed. The markets shot up this week.

S&P 500 June 20 2010 to December 3 2010

The word on the street is that Obama is ready to cave on the Bush tax cuts, extending them for two to three more years. Liberals are furious with him. Obama ran promising to unite the left and right, and I think he's making good progress on that. If the Bush tax cuts aren't extended by Dec. 15th, look for a market drop for the last two weeks of the year as people dump stocks to realize gains this year at the lower rate. My prediction: A compromise will pass, late, and the market will shoot up after a dip.

This week we're all scared of Euro debt. Iceland, two years ago, had a serious banking crisis. They considered a bailout of their banks, and decided instead to let them fail. This has been very hard on Iceland, but not nearly as hard as a bailout would have been. Iceland has their own currency and was able to lower their exchange rate, an important step towards recovery. Ireland doesn't have the option of lowering their exchange rate as they use the Euro, and now is hearing from the EU that the Irish taxpayers should bail out Irish banks and their bank's creditors in France, Germany and the UK. It's becoming clear to Irish taxpayers that the price of Euro membership is going to be horrendous. However, with Portugal hot on Ireland's heels in terms of bank problems, and Spain just a step or two behind, it's important to the EU that Ireland toe the line and that their taxpayers take a few on the jaw. Else the precedent could destroy the Euro and bring down French and UK banks, and possibly even German and Swiss banks.

Ireland got their "bailout." This bailout didn't change their debt, it didn't change their interest rate, it didn't change their future prospects. Ireland is still in serious trouble, serious enough that it's likely in January they'll have a shiny new government. So, what did change? This is a standard game of bankers everywhere. In good times bankers buy a bunch of bonds, like Irish bonds, without much thought. One day it starts to all go bad, and it looks like maybe the bonds won't be repaid. This is where the bankers have a standard game that they've been playing for several hundred years. Get the population panicked. A long, deep recession pretty much does this for them. Get the politicians to promise to do something, anything. A panicked population pretty much guarantees this will happen. Get a slogan going, "save the banks or the economy will collapse." Then the bankers offload the suspect bonds onto some government agency, like the Fed or in this case the European Central Bank. The ECB / Fed keep the market from collapsing for a year or two, and this gives the bankers time to swap their Irish or Portuguese or California or mortgage bonds for treasury notes and ECU bonds. Then a couple years later it all falls apart and the original bonds are shown to be next to worthless, but now they're owned by the taxpayers, not by the banks. This is who got bailed out this weekend: French and German and British and Swiss bankers. And who got screwed? Irish, British, French, German taxpayers and workers. But that screw job won't be apparent for another 18 to 36 months.

Belgium has now gone 6 months without a government. Belgium is effectively two countries taped together: Walloon in the south, primarily made up of French speakers who believe in big government with big government handouts; and Flanders in the north, made up of Germanic / Scandinavian stock that believes in hard work and saving. The northerners are getting sick of paying for the southerners benefits. It looks a lot like the country will split in two, however it's unclear that the European Union can tolerate this. EU membership is looking less and less like the wine-of-the-month club and more and more like a prison sentence for a lot of the countries not named France or Germany.

Why is the Euro zone having trouble? Economist Duncan Weldon points out that German unemployment is at an 18-year low, while Euro zone unemployment is at a 12-year high. There are conflicting priorities among the Euro zone nations. This suggest that the simplest solution to the Euro problem is for Germany to quit, and the rest of the nations to devalue. Unfortunately, the entire reason for the Euro is to keep Germany tied to the rest of Europe, so once Germany is out there's no point.

Back on November 10th, a month ago, a Los Angeles KCBS helicopter cameraman, Gil Leyvas, shot footage of what appeared to be a missile plume raising over the pacific near LA. The pentagon immediately denied knowing anything about it. Now it's coming out that this was a missile test, fired from international waters, by a Chinese nuclear submarine. The missile is reported to have been tracked in detail by the NSA, and to have landed in China; an obvious reference to the idea that they can launch missiles from their submarines off the Chinese coast and hit Los Angeles. It seems our government doesn't think we can handle the truth. I think they should have used Jack Nicholson to give their press conference denying everything.

China has announced plans to build 10 million low income housing units in 2011. Here in the US we have an overhang of about 5 million foreclosed and delinquent houses, and this is going to trash our housing market for three to five years; China will build double this in a year. China started this program in 2008 when they ordered 1 million units built. In 2009 they liked it enough that they built another 3.3 million; in 2010 5.8 million small apartments. If you want to stimulate your economy and put unskilled people to work, this is how to do it: spend $210 billion on building 10 million new apartments. Many of which will likely be occupied by the guys hired to build them.

China also announced they would change their monetary policy in 2011 from "moderately loose" to more "prudent." What does this mean? Well they will still have to pay for the $210B of apartments, but apparently they won't be paying by simply having their banks print up the money. This would indicate that they will be paying more with savings, e.g. US Treasury bills, and less by printing money. Bernanke is buying treasury bills to drop the value of the dollar, import less, and export more. China doesn't like this policy, so they will sell treasury bills to offset Bernanke's work and keep the dollar up and the Yuan down. Grab some popcorn, this show is starting to get interesting.

When I was young, I worked for Clay Matthews who taught me, "I've seen a lot of companies that are profitable as hell, but have no cash, so they can't meet their Friday payroll. They're out of business. I've seen companies losing $1 million per month, but they have $50 million in the bank, they're in great shape." China has $2.6 trillion in the bank, they're in great shape. They're printing money and causing inflation, but this tends to devalue the Yuan so that's ok with them. They're inflating real estate bubbles, but they have lots of savings, they're building housing for their people, and they're making jobs, so that's ok with them. Their bubbles will pop - bubbles always do - but not in the immediate future. Similarly, Japan has been running enormous deficits for 20 years now. However, until recently, their citizens had a 15% savings rate, so they sold their government bonds to their own citizens and nothing bad happened. Now Japan is aging and their savings rate has dropped in the last couple of years to 2% as their people start retiring and drawing down on savings. Now, after 20 years of seemingly bad policy, now Japan is near the end. China has a ways to go.

Unemployment numbers came out. Not so great. Unemployment is back up to 9.8%, we've made no jobs progress all year. I've added my own little blot to this month's graph, some blue dots showing roughly what unemployment would look like if this were like the other recessions. If it were, unemployment would be about 7.3% instead of 9.8%, and we would have about 3 million more people working.

Calculated Risk Blog's unemployment graph

Six months ago the government's first-time buyer housing subsidies ended. How are things going? Not well. Price reductions since then are 15% to 25% or more in much of the US. The overhang of foreclosed houses not yet on the market is only growing, showing that the worst is not yet behind us. Where is the storm gathering? New Jersey, Arizona, Nevada, Florida. Houses on the Florida coast are already down in price by half or more compared to their peak, with another 20% to 25% reduction anticipated in 2012. If you can't afford a Greek island, consider a Florida condo. In the graph below we see that new homes aren't selling at all, we're waiting on the existing foreclosed homes to sell and the market to clear. There will be no hiring of unskilled workers until this happens, a few years from now.

New And Existing Home Sales, 1994-2010

New home sales, and with it construction and employment, have fallen off a cliff. This same thing will happen when China's bubble bursts, but they have 500 million people to house so this is in their longer term future.

New House Sales 2000-2010

What new homes that are selling are smaller and selling for a lower price - which also means they need less labor to construct.

New House Median Price 2003-2010

Meanwhile, we have record numbers of used homes sitting around waiting to sell. Until this market clears, nothing else will happen: no new construction, no employment, no clearing of the mortgage bond market. This crisis has in now way run its course.

Supply Of Houses On Market 1998-2010

Should jobless benefits be extended? Many people have been collecting unemployment benefits, which normally last for 6 months, for up to for up to two years. Some claim that these benefits mean people aren't motivated to look for work - statistics and anecdotes back this position up. Others claim the jobs simply aren't there, and cutting off these benefits will push the country back into recession, causing yet more people to be laid off. Statistics and analysis also backs this position. It's likely the democrats will vote to extend benefits for three to six more months, then leave the republicans to cut them off and take the heat. This is the central problem of the coming decade: what do we do with 10 million workers that have no value to our economy?

We've seen a couple deficit reduction package proposals now, one from the conservative Heritage foundation, one from the bi- partisan Simpson-Bowles commission. Now the liberals progressives have a plan too. A quick overview: 1) slash defense spending 2) put a single-payer option into Obama care and increase it's coverage 3) raise carbon taxes, social security taxes, medicare taxes, capital gains taxes, dividends taxes, income taxes, "speculation" taxes 4) limit deductions to 15% of income 5) increase federal spending on child care, education, R&D, infrastructure. One wonders, if these guys love French style government so much, why don't they just move there?

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