A First Person Account Of How Bernanke's Export Of Inflation Is Fueling Asia's Last Bubble, And The Bonfire Of The Fiaties
Much has been said about how the PPI and the CPI are stuck in deflation mode (despite what everyone is seeing when buying groceries or filling up empty gas tanks). Much less has been discussed about how Bernanke's blunt policy tool of unlimited liquidity is leading to an inflation-driven bubble in Asia (and all Emerging Markets). Luckily, Macro Man Simon Black provides a first person perspective of how this bubble is developing, and how it will soon pop. In some ways this is empirical evidence of what Knight Research said previously: namely that the days of an EM push-pull mechanism are coming to an end. Here is why Knight's conclusion is spot on, paraphrased half way around the world: "when central banks start ratcheting up interest rates (like the Fed did in 2004 and what China is doing now...), buyers and developers no longer have access to cheap credit. Demand drops, and prices fall. When this finally happens, I think the subsequent fallout will serve as another strong argument to abandon the dollar and reset the financial system, especially in the developing world. All they need is a reasonable alternative. China is already allowing its currency to be used for cross-border settlement and limited reserve status, and as this function grows for the renminbi, you can bet that Asian nations will stop importing American monetary inflation and start exporting those dollars back home." A must read note for all those who base their investment decisions based on theoretical musings and thought experiment speculation.
Date: November 17, 2010
Reporting From: Labuan, off the coast of Borneo
Because I travel so much, I have the luxury of being able to compare real estate prices among all the places I've been recently. How does a flat in London compare with an apartment in Bangkok? How does an estate in Cape Town compare with a single family home in Singapore?
I have to say, residential real estate prices in many developing economies are astoundingly high on a value-adjusted basis... and it's because supply and demand fundamentals are being distorted by central bankers and politicians.
Housing demand, for example, should primarily be driven by demographic factors and real wages; rising populations and net migration increase the number of new households, and higher incomes reduce the average size of existing households (kids move out of mom and dad's house and find their own place).
Demand is often twisted by government policy, though. In certain countries like the US and the Netherlands, the tax code incentivizes home ownership by allowing the deduction of mortgage interest. Carrying costs like home repairs and property taxes may also be deducted in many countries.
Perhaps the ultimate demand distortion, though, is easy monetary policy. Interest rates don't generally matter for smaller purchases-- nobody checks the 3-month LIBOR before heading out to the local convenience store for a cup of coffee and a candy bar.
When money is cheap and easy to borrow, though, people have a strong incentive to purchase a home and bid higher prices because they can afford more house for the same (or lower) monthly payment.
On an institutional level, banks have a strong incentive to make loans for property in an environment of loose monetary policy; capital is plentiful, burning a hole in the bankers' pockets, and they're accountable to shareholders to turn that capital into profit.
We all know how this story worked out in the United States and the UK over the last few years; simply put-- not well. I'm seeing similar bubble indicators in several Asian countries right now... and it's a direct result of the so-called currency wars.
Ben Bernanke's successful efforts to reduce the value of the dollar have caused commensurate money printing around the world; foreign central banks are fighting to keep their currencies restrained against the dollar because nobody wants to be the country with the 'expensive' currency-- that would reduce their cheap exports.
A common tactic of foreign central bankers has been to artificially depress interest rates, making a great deal of capital available to local banks. Add to this many hundreds of billions of newly printed dollars that have fled the US seeking higher returns overseas, and it's easy to understand why asset prices are rising so quickly: there's too much new money in the system.
Thailand is a good example. The Thai baht has strengthened over 10% this year against the US dollar because institutions and large investors have abandoned their greenback holdings in favor of greater potential returns in Thailand. Coupled with the low interest rates set by Thailand's central bank, the country is awash with new money.
A substantial portion of this capital is flooding the housing market. Developers can get cheap loans to build their projects, buyers can get cheap mortgages to purchase the end-units, and contractors are able to get cheap credit facilities.
The final result in Thailand has been a significant runup in housing prices, as well as the number of units available. There is a massive bubble forming in the country, and the indicators are everywhere. One of the strongest that I saw was a series advertisements offering teaser mortgage rates at 90% loan-to-value... to foreigners!
(Now, if you've ever bought property overseas, you know how difficult it can be for a foreigner to qualify for a mortgage... yet it's getting to the point where if you have a pulse, you can get a loan. When banks and developers are giving money away, this is a major sign of a liquidity bubble.)
Thailand is just one example; there has been much discussion about mainland China's housing bubble as well.... the People's printing press has been running around the clock to keep up with Bernanke's, and the trillions of renminbi created has given rise to triple-digit housing returns.
Chinese money is also finding its way into regional property markets. Hong Kong is a massive recipient-- interest rates on the island are already near zero, and the combination of cheap money and Chinese capital has spun housing prices out of control.
For property investors, rental income hasn't kept pace with the funny money that's fueling the asset price gains; in fact, many investment properties are cash-flow negative (rents are too low relative to mortgage and other carrying costs). When you can't turn a profit in an environment of historically low interest rates, it's time for the bubble to pop.
We've already seen what happens next-- when central banks start ratcheting up interest rates (like the Fed did in 2004 and what China is doing now...), buyers and developers no longer have access to cheap credit. Demand drops, and prices fall.
When this finally happens, I think the subsequent fallout will serve as another strong argument to abandon the dollar and reset the financial system, especially in the developing world. All they need is a reasonable alternative.
China is already allowing its currency to be used for cross-border settlement and limited reserve status, and as this function grows for the renminbi, you can bet that Asian nations will stop importing American monetary inflation and start exporting those dollars back home.
In the meantime, if you're mulling over a life change and thinking about a move to one of Asia's vibrant, growing economies.... consider renting first.