Posts Tagged ‘Economic bubble’

It is not often that we get a chance to test theories, at least not when it comes to the economy. But we have such a chance right now, and it relates to China, and whether or not China is experiencing its own credit crunch, or something altogether less serious.

Critics of Mervyn King and Ben Bernanke said that they misread things before the crisis of 2007/08 erupted. These critics say that during the build-up of the credit bubble, central banks should have hit the brakes, and upped interest rates. In short, like the very best party pooper, take away the punch bowl just as things start to get going.

Right now, in China, it appears that the central bank – presumably under instructions from the government – has taken away the punch bowl. The markets don’t like it, but then maybe on this occasion that is how it should be.

The interbank rate in China – that is the interest rates at which banks lend to each other –has soared. Déjà vu say those who recall what it was like in 2007 and 2008 in the West, when the words credit and crunch first started to appear in the same sentence.

It is just that some say China is not at that stage yet. Sure, signs of a credit bubble are clear, but it is not like the UK and the US during the height of their bubble – not yet.

The People’s Bank of China, or PBC, published a note last week saying: “Liquidity for the banking system as a whole remains at a reasonable level.” And since the PBC tends to follows the dictates of government, it is generally assumed that is the view of China’s government too.

China’s State Council recently stated: “We must promote financial reform in an orderly way to better serve economic restructuring.” Again, this suggests the government wants to rein back all that borrowing.

There is one major difference between China’s credit bubble and the one we experienced in the West. In the economy behind the Great Wall, it is local government and state owned companies that are hitting the credit button.

What China needs is for less money to be thrown at investment projects and more to trickle down into wages. In the case of China, squeezing credit may boost consumer spending – in the long run at least. It is all part of the process of adjustment China must go through as it shifts from investment to consumer led growth.

China’s government appears to understand this.

Interest rates are going up – at least that’s the way it looks. They are going to go up in the US, as the Fed has suggested, and they appear to be rising in China, as the government wants.

In the case of the US, if rates rise it will be because of good news on the US economy. If they rise in China, it is because the government is trying to learn from the lessons of Alan Greenspan and Ben Bernanke.

© Investment & Business News 2013

Time was when people thought a bubble was something kids blew, and you put into a bath.

Time was when the South Sea Bubble and Tulip Bubble were things that only historians seemed to know about. “This time,” to coin a phrase, “it is different.” Bubbles are now things that not only all investors know about, but non-investors do too.

Joseph Kennedy sold his stock after a shoe shine boy asked his advice on what stocks to buy. “I smell bubble,” thought Joe, or words to that effect, and the Kennedy family fortune was made. But what happens when a shoe shine boy asks you if there is a bubble in the making? It feels a little like that now. Whenever anything rises, the popular press cries bubble, unless it is UK house prices of course, because the lesson of bubbles doesn’t seem to have infiltrated the psychology of baby boomers as far as UK house prices are concerned.

It is, of course, tempting to say that equity prices are so high because of QE: that once it is reversed equities will crash like a child’s bubble wand thrown to the ground in a fit of temper. Yesterday, 23 May, equities saw sharp falls after minutes from the Fed hinted that QE may be coming to an end.  See Fed at sixes and sevens.

Then again, look at valuations, and things don’t look too serious. See: Are the stock markets set to crash? 

The fear however – and this is where bubble comes in – is that corporate earnings themselves are not sustainable. It is a puzzle how company profits and the economy have been moving out of alignment. In the long run either the economy will adjust upwards to reflect corporate strength, or profits will fall to reflect economic weakness.

If we see the latter of these scenarios then equities probably will crash, and we will be able to look back on the last year or so and say that the period saw the formation of a bubble. And we might add that it was so obvious that it’s a puzzle why people couldn’t see it at the time.

The next possible bubble relates to bonds. QE has pushed up the price of bonds with interest rates being so low that they are even negative in Germany for some government bonds. It seems inevitable they will fall in price, and fall sharply too. Indeed in Japan, government bonds have been falling in price of late, despite QE. That really is a source of concern.

A few days ago it was told here how the ITEM Club reckons inflation may rise in the West as Chinese wages increase. This may be just the catalyst to lead to bond prices crashing. See: Will rising inflation spoil the market’s party?

Another danger area relates to emerging market debt. This is a big topic and will be discussed in more depth at a later date. Here are some headlines for you to consider. Between 2002 and today, outstanding credit in China rose from around 110 per cent of GDP to around 180 per cent. Over the same time frame outstanding debt In Brazil rose from around 30 to roughly 80 per cent of GDP. The average cost to households of servicing their debt to their income is around 22 per cent in Brazil against 10 per cent in the US.

Emerging market debt is a problem. It often works out like that after a period of rapid growth, but bear in mind that in South East Asia, things may be different this time. You may recall that during the 1990s the region boomed, took on too much debt, and crashed in 1997. This time around however, much of the boom has been funded internally for domestic savings. “Local investors hold 88 per cent of domestic government notes in the Philippines, 85 per cent in Thailand and 73 per cent in Malaysia,” stated this article from Bloomberg. See: Record Bond Sales Showing Lessons of 1997 Learned: Asean Credit

A bigger fear relates to demographics. In Europe, both East and West, the US, Japan and indeed China, aging is a problem. For Japan it is hard to see how government debt more than approximately 230 per cent of GDP will be affordable when the working population starts to shrink. But this has already happened. Maybe this is why Japanese government bonds have been falling even as the central bank kicks off more QE. Japanese households are not saving like they used to either; in fact, the Japanese savings ratio is much lower than that of the UK. This may be a symptom of the fact that the Japanese baby boomer generation has already retired, and is drawing down savings to fund day to day living.

In China, the country will shortly pass what’s called the Lewis Turning Point and will run out of workers to migrate from the country to cities. Its policy of one child per family is taking its toll too. But even when the government reverses this policy, getting the birth rate up may prove quite difficult – not least because of the high proportion of younger males to females in the population. By 2030 China is expected to have a shortage of around 140 million workers, according to the IMF.

That leaves one more bubble to warn you of, and this relates to US student loans. See: Student Debt and the Crushing of the American Dream 

© Investment & Business News 2013