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Monday, October 27, 2008

I Don't Think This Will End Until ECB Cuts

Until the ECB chops its main rate to somewhere around 2%, I don't see the pain ending.

What's going on now is the Japanese collapse I've been so worried about. There are a number of reasons for it, but the collapse of the yen carry trade is pushing up the yen, which is going to cut exports, and the Nikkei is collapsing. To make matters worse, Kaupthing just defaulted on some samurai bonds (yen denominated). Obviously Lehman was the first defaulter. Worries over another round of Japanese real estate deflation are growing. Nothing's really going Japan's way; the collapse in the Baltic Dry means that their major shipping lines are impacted even more than their export market. Back in 2007 I wrote about seeing increasing problems on the horizon for shipping. Well, now it's here. One would expect some of the Japanese banks to be sliding into capital trouble at this rate. The Japanese government is working on a domestic stimulus package.

Canada remains one of the healthier world economies, but Bank of Canada is forecasting extremely slow growth and their government is experiencing a sharp decline in corporate tax revenues.
India also is in relatively good shape. However their growth is slowing sharply and their corporate debt and banks are beginning to show the strain. The major devaluation of the rupee is going to make their exporters more competitive in world markets, but it will slow the decline of inflation in India. Right now their export growth is slowing sharply, and the Indian government is rapidly dropping restrictions on exports (usually implemented in an effort to drive down domestic costs for manufacturers). India will probably end up guaranteeing bank debt for a time. No better symbol of what is happening in India exists than the buy-a-home-get-a-free-car deals now popping up:
Your "dream house" now comes with a free Mercedes or BMW, or at least a few gold coins. In some cases, even a small flat is being thrown into the deal for those eying premium segment bungalows.
The promoter of Ashiana Housing, Rohit Modi, said they had started an apartment project at Rs 2,100/sq ft on NH 58 in Ghaziabad. Till six months back, apartments at these places were quoting at upwards of Rs 3,000/sq ft.

Not only this, many developers are reducing the floor size of the flats from 2000 sq ft to around 1,200 to 1,500 sq ft. This translates to a fall in the price of a three-bedroom apartment from Rs 60 lakh to around Rs 30 lakh.
To US readers of The Housing Bubble Blog, this will all sound very familiar! I recommend reading the comments on the above article. Here's one:
geeta, chennai, says: Re:Value of Real Estate in India. Whilst landed property is a good investment bet, the global recession has not been factored by the industry. It is possible that black money investments is keeping the hopes of the industry alive. The average salary of a 35-year old person in the non-IT sector is about Rs10 lakhs pa. His net savings is about 2 lakhs pa. If he has to buy a house for Rs 1 Crore, it is equivalent to 50 years savings for him. How can he service a 20 year loan? What sort of economics is that? The real estate in India can expect to see a 50% drop in their prices, not withstanding the laundered funds that pour into the sector.
All bubbles end in buyer's exhaustion. Even in China, buyers' exhaustion and affordability problems are dominating. At this point going back to this link and reading Carney's comments on the global financial tinderbox might be worthwhile.

There's something of a run on Gulf Bank (Kuwait). The problems in Dubai, UAE and Kuwait aren't ending. Pakistan's position is pitiful. I wrote this summer about the Dubai apartment boom, noting that the major consumers of housing were immigrants. Check out this Arab News article about the move to force multiple occupants out of Dubai housing. More. Mover Mike had written years ago about his worries over currency speculation in the new ME exchanges. I think he may have been prophetic.

So much of what we are seeing is the reaction and interaction of fundamentals rather than simply a credit crunch. The sharp rise in shipping rates, oil and commodities this year inevitably was going to draw down working capital and produce a contraction in the movement of goods because it created a sharp increase in the amount of working credit needed.

Of course the crunch accentuates the crisis, as in the alarming slide of the eastern European currencies. It is clear that boosting demand in the oil and natural resource economies is going to be extremely difficult and China will be struggling to support its own growth by internal investment. Therefore, the only way is to make consumer incomes in the developed economies stretch further. The Eurozone can cut rates and generate real consumer buying power because a lot of consumer and mortgage debt is variable indexed in some of the faster-growing areas, and the Eurozone will be aided by the decline in inflation induced by the commodity bust.

Growth in Europe should help to support the Asian economies somewhat - but world leaders have to be realistic about what is occurring. This downturn is a needed development controlled by world fundamentals.

The impact of foreign currency loans in the eastern European countries (see this 2007 paper), and the inevitable default on many of these loans on the European banks, has yet to be fully felt. It's time to panic and hit the down button on EU interest rates. Iceland's foreign currency loans were a huge factor in its currency collapse. This has to be stopped ASAP. (For those who wouldn't read an economic paper if their lives depended on it, the bottom line is that growth in the eastern European countries accelerated rapidly, and their currencies appreciated. Inflation accelerated. When and if their central banks tried to control inflation by raising rates, the availability of foreign currency loans, which were then cheap because of the appreciation of the local currency against the Euro, generated even more growth and more inflation. The backlash now is vicious.)

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