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View Full Version : New Economist Article : Bubbles Forming, Brace Yourself



Feryk
7th January 10, 04:06 PM
Cullion, this one is for you.

http://www.economist.com/opinion/displaystory.cfm?story_id=15213157

tl;dr version

Free money policies for the last year are causing the potential for asset bubbles to form. Specifically named are emerging markets, british housing prices, and the S&P 500.

Interest rates are expected to rise around the world this year.

HappyOldGuy
7th January 10, 04:10 PM
I hadn't been paying attention. Did UK housing prices really not fall?

I know our aussie members have said that theirs really haven't.

Cullion
7th January 10, 04:39 PM
You know me too well Feryk. I certainly agree with the broad premise of the article and even in the worst months of the 'crunch' so far have been sure that markets have a lot further to fall before real recovery can start.

UK house prices fell and then started going up again in some parts of the country. Average house prices are still massively overvalued relative to average incomes, historically speaking.

There are a couple of possible reasons for the UK house price moves which I haven't yet seen enough data to distinguish between:-

i) The average may be being distorted by a relatively small section of the market, such as the revival of investment bank bonuses, although this cannot explain the whole phenomenon.

ii) Housing alone may not look like a great investment compared to it's historical norms, but how does it compare to alternative uses of the cash? Well, lots of other assets look pretty overstretched as well. Sometimes the movement of an asset price is as much about what investors are running from, as we saw in the oil price bubble a couple of years ago when people were running from the stock market.

iii) The pound hasn't done great against other currencies. British assets might be looking cheap to foreign investors.

I only have anecdotal evidence to work with at present. Looking at real estate prices where I live (country town just outside the reasonable daily commute of London and a little too far from Oxford for college students to want to commute), whilst there have been drops, modest family homes like mine are still holding values representing an increase way above the growth in wages since I bought at the end of 2001. I doubt this has much to do with banking bonuses (I don't live in the kind of home that would see competitive bidding from investment bankers).

I don't know much about the local landlord community (I doubt it's highly speculative as I don't live in a major city with volatile prices like London, and it's not a low-end speculative landlord market like the student districts of a college town).

Feryk
7th January 10, 05:04 PM
It doesn't mean EVERYTHING is going to go in the toilet, but their point about the emerging economies leveraging their peg is spot on, and we've seen that before.

UK Housing prices are getting to be a concern, but I think rising interest rates will bring the prices in line later this year. The UK has a similar problem to the US in that the de-leveraging of the consumer has yet to occur.

Look for it later this year. Hopefully, it won't be utter carnage, but more of an orderly stepping down.

Cullion
7th January 10, 05:07 PM
It doesn't mean EVERYTHING is going to go in the toilet, but their point about the emerging economies leveraging their peg is spot on, and we've seen that before.

UK Housing prices are getting to be a concern, but I think rising interest rates will bring the prices in line later this year. The UK has a similar problem to the US in that the de-leveraging of the consumer has yet to occur.

Look for it later this year. Hopefully, it won't be utter carnage, but more of an orderly stepping down.

We have more deleveraging to do than the US and it will probably happen at the same time as substantial bond and currency problems for the UK government.

Sun Wukong
7th January 10, 06:09 PM
You know me too well Feryk. I certainly agree with the broad premise of the article and even in the worst months of the 'crunch' so far have been sure that markets have a lot further to fall before real recovery can start.


In opinion of probable outcome's, I agree with Cullion. This of course is only speculation in the US only.

I see bubbles in the investment market forming right now but my opinion is the primary Culprit is interest rates. The bail-out cash program hasn't been a failure, imo, but much of it found it's way in the wrong pockets.

My kneejerk reaction is to blame partisan politics in the construction of the bill, but that doesn't really jive given that congress has always been shit at spending money intelligently.



UK house prices fell and then started going up again in some parts of the country. Average house prices are still massively overvalued relative to average incomes, historically speaking.

Same here.




There are a couple of possible reasons for the UK house price moves which I haven't yet seen enough data to distinguish between:-

i) The average may be being distorted by a relatively small section of the market, such as the revival of investment bank bonuses, although this cannot explain the whole phenomenon.

ii) Housing alone may not look like a great investment compared to it's historical norms, but how does it compare to alternative uses of the cash? Well, lots of other assets look pretty overstretched as well. Sometimes the movement of an asset price is as much about what investors are running from, as we saw in the oil price bubble a couple of years ago when people were running from the stock market.

iii) The pound hasn't done great against other currencies. British assets might be looking cheap to foreign investors.


I think you are over looking one obvious culrpit. Opportunists with deep, deep pockets and little need for easy credit. Not just speculators, but extremely wealthy speculators.

If ever there was a time for wealthy people to speculate on any hard asset for the last 20 years, that time is now.

All the little players have been pushed out of the market. Wealthy families can consolidate their wealth by simply buying up the cheap assets; like slum lords do in poor neighborhoods.

I think you're too pessimistic sometimes; the market is at least somewhat self correcting. I wouldn't suggest that middle class people try to speculate right now; oh no, I suggest they hold onto their wealth like a heavily armed pirate. If I had a spare 100 million dollars, I'd be speculating my ass off right now. I dare say nobody would see my face socially for a year or two.

Cullion
7th January 10, 06:26 PM
I think you are over looking one obvious culrpit. Opportunists with deep, deep pockets and little need for easy credit. Not just speculators, but extremely wealthy speculators.

If ever there was a time for wealthy people to speculate on any hard asset for the last 20 years, that time is now.

Housing still seems so overvalued though. I can understand the debt free people driving the gold price like they have.



I think you're too pessimistic sometimes; the market is at least somewhat self correcting. I wouldn't suggest that middle class people try to speculate right now; oh no, I suggest they hold onto their wealth like a heavily armed pirate. If I had a spare 100 million dollars, I'd be speculating my ass off right now. I dare say nobody would see my face socially for a year or two.

I'm pessimistic for two reasons:

i) I still believe that the historical yield ratios that indicate 'good value' in asset classes like stock and real estate will hold true in the end (and those are large gaps between profits/income and stock/real estate prices to close).

ii) The political programmes in the US and UK seem purely intended to prop-up already overstretched and unrealistic prices at any cost, in the hope that something will just come along from underneath and make those prices seem reasonable again. Do you forsee corporate profits and household disposable incomes surging in the next few years in the US and UK? I can't.

Cullion
7th January 10, 06:27 PM
I should add the conspiracy theory option: We are in the early stages of a deliberately (but possibly opportunistically) engineered wave of inflation designed to restore fiscal balance by reducing the real fixed liabilities in baby-boomer pension benefits and debt liabilities of younger households, both of which are a pretty serious burden at today's prices.

This will come at the cost of lower living standards long term (especially for middle and working class retires), transfer an even larger proportion of our nations' real wealth to the already asset rich, but it will get the moolah flowing around again.

HappyOldGuy
7th January 10, 06:35 PM
I should add the conspiracy theory option: We are in the early stages of a deliberately (but possibly opportunistically) engineered wave of inflation designed to restore fiscal balance by reducing the real fixed liabilities in baby-boomer pension benefits, which are a pretty serious burden at today's prices.

Alternatively, our bond debt to various creditor nations.

Anyhow, on the "it's over" side, the US housing market has taken a big hit, and is still down around 2004 prices. US consumers have cut their debt by a decent amount. And the markets of course have almost come back up to their high points.

On the, "grease up cause here it comes again" side. The US housing market is still not down to 2000 levels, US consumers are still more in debt than they were any time before the recession, And the markets of course have almost come back up to their high points.

I'm for sure expecting another bump. But I still don't see the apocalypse. What makes me most nervous are all the signs that credit is available for financial games but not for companies trying to make payroll.

Cullion
7th January 10, 06:51 PM
What was the avg. house price / avg. wage ratio for the US in 2000 ?

I tend to look at long-term things in terms of these kinds of ratios rather than specific prices or dates.

HappyOldGuy
7th January 10, 07:12 PM
What was the avg. house price / avg. wage ratio for the US in 2000 ?

I tend to look at long-term things in terms of these kinds of ratios rather than specific prices or dates.

It's a very good question. I could not find an answer more up to date than mid 2009.

http://www.ritholtz.com/blog/2009/02/us-existing-house-price-median-family-income/

Cullion
7th January 10, 07:17 PM
That's actually an optimistic graph from my perspective. It doesn't look like there's too far left to go before it becomes a rational time to buy a first home again. Of course if the ratio has to be achieved whilst incomes are still falling, then it's a bit more of a real decline than first impressions indicate, meaning a lot more trashed credit ratings.

It was stretched much further at the peak and is still considerably further stretched than that in the UK.

HappyOldGuy
7th January 10, 07:33 PM
Yeah, I look at housing prices and I see a mostly deflated bubble.

It's Goldman Sachs stock price that concerns me. The financials are way out ahead of businesses that actually make stuff, other than tech. And I can't get my head past thinking that's bad.

Cullion
7th January 10, 07:42 PM
The dividend yields on US and UK stocks are very thin. Money's just being printed and used to pump those markets up. The problem is that the people who print the money and decide who to give it to are basically employees of the large financials.

Feryk
8th January 10, 02:48 PM
I should add the conspiracy theory option: We are in the early stages of a deliberately (but possibly opportunistically) engineered wave of inflation .

Yes, we are.



designed to restore fiscal balance by reducing the real fixed liabilities in baby-boomer pension benefits and debt liabilities of younger households, both of which are a pretty serious burden at today's prices. .

But I disagree with your reasoning. The US Debt is not monetized with inflation, so by devaluing their currency, they will (over the long run) have the following benefits from inflation:

1.) The absolute value of the debt will fall relative to GDP, and thus be easier to pay.

2.) The exchange rate will be more favorable for US companies, and harder on countries that refuse to 'play ball' with the US on imports (China and Japan come to mind). The Economist article's point about the emerging markets falls in here.

3.) If they are able to engineer inflation without wage inflation (see Auto industry roll backs), they can cut the relative cost of labor at the same time - again, adding to their international competitiveness.

4.) All of these things will help erase a $500B trade deficit that, until recently, has been growing like Rosie O'Donnell at a buffet.

The pensions you mention usually have some form of inflation indexing, so unless that is unwound, it won't be that much of a benefit.




This will come at the cost of lower living standards long term (especially for middle and working class retires), transfer an even larger proportion of our nations' real wealth to the already asset rich, but it will get the moolah flowing around again.

Vultures circling the carcass always do well. Keep in mind that a lot of the 'asset rich' people you are talking about took one hell of a bath last year. Not saying that they won't recoup their losses, but on paper, they lost a lot more than you or I.

HappyOldGuy
8th January 10, 03:12 PM
As far as non-secret-conspiracy openly talked about dollar games. Remember that pretty much everyone including the US, the EU, Japan, and China are involved in an effort to remove the dollar as the worlds primary reserve currency and branch out into multi-currency reserves. All while trying to preserve as much of the dollars value as possible since that is what everyones wealth is in currently.

And also remember of course that it's only slim majorities (of financial players, us peons don't get a vote) in most of those countries who actually think this is a good idea.

BadUglyMagic
8th January 10, 03:18 PM
Originally Posted by Cullion
I should add the conspiracy theory option: We are in the early stages of a deliberately (but possibly opportunistically) engineered wave of inflation .




Not with the conspiracy theorists.

What sectors would you identify as engineered for the inflation wave?

Would targeting certain consumer sectors, fuel (gasoline, diesel), home heat (propane, natural gas), with the resulting inflationary price increases to food prices have any particular outcomes in the economy?

By the above, the suggestion is that "the govt" would intentionally create inflationary bubbles in those commodities/consumables to affect domestic economies. ie speculative futures driving gasoline prices to record highs.

This may have more of an effect in the US. Thoughts?

As a public policy, would this be desirable?

Sorry, this was incomplete. The objective would be to take "excess" or inflationary discretionary spending dollars away from consumers.

Robot Jesus
10th January 10, 05:24 PM
as long as thule is fine, so will i.

car racks are surprisingly recension proof.

EvilSteve
11th January 10, 01:01 PM
As long as the Thule Society is fine, so will I.

Proto-Nazi secret societies feed surprisingly well on recessions.

Feryk
11th January 10, 01:35 PM
Originally Posted by Cullion
I should add the conspiracy theory option: We are in the early stages of a deliberately (but possibly opportunistically) engineered wave of inflation .




Not with the conspiracy theorists.

What sectors would you identify as engineered for the inflation wave?

Would targeting certain consumer sectors, fuel (gasoline, diesel), home heat (propane, natural gas), with the resulting inflationary price increases to food prices have any particular outcomes in the economy?

By the above, the suggestion is that "the govt" would intentionally create inflationary bubbles in those commodities/consumables to affect domestic economies. ie speculative futures driving gasoline prices to record highs.

This may have more of an effect in the US. Thoughts?

As a public policy, would this be desirable?

Sorry, this was incomplete. The objective would be to take "excess" or inflationary discretionary spending dollars away from consumers.

I won't try to speak for Cullion and his tinfoil hat, but I'll take a stab at answering this. I would expect him to add his own perspective some eventually. You should know that he and I fundamentally disagree about many things happening in the world economy.

The inflationary pressure being discussed is due to a deflating currency. Essentially, the US dollar will not be worth as much worldwide, so it will buy less of all commodities. This is happening due to balooning debt and trade deficits, not a spike in demand for any particular good or service. The 'bubbles' being discussed in the article are due to commodities or economies that for whatever reason are bucking this trend. The point is that they will not be able to continue to do so indefinitely, so there is pressure being created.

This happens in other countries, but the US is relatively unique for two reasons:
1.) The size of the economy at stake

2.) The notion that the US dollar has been a 'benchmark currency'.

The US is the world's largest trading partner and consumer. If it loses it's buying power, then effectively, the rest of the world loses its selling power. The rest of the world has been busy trying to prop up the US dollar, but they have been made aware that there is more risk in the dollar than there used to be, so they are also trying to diversify their reserves. It's a bit of a tap dance.

The 'bubble' in the prices of some commodities had been due to speculation (which has settled down over the last several months), but prices are still rising. Some of this is because of demand creation, but a lot of it is simply that the US prices are rising -- because the USD is worth less. The rest of the world is seeing less of an increase in their commodity pricing, but it's masked because the prices of gold, oil, etc. are posted in USD.

Using gold as an example, the price increase in different currencies over the last year:

Canadian Dollars: 15.85%
Euro: 26.12%
USD: 32.91%

Source: http://www.goldprice.org/spot-gold.html

Does this mean that there is a gold 'bubble'? I would argue that it does not. It does, however, illustrate that the USD buys 33% less than it did a year ago. That means that US consumers just got that much poorer.

Cullion
11th January 10, 03:37 PM
But I disagree with your reasoning. The US Debt is not monetized with inflation

US debt bought by the Fed is financed by inflation.



1.) The absolute value of the debt will fall relative to GDP, and thus be easier to pay.

Inflation puts an upward pressure on interest rates.



2.) The exchange rate will be more favorable for US companies, and harder on countries that refuse to 'play ball' with the US on imports (China and Japan come to mind). The Economist article's point about the emerging markets falls in here.


Yes, true.



3.) If they are able to engineer inflation without wage inflation (see Auto industry roll backs), they can cut the relative cost of labor at the same time - again, adding to their international competitiveness.

If they engineer inflation without wage inflation they'll drive a higher proportion of the population into bankruptcy because their debts won't become easier to service, but the cost of other goods they're trying to buy will eat further into their budgets.



4.) All of these things will help erase a $500B trade deficit that, until recently, has been growing like Rosie O'Donnell at a buffet.



The pensions you mention usually have some form of inflation indexing, so unless that is unwound, it won't be that much of a benefit.

You may well be right. Are you aware of public data on the question of US pension inflation vulnerability ?




Vultures circling the carcass always do well. Keep in mind that a lot of the 'asset rich' people you are talking about took one hell of a bath last year. Not saying that they won't recoup their losses, but on paper, they lost a lot more than you or I.

Certainly. But the people who will do best will be the people who get their hands on the new money first.

Feryk
11th January 10, 03:52 PM
US debt bought by the Fed is financed by inflation.

Sorry, what I meant was that the debt is a fixed amount of dollars NOT dollars indexed for inflation




Inflation puts an upward pressure on interest rates. Yes. And the US people will have the dual joy of rising taxes AND interest rates at the same time. If you hadn't had incentive to pay your debt down before, you will now.








If they engineer inflation without wage inflation they'll drive a higher proportion of the population into bankruptcy because their debts won't become easier to service, but the cost of other goods they're trying to buy will eat further into their budgets.

Absolutely, but we are talking about fixing the nation's books, and frankly, they are past the point of worrying too much about another few million bankruptcies. Bankrupt people STILL have to pay their taxes.[/QUOTE]






You may well be right. Are you aware of public data on the question of US pension inflation vulnerability ? Not yet, but give me a day or two, I'll see what I can find.

EDIT - This is the book you want, but I don't know that it's easily available.

http://www.amazon.com/Financial-Aspects-National-Economic-Research/dp/0226062813




Certainly. But the people who will do best will be the people who get their hands on the new money first. Are you thinking that the US will let their dollar fall to the point of floating a 'new dollar'? Or something else?

Cullion
11th January 10, 04:42 PM
Yes. And the US people will have the dual joy of rising taxes AND interest rates at the same time. If you hadn't had incentive to pay your debt down before, you will now.

I'm sure you can see how dangerous that line of thinking is.



Absolutely, but we are talking about fixing the nation's books, and frankly, they are past the point of worrying too much about another few million bankruptcies. Bankrupt people STILL have to pay their taxes.

There comes a point where this kind of thing leads to social unrest of various sorts.



EDIT - This is the book you want, but I don't know that it's easily available.

http://www.amazon.com/Financial-Aspects-National-Economic-Research/dp/0226062813

Thanks.



Are you thinking that the US will let their dollar fall to the point of floating a 'new dollar'? Or something else?

I'm not talking about a replacement currency, just the way that inflationary financing most benefits the people who get their hands on the money earliest.