Recessions are good. Not because of the human turmoil and unemployment they produce but because they are the only economic mechanism which correct poor resource allocation. Without this periodic "house-cleaning" nations accumulate wasteful companies, industries and institutions. The resulting inferior productivity costs jobs and wealth. It also engages workers in activity which are unsustainable. Arguably they are punished the hardest.
Here in the UK, our recession has appeared extremely mild so far as compared to the US.
Two Bullets - One to Come
We have actually had a bigger hit than most British people feel directly. Whilst nominal GDP has dipped mildly, "real" GDP has plunged massively. I believe the political definition of recessions is nonsensical. Nominal GDP does not take into consideration the massive loss of wealth of the nation from its currency devaluing.
Sterling has taken a caning against pretty much all currencies since 2007. It has almost halved against the Swiss Franc. Even against the much maligned USD, we are nearly 25% worse off. This does put the country in a hole - don't kid yourself that we are coming out of recession because there is 1% nominal GDP growth. If a British company wants to invest/enter a new international market, it will be 20-30% more expensive to so so than three years ago, just because of the weak pound. Put another way, that company has become 20-30% poorer on the international stage. The fall back position we are left with is to try and export our way out of trouble from a domestic base as now everything we produce is cheaper in a global market. Hopefully this will reduce our trade imbalance and help the country reduce its debt. If this happens, then Stirling will start to strengthen and real GDP can increase. That's quite a slog ahead and will take much longer than nominal GDP growth figures imply.
Second Bullet To Come
The second recessionary knock is naturally going to be the job losses in the public sector. It is difficult to see the private sector creating sufficient jobs next year to absorb these workers. Most concerning is that many of these workers have developed skills solely for the public sector which have little application in the private sector. Too many workers have been engaged in activity that just was not sustainable and it will take many years to integrate them into productive society.
My Beef With Nominal GDP Figures
Simply, it enables politicians to claim the economy is far healthier than it really is. It masks the fact that our economy plunged in 2007, and it will not recover for many years. Consumers increasingly feel this reality as they now have virtually no discretionary income due to soaring food and energy prices.
Thursday, November 18, 2010
Tuesday, November 16, 2010
UK House Prices - 2011 and Beyond
In 2007 we saw the images of Northern Rock customers queuing on the streets to withdraw their funds. It seemed that finally the exuberance in the housing market was going to be deflated. Three years on and this has not happened to any really significant extent. Up until recently, I have been waiting for the monthly data from various sources to show an accelerating rate of falls. In reality, the market has traded sideways at a level just below the all time peak. When markets do not do what you expect them to you eventually have to ask why.
Life Before and After Northern Rock
Prior to Northern Rock, the housing market appeared on the face of it similar to any other. Ultimately, one believed it was driven by the invisible hand of market forces. Clearly the explosion of credit was propelling it forward but supply/demand fundamentals still appeared at the fore. The reality of the market has become apparent post Northern Rock - the house market is subsidised by the UK taxpayer.
If Northern Rock and HBOS had been allowed to go to the wall, then a drastic correction would have occurred in house prices. Instead, the taxpayer came to the rescue and has been putting in scaffolding under a fragile market ever since. Approximately 70% of households are owner occupied so there are political and economic reasons why this is the case.
Economy and Consumer Penalised
Ultimately, it is bad for the British public. In the long run, high house prices benefit very few. Non-owners and owners are now being taxed to support the value of their house.
This can not be good for the economy but policy is now backed into a corner by housing data. Even though the market is viewed as over-valued, any significant falls towards a healthy level are apparently unthinkable. A depressed housing market will be used as good reason for further QE.
2011 and Beyond
This has profound implications for the next few years. I believe the market will feel a heavy hand on its head as consumers struggle with job losses, rising food/petrol prices etc resulting a downward grind by a few percentage points, probably between 5% and 10% over 2011. Beyond this, the data will probably not get much worse. If it does, the BOE will be quick to inject liquidity and rubber hammer banks into lending when they shouldn't. If this is correct then a bear like myself has to consider becoming neutral or marginally bullish. If nominal price falls are unlikely, the yield of 4-10% on residential property looks attractive compared to most other investments even without the tax benefits. The biggest risk is if the BOE loses control of interest rates due to lack of faith in its debt and currency. However, if there is a currency crisis then property will be better than cash or gilts.
Conclusion
The market should have been allowed to correct itself. Instead resources continue to be wrongly allocated into supporting over-valued housing stock. Buy-to-let entrepreneurs return in droves when they could expend their energies and cash in other enterprises that might generate jobs. However, if you are a UK resident there is a new reason to owning a house - to capture the subsidy the tax payer is providing.
Life Before and After Northern Rock
Prior to Northern Rock, the housing market appeared on the face of it similar to any other. Ultimately, one believed it was driven by the invisible hand of market forces. Clearly the explosion of credit was propelling it forward but supply/demand fundamentals still appeared at the fore. The reality of the market has become apparent post Northern Rock - the house market is subsidised by the UK taxpayer.
If Northern Rock and HBOS had been allowed to go to the wall, then a drastic correction would have occurred in house prices. Instead, the taxpayer came to the rescue and has been putting in scaffolding under a fragile market ever since. Approximately 70% of households are owner occupied so there are political and economic reasons why this is the case.
Economy and Consumer Penalised
Ultimately, it is bad for the British public. In the long run, high house prices benefit very few. Non-owners and owners are now being taxed to support the value of their house.
This can not be good for the economy but policy is now backed into a corner by housing data. Even though the market is viewed as over-valued, any significant falls towards a healthy level are apparently unthinkable. A depressed housing market will be used as good reason for further QE.
2011 and Beyond
This has profound implications for the next few years. I believe the market will feel a heavy hand on its head as consumers struggle with job losses, rising food/petrol prices etc resulting a downward grind by a few percentage points, probably between 5% and 10% over 2011. Beyond this, the data will probably not get much worse. If it does, the BOE will be quick to inject liquidity and rubber hammer banks into lending when they shouldn't. If this is correct then a bear like myself has to consider becoming neutral or marginally bullish. If nominal price falls are unlikely, the yield of 4-10% on residential property looks attractive compared to most other investments even without the tax benefits. The biggest risk is if the BOE loses control of interest rates due to lack of faith in its debt and currency. However, if there is a currency crisis then property will be better than cash or gilts.
Conclusion
The market should have been allowed to correct itself. Instead resources continue to be wrongly allocated into supporting over-valued housing stock. Buy-to-let entrepreneurs return in droves when they could expend their energies and cash in other enterprises that might generate jobs. However, if you are a UK resident there is a new reason to owning a house - to capture the subsidy the tax payer is providing.
Friday, November 12, 2010
Demise of US Over Hyped
Right now, the most crowded trade on the planet is the bet against the dollar and the US.
In my view, those that believe the dollar will become trash have gotten carried away. When Warren Buffet was a young man, his father was terrified of just this. Granted, you would have been better to invest in stocks for the past 60/70 years but the dollar has not collapsed in the way he feared. On the contrary, it is now more pivotal to the world's economy rather than less and here are a few reasons I believe it will be around for another 70 years at least:
Utility - it has a unique role in world trade that we will struggle to replace. Paper currencies were invented because it was impractical to use gold/silver for trade. This is more so today.
The US has a massive debt problem but the bulk of this is held domestically. There will probably be internal defaults but the US will not default on international creditors unless it wants to.
At the moment, the only country that wants a weak dollar is the US. It suits the Fed and Washington for now but an imploding dollar will not.
Although a democracy, it will act autocratically when need be. This could mean almost anything from exceptional taxes to leveraging their military strength. Marc Faber predicts the dollar will go to zero within ten years and says that you want to buy a small farm in the middle of nowhere in preparation for financial and geopolitical melt down. Well, if it comes down to that kind of global fist fight who's team do you want to be on?
The assets of the US are staggeringly large. I am not suggesting they will start selling aircraft carriers or Alaska but often the enormous wealth, land/real estate value and natural resources of the country are taken for granted.
The US is the biggest innovator and exporter of intellectual property on the planet. That is some long suit. Oh, and also its pretty strong in energy, agriculture, pharma, finance, media, internet, technology, electronics, defense.....
It is in an enviable position of having developed a diverse and massive economy. It's taken hundreds of years and millions of failed innovations, businesses, lifetimes and several wars.
Do not get me wrong, the country has a massive task ahead which needs the right political will and many years of hardship and graft by the taxpayer. The country has a spending rather than an earning problem. Any businessman knows hatchet jobs are far easier than growing revenue. You do need a strong stomach but this comes from necessity. The public is already sensing this. Obama is unlucky to be president at a time when essentially a wartime style is required. This is why I believe the public are now looking for a more familiar presidential style for facing the tough years ahead. The country is in a hole and it is going to take a war-like effort to get them out of it. But, I believe they will do it.
Wednesday, November 10, 2010
UK House Prices
Overvalued - so where's the Crash?
It is fairly unanimous that houses in the UK are over-priced - 30% according to The Economist. I have been a long term bear for a decade as by every measure such as income, yield etc they seemed well due for a much greater correction than has occurred.
I remember Professor David Miles saying in 2000 that houses were expensive then and crucially consumers could no longer have their debts inflated away as they had in the 70's and 80's. However, there has been really no price crash and now Professor Miles believes that more falls are unlikely. In nominal terms, I believe he may be right.
Normal Rules No Longer Apply
This is not to say I think they represent a good investment, are at fair value or that you can "never go wrong with bricks and mortar". Rather, we are now in a period where normal investment rules no longer apply. Equities rally the worse the economic data is, in anticipation of QE. Commodities prices are largely driven by anti-dollar sentiment rather than supply/demand dynamics. Houses are no longer constrained by rental yields, opportunity cost of capital etc but are a massive speculative trade almost solely on central banking policy. Relative to Gold, UK house prices have crashed by about 50 - 60% but relative to cash they have upheld very well. Since cash is what most consumers on the house market sidelines will hold, and continue to get frustrated by negative real returns they could offer support to the market at least in nominal terms. Similarly, there a few forced sellers yet as interest rates remain low. Hence, as long as BOE policy holds, bizarrely house prices could remain over-valued for years to come.
Hobson's Choice
You win the lottery today - where do you stick the money? Due to the mess governments have got us into, there are literally no low risk investment choices for your average citizen. Cash used to give a marginally positive return with low volatility. It now gives a negative return with much higher risk. Central bank policy has now surpressed the yield on all asset classes. Since assets are valued as the discounted sum of future cashflows this creates greater volatility. Commodities are such a volatile asset class as they generate zero yield and now all other asset classes mirror this.
Who Cares?
Well, bankers love this as this is now a traders environment, rather than one for investors. It is a nightmare for your average worker or pensioner. Very few of us feel comfortable trading commodity futures in our lunch break! Hindsight trading would say we should have put all our savings in Gold but try doing that at today's prices and sleeping soundly tonight. Hence, consumers appear to be acting rationally with regards to housing. An owner will think yes I could sell but where will I put the funds. A potential buyer with £50k deposit is getting no return in their cash. They still have to pay their rent so even though they feel prices are over valued will still be right to consider housing as potentially no worse than any other option available.
Article also available on http://www.marketoracle.co.uk
It is fairly unanimous that houses in the UK are over-priced - 30% according to The Economist. I have been a long term bear for a decade as by every measure such as income, yield etc they seemed well due for a much greater correction than has occurred.
I remember Professor David Miles saying in 2000 that houses were expensive then and crucially consumers could no longer have their debts inflated away as they had in the 70's and 80's. However, there has been really no price crash and now Professor Miles believes that more falls are unlikely. In nominal terms, I believe he may be right.
Normal Rules No Longer Apply
This is not to say I think they represent a good investment, are at fair value or that you can "never go wrong with bricks and mortar". Rather, we are now in a period where normal investment rules no longer apply. Equities rally the worse the economic data is, in anticipation of QE. Commodities prices are largely driven by anti-dollar sentiment rather than supply/demand dynamics. Houses are no longer constrained by rental yields, opportunity cost of capital etc but are a massive speculative trade almost solely on central banking policy. Relative to Gold, UK house prices have crashed by about 50 - 60% but relative to cash they have upheld very well. Since cash is what most consumers on the house market sidelines will hold, and continue to get frustrated by negative real returns they could offer support to the market at least in nominal terms. Similarly, there a few forced sellers yet as interest rates remain low. Hence, as long as BOE policy holds, bizarrely house prices could remain over-valued for years to come.
Hobson's Choice
You win the lottery today - where do you stick the money? Due to the mess governments have got us into, there are literally no low risk investment choices for your average citizen. Cash used to give a marginally positive return with low volatility. It now gives a negative return with much higher risk. Central bank policy has now surpressed the yield on all asset classes. Since assets are valued as the discounted sum of future cashflows this creates greater volatility. Commodities are such a volatile asset class as they generate zero yield and now all other asset classes mirror this.
Who Cares?
Well, bankers love this as this is now a traders environment, rather than one for investors. It is a nightmare for your average worker or pensioner. Very few of us feel comfortable trading commodity futures in our lunch break! Hindsight trading would say we should have put all our savings in Gold but try doing that at today's prices and sleeping soundly tonight. Hence, consumers appear to be acting rationally with regards to housing. An owner will think yes I could sell but where will I put the funds. A potential buyer with £50k deposit is getting no return in their cash. They still have to pay their rent so even though they feel prices are over valued will still be right to consider housing as potentially no worse than any other option available.
Article also available on http://www.marketoracle.co.uk
Tuesday, November 9, 2010
Why QE2 INCREASES risk of Deflation
Markets lapped it up!
QE2 was met with rapture by commodity and stock markets as traders and investors continue the easy money ride of a sinking dollar. The effect on the real economy is unknown but common sense rather than models suggests this extra $600billion is a mistake.
GDP growth at the stroke of a pen?
In order to have GDP growth, the US will have to continue to do what it is best at, namely attract the brightest talent globally to its universities, retain a significant proportion of this talent, and be at the cutting edge of innovation development. As Alan Greenspan once said, developed nations have no one to borrow technology from. Their GDP growth is low as humans are not smart enough to develop technology any quicker. You can not magic growth out of a hat but try telling that to the Fed.
A Life Less Certain
QE2 has just made the average taxpayer even more worried about rising costs of oil, food etc plus higher taxation to come to eventually pay off the even bigger mess that the government has got him into. In short, he feels POORER from QE2 and will act accordingly. He is less likely to leave his job to start new businesses and therefore job creation opportunities go out of the window. He is likely to spend less rather than more this Christmas and beyond. As for small businesses, they are behaving like consumers (perfectly rationally) and de-leveraging in anticipation of tough months and years ahead. So why then does the FED expect them to do a 180 degree turn and taking up loans just because they may be a few basis points cheaper? Ain't gonna happen.
The Trade Deficit
Ben Bernanke can have no idea of how de-stabalising the dollar will affect the trade deficit. Maybe it will help exporters, but this could be wiped out by an oil price spike. Even if there is a positive trade balance effect, I believe this will be a jobless boon to the economy. Guess what - no extra jobs, no feel good feeling on the street.
Its a Party.... but your not invited!
The average man on the street can not enjoy the benefits of this money printing, and indeed is most likely to feel poorer as he knows he will have to pay it back in the future. Life on main street is now essentially a different world to Wall Street. Wall St met QE2 with excitement as stocks and commodities soared. Some traders griped they would have liked to have seen a bit more than $600m but hey ho. QE2 added more momentum to a an already strong trend. The biggest growth business for 2010 has been trading an unstable dollar.
QE2 is Extra Head Wind
On Main St, there are no quick fixes, just the hard graft of finding work, setting up small businesses, innovating and differentiating services and products from competitors - essentially graft, elbow grease, creativity and uphill scrapping. By de-stabalising the dollar the Fed has fuelled uncertainty. This has ADDED to deflationary pressures in the wider economy.
QE2 was met with rapture by commodity and stock markets as traders and investors continue the easy money ride of a sinking dollar. The effect on the real economy is unknown but common sense rather than models suggests this extra $600billion is a mistake.
GDP growth at the stroke of a pen?
In order to have GDP growth, the US will have to continue to do what it is best at, namely attract the brightest talent globally to its universities, retain a significant proportion of this talent, and be at the cutting edge of innovation development. As Alan Greenspan once said, developed nations have no one to borrow technology from. Their GDP growth is low as humans are not smart enough to develop technology any quicker. You can not magic growth out of a hat but try telling that to the Fed.
A Life Less Certain
QE2 has just made the average taxpayer even more worried about rising costs of oil, food etc plus higher taxation to come to eventually pay off the even bigger mess that the government has got him into. In short, he feels POORER from QE2 and will act accordingly. He is less likely to leave his job to start new businesses and therefore job creation opportunities go out of the window. He is likely to spend less rather than more this Christmas and beyond. As for small businesses, they are behaving like consumers (perfectly rationally) and de-leveraging in anticipation of tough months and years ahead. So why then does the FED expect them to do a 180 degree turn and taking up loans just because they may be a few basis points cheaper? Ain't gonna happen.
The Trade Deficit
Ben Bernanke can have no idea of how de-stabalising the dollar will affect the trade deficit. Maybe it will help exporters, but this could be wiped out by an oil price spike. Even if there is a positive trade balance effect, I believe this will be a jobless boon to the economy. Guess what - no extra jobs, no feel good feeling on the street.
Its a Party.... but your not invited!
The average man on the street can not enjoy the benefits of this money printing, and indeed is most likely to feel poorer as he knows he will have to pay it back in the future. Life on main street is now essentially a different world to Wall Street. Wall St met QE2 with excitement as stocks and commodities soared. Some traders griped they would have liked to have seen a bit more than $600m but hey ho. QE2 added more momentum to a an already strong trend. The biggest growth business for 2010 has been trading an unstable dollar.
QE2 is Extra Head Wind
On Main St, there are no quick fixes, just the hard graft of finding work, setting up small businesses, innovating and differentiating services and products from competitors - essentially graft, elbow grease, creativity and uphill scrapping. By de-stabalising the dollar the Fed has fuelled uncertainty. This has ADDED to deflationary pressures in the wider economy.
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