|Boom and burst: Don’t be fooled by false signs of economic recovery.
It’s just the lull before the storm
Andy Xie is a former Morgan Stanley economist now living in China; The
following is from the South China Morning Post:
The A-share market [a Chinese yuan-denominated stock market] is
collapsing again, like many times before. It takes numerous government
policies and “expert” opinions to entice ignorant retail investors
into the market but just a few days to send them packing. As greed has
the upper hand in Chinese society, the same story repeats itself time
A stock market bubble is a negative-sum game. It leads to distortion
in resource allocation and, hence, net losses. The redistribution of
the remainder, moreover, isn’t entirely random. The government, of
course, always wins. It pockets stamp duty [Tobin tax?] revenue and
the proceeds of initial public offerings of state-owned enterprises in
cash. And, the listed companies seldom pay dividends.
The truly random part for the redistribution among speculators is
probably 50 cents on the dollar. The odds are quite similar to that
from playing the lottery. Every stock market cycle makes Chinese
people poorer. The system takes advantage of their opportunism and
credulity to collect money for the government and to enrich the few.
I am not sure this bubble that began six months ago is truly over. The
trigger for the current selling was the tightening of lending policy.
Bank lending grew marginally in July. On the ground, loan sharks are
again thriving, indicating that the banks are indeed tightening. Like
before, government officials will speak to boost market sentiment.
They might influence government-related funds to buy. “Experts” will
offer opinions to fool the people again. Their actions might revive
the market temporarily next month, but the rebound won’t reclaim the
high of August 4.
This bubble will truly burst in the fourth quarter when the economy
shows signs of slowing again. Land prices will start to decline, which
is of more concern than the collapse of the stock market, as local
governments depend on land sales for revenue. The present economic
“recovery” began in February as inventories were restocked and was
pushed up by the spillover from the asset market revival. These two
factors cannot be sustained beyond the third quarter. When the market
sees the second dip looming, panic will be more intense and thorough.
The US will enter this second dip in the first quarter of next year.
Its economic recovery in the second half of this year is being driven
by inventory restocking and fiscal stimulus.
However, US households have lost their love for borrow-and-spend for
good. American household demand won’t pick up when the temporary
growth factors run out of steam. By the middle of the second quarter
next year, most of the world will have entered the second dip. But, by
then, financial markets will have collapsed.
China’s A-share market leads all the other markets in this cycle. Even
though central banks around the world have kept interest rates low,
the financial crisis has kept most banks from lending. Only Chinese
banks have lent massively. That liquidity inflated the mainland stock
market first, then commodity markets and property market last. Stock
markets around the world are now following the A-share market down.
By next spring, another stimulus story, involving even bigger sums,
will surface. “Experts” will offer opinions again on its potency.
After a month or two, people will be at it again. Such market
movements are bear-market bounces. Every bounce will peak lower than
the previous one. The reason that such bear-market bounces repeat is
the US Federal Reserve’s low interest rate.
The final crash will come when the Fed raises the interest rate to 5
per cent or more. Most think that when the Fed does this, the global
economy will be strong and, hence, exports would do well and bring in
money to keep up asset markets. Unfortunately, this is not how our
story will end this time. The growth model of the past two decades -
Americans borrow and spend; Chinese lend and export - is broken for
good. Policymakers have been busy stimulating, rather than reforming,
in desperate attempts to bring growth back. The massive increase in
money supplies around the world will spur inflation through
commodity-market speculation and inflation expectations in wage
setting. We are not in the midst of a new boom. We are at the last
stage of the Greenspan bubble. It ends with stagflation.
Hong Kong’s asset markets are most sensitive to the Fed’s policy due
to the currency peg to the US dollar. But, in every cycle, stories
abound about mysterious mainlanders arriving with bags of cash. Today,
Hong Kong’s property agents are known to spirit mainland-looking men,
with small leather bags tucked under their arms, to West Kowloon to
view flats. Such stories in the past of mainlanders paying ridiculous
prices for Hong Kong flats usually involved buyers from the northeast.
In this round, Hunan people have surfaced as the highest bidders. The
reason is, I think, that Hunan people sound even more mysterious. But,
despite all this talk, the driving force for Hong Kong’s property
market is the Fed’s interest rate policy.
Punters in Hong Kong view the short-term interest rate as the cost of
capital. It is currently close to zero. When the cost of capital is
zero, asset prices are infinite in theory. At least in this
environment, asset prices are about story-telling. This is why, even
though Hong Kong’s economy has contracted substantially, its property
prices have surged. Of course, the short-term interest rate isn’t the
cost of capital; the long-term interest rate is. Its absence turns
Hong Kong into a futile ground for speculation, where asset prices
increase more on the way up and decrease more on the way down.
When the Fed raises the interest rate, probably next year, Hong Kong’s
property market will collapse. When the Fed’s policy rate reaches 5
per cent, probably in 2011, Hong Kong’s property prices will be 50 per
Andy Xie is an independent economist
South China Morning Post
Article printed from The Big Picture: www.ritholtz.com