Search This Blog

Thursday, October 18, 2012

US housing starts at record highs -

In my lengthy post from September 2011 (The "Inflation Storm", initially posted on, now discontinued, but re-published on this site, below) I assigned a high probability to the US housing market would turning in 2012.

The housing market has now turned. September 2012 building starts are the highest in 4 years, and house prices have increased about 2.2% in the second quarter of 2012 (up 1.2% year on year, according to the Case-Schiller index).

With the Fed recently mandated to buy $40 billion of mortgage backed obligations per year, this is likely to continue. Banks have massive un-used ability to lend and the velocity of money (how fast new funds trickle into the economy) is at an all time low (see the below chart).

Graph of Velocity of M2 Money Stock

With housing prices now poised to rise at rates that are higher than the cost of financing, funds will continue to be deployed in the housing market, driving up prices, creating expectations concerning future price increases etc. Unemployment (latest figures reported at 7.8%) will continue to decline as the construction sector picks up, and consumer credit grows again. If the US government can continue to finance (and increase) its debt burden, 2013 may be a boom year, instead of the depressing recession currently predicted by so many (Nouriel Roubini, Jim Rodgers etc). T-bonds and T-bills have yields at all-time lows, so it seems like the market (e.g. the Chinese central bank, sovereign wealth funds etc) are willing to do just that.

Many people have been predicting US hyperinflation since year 2000, the voices becoming stronger and stronger over the years. However, in spite of massive monetary increases by the Fed, inflation has failed to materialize. The divergence from the historic relationship between domestic monetary supply increases and inflation is due to the massive US' trading deficit versus the rest of the world, and the strong interest of major national governments to keep their currencies pegged to the US dollar. This factor is completely overlooked by most economic commentators.

The future welfare of US citizens is as such in the hands of Chinese policymakers. Luckily for them, both the US and China have an interest in allowing for the imbalances to continue, as correcting them would imply a painful restructuring in both economies, inevitably leading to social un-rest and regime changes. A prediction of hyperinflation in the US (which can easily materialize) thus becomes a question of game-theory more than anything else.

It is clear however, that the imbalances at some point must be corrected. The larger they become, the more painful the correction will be. The most likely trigger is inflation in countries with currencies pegged to the USD coming out of control, which is already happening; food prices are increasing all over the world, certain metal prices are near all-time highs. Rising food prices have the potential of toppling regimes everywhere; they were a significant factor in motivating the public during the Arab Spring, just as they were during the French revolution in 1789.

Thursday, October 11, 2012

Bad Bank in Spain - so far just window dressing.

On October 3rd, the Spanish government announced the implementation of a Bad Bank in December, to relieve domestic banks of their toxic real estate assets.

The model was successfully applied in Sweden and Norway in aftermath of the 1992 banking crises, which followed during a period of collapse in real estate markets. The implementation of a Bad Bank allowed for the restoration of the balance sheets of banks, with two distinct benefits:

1. Removing the risk of a systematic collapse should one of them fail, and;

2. Allowed the countries' banks to lend out to deserving companies and individuals again.

Though the concept of a Bad Bank as has historic evidence that it can be an effective initiative for restoring credit market liquidity and reducing risk, there are some significant differences that imply the Spanish initiative is nothing more than window-dressing:
  • In Norway and Sweden in the 1990s, shareholder equity in distressed banks was nulled with shareholders loosing all of their investments. Bond-holders were the only ones protected. After the banks had been restructured and were showing profits again, government capital outlays were recovered by re-privatizing the banks.
  • The Bad Bank was funded with public sector money. The transfer of assets to the Bad Bank happened at market rates. There was a minimal element of negotiation between the Bad Bank and the bankrupt banks; as all entities became government owned they had the same shareholder. Bankrupt commercial banks were re-capitalized by the government only to regain sufficient capital adequacy ratios.
In Spain, banks will not be forced into bankruptcy and have even made public statements that they will be co-financing the Bad Bank. This undermines the entire principle of a Bad Bank, which is why the Spanish initiative will fail:

1. The banks' equity exposure to the transferred assets continue to exist, just now in the form of an equity stake in the Bad Bank, so it does not completely de-risk the banking sector.

2. Investor's capital outlay's into the Bad Bank cannot be recovered by a future sale of equity of the restructured banks.

3. Transfer of assets will most likely NOT happen at market prices, as doing this will erode capital adequacy ratios for the banks, trigger re-financing.

The currently proposed structure is a political compromise (or a result of the bank's bribing the policy makers?) designed to protect the interest of the country's wealthy, with (again!) Northern European tax-payers paying the price in the form of higher inflation (only financing available is printed money from ECB).