Sunday, December 07, 2008

Fancy 2 wagers?

Wager 1: China Will become an economic basket case.

This is essentially predicting that China is an economic bubble. It's not based on extensive research I just went to Beijing in Feb and had a look around. Read a few press articles and am familiar with Japan.

Basically I'm betting against China because for a multitude of problems that fit in to the 'choose to ignore' category by many business pundits and economic commentators.

The first is the fact they effectively have leveraged the whole economy. Peter Schiff talks about how China has enough domestic demand to consume their own output and then some. But instead they loaned money to American consumers to consume their output for them, at the same time undermining the US manufacturing base that was chiefly responsible for servicing the debt. That means in order to amplify their profits (by getting more ravenous customers) China lent money instead of just building demand locally. The equivalent of McDonald's avoiding their own lean customers with money in order to attract big fat customers with ravenous appetites and crucially - no money.

The second is the fact that garbage in = garbage out. China has a long standing culture of graft that has been met with a recent economic boom. Accounting practices are dodge, corruption at the government level is rife. China doesn't have reliable economic statistic collecting methods, they don't even have a reliable population count. Their ability to collect taxes, audit companies and so fourth leaves the path open to huge financial black holes within the economy that will eventually I'm sure bury a dozen major institutions or so.

The third is that China is using the unsuccessful Japan strategy of suppressing exchange rates and keeping exports competitive by letting foreign reserves accumulate. Many an American might be heard remarking 'China owns our ass' but perhaps these same Americans might be surprised to learn that Japan still does as well. Once you hit the trillion USD in reserves mark you are in trouble. You can't cash in on the reserves without inflationary pressures turning the USD into a Peso. It means having the 'government facilitated' economic growth plan ends up shooting yourself in the head. By coordinating a mass of organizations that should function independently and thus never cooperate to suppress exchange rates (like Australia doesn't) then you can't keep on an explosive growth spurt because the money markets start compensating to slow you down.

The fourth is that China isn't Japan. China is yet to produce a Sony, Toyota, Honda, Nintendo or Pokemon. It hasn't done anything innovative. It is just a beast of scale playing catch up. It's not impressive. I've said before its exactly the scene from Simpson's Stone cutter episode where Homer asks Lenny and Karl if they are jealous of his fancy new chair - the response is 'Well No Homer, we have exactly the same chair'. It's also covered in Growth fetish, the phenomena where the developed world gets jealous of double digit growth figures as if our government is doing something wrong. Go to Beijing, it's a horrible place, you can't drink water from the tap. You might vomit if you think about what you are stepping in and there's absolutely no rights. The legal system is somewhat of a bogus dilemma - you either go through the proper channels where you are always wrong, or you take to the streets in a massive riot to put pressure on some landlord or business person hoping the government is scared enough to pay you hush money. At any rate, Thomas Friedman in his book assures me that China is now exceeding America in the number of patents its registering but I'm yet to see some consumer device that everyone loves come out of China this side of the opium wars.

The fifth is that the world just isn't big enough. If the Chinese want 'first world' lifestyles they need 6, yes 6, that's right 6, planet earths. We have only one. Thus at some point I'm more or less gaurunteed that China will hit the wall, which is kind of like winning by default because everybody else on earth will too.

The sixth is that economic prosperity doesn't trump human rights. People argue, and when I say people I'm referring to the CCP that says 'we are doing a good job, people are getting rich' which is a terrible argument as Chomsky points out. It was the exact same argument that was used to defend slavery, saying the treatment of 'blacks' was better in the south because they were business assets. But as Abe Lincoln says 'We know, Southern men declare that their slaves are better off than hired laborers amongst us. How little they know, whereof they speak! There is no permanent class of hired laborers amongst us...Free labor has the inspiration of hope; pure slavery has no hope.'

Wager 2: Australia has a housing Bubble.

Wayne swan and other economic commentators urge Australia not to talk ourselves into a recession. The housing bubble I am 100% certain exists for the following reasons, based on research I've been doing for a while now.

Reason 1 - Australia has an identical real estate scenario to pre-crash US and UK markets. That is huge private debt, unaffordable housing combined with purported shortages and population growth. In a few months with significant job losses undertaken Australia's property prices will reach the critical mass neaded for their implosion. Cut your losses while you still can.

Reason 2 - Confirmation bias. Last year property prices were increasing and the reason given was population growth. This year property prices have declined yet the population has still been growing. The industry forecasts price rises all the time and for the same reasons. It is safe to ignore demographic arguements. Furthermore, these projections of population growth are easily accepted and not scrutinised. That is people accept them because it agrees already with what they want to believe. Nobody goes okay - with all this population growth what kind of growth is it? Is it highly skilled billionaires that will want to buy my property for more than I paid for it with pocket change? Or is it semi-skilled migrants coming in to do shitty jobs that Australians don't want, or refugees with really poor employment prospects that really won't be able to afford a house at more than I paid for it.

Reason 3 - Speculating makes plain damn sense. It just makes sense that if you can buy a property that somebody else needs you'd be able to extort a higher price for them. So why not just buy 10 properties. And the more properties you buy the less recourse any consumers have, they will have to buy the property off you eventually. And if the government tries to release land for new affordable housing, you should just buy that up as well to keep your strangle hold tight.

Reason 4 - people are stupid. Money, the simplest and most fundamental of economic concepts is difficult to fully comprehend. Most of the players in the housing market (in terms of frequency not size of investments) don't understand property, specifically they wouldn't be able to explain confidently to you - leverage, business cycles, gearing, negative gearing, risk - profit, liquidity, divisability, rental yeild, cost of sales, capital gains tax, council rating, land and improvements etc. They will know that they are supposed to like negative gearing as property investors even though its actually a guarunteed loss of limited benefits to few people in certain income brackets, and that you make your money from capital appreciation whilst not understanding why price should be based on rental yeild.

Reason 5 - Smart economists predict it. Keynes pointed out that in the long run we are all dead. The former Governor of RBA though was saying 'people have been predicting this for ten years, so nobody really predicts it' and in a way this is true. If economists were able to say 'the crash will definitely happen on January 23rd' then the proficy would self fulfill as everyone desperately tried to offload their properties on Jan 22nd. Albeit this means the crash would happen a day early due to the existence of the prophecy and people believing them. So when everyone talks about economists predicting things, and then having real estate investors and dodgy financial advisors deride them as predicting them all the time here is why - an economist/investor like Steve Keen, Peter Schiff, Robert Schiller etc. looked at property prices, then looked at rents. The property prices were far higher than the rental yeild would return a decent return on investment. This could have been 1 year ago or ten years ago. The fact was, during the boom people were buying houses off people at prices that were irrational for an investment, they were speculating. There was no reason to buy yesterday and the same lack of a reason is present everyday for ten years. The economists that predict busts are merely saying that it should already have happened, they can't explain why it hasn't already though so they don't really know when the market will wake up and crash. Similarly if we sedated a man and put him behind the wheel of a lamborghini, taped his hands to the steering weel and glued the accelerator down we might predict that it was likely to crash somewhere along the street. But we don't know whether he will crash in 10 meters, 20 meters or 100. But the more time goes on the more certain it becomes.

Anyway those are my two wagers. I think the housing glut in Australia would be in the neighbourhood of 10%. I have found it to be 7% which I think is deflated either way that's enough houses to spark an irrational panick. As for China the CCP's best bet is to change it's tune to the old 'with us or against them' so that if the Economy goes up it's the CCP's fault but if it goes down it's America, do that and China might hold together for another 5-10 years.


Anonymous said...

Very interesting and thorough commentary. Thanks.

mr_john said...

Oh, I forgot, I like the section on the housing bubble too.

Anonymous said...

There is some pretty insightful stuff in this - good job!

you seem to have ingested the useful stuff from economics - and show a justifiable scepticism about other parts of it.

Surely the thing to do is to get yourself into a position where you're reasonably indifferent to China or Aus real estate crashes - while still selling resources to China and having somewhere to live?

If you're not across it already, I think you'd find Nicholas Nassim Taleb interesting.

ohminous_t said...

I'll check out Taleb and have a look for his Black Swan Book it sounds interesting.

As for Indifference to real estate crashes I think the best way is shifting tax burden from productive activities onto resources like real estate that are currently classed as capital and can be sold as private property instead of leased from the community.
That solution I believe in a land obsessed country like Oz is not politically pragmatic although Canberra was initially developed on such a tax basis.

As for selling resources, I'm not sure, I did another post on Australia's economic model called 'the hole lotta resources' model and I think resources are the equivalent of savings or an inheritance (or missapropriation in Australia's case) and whilst the idea of savings is to spend them at some point, GNP calls spending more of your savings 'growth' and by default a good thing.
China's role in this has been that of a buyer for a country that is liquidating.
GNP says spending and consuming is inherently good. The big questions for Australia's resource driven economy is whether we are spending our savings on worthwhile pursuits? And for me at least there's big questions on whether any of the coal sold to China's aggressive growth model has been worthwhile for the global community (since the goods were sold to people who really can't pay, and environmental degredation in China to boot) and whether the proceeds from the sale of our resources have been put towards transforming Australia into a sustainable economy (and I see little evidence of that).

So I'd rather see the government taxing heavily things like coal and delivering all that into expansion of education and health care systems and so fourth. I'd feel much more comfortable then. But with a 5% Carbon Cut target I predict it will be the hard path for Australia.