Would German Like Vocational Training Ever be Accepted in the U.S.?

Friday, August 3rd, 2012

After the financial implosion of the past half decade, along with relative stagnation of the U.S. economy ex housing bubble since the early ’00s, many are looking at Germany as a compelling mix of private enterprise, government, and worker i.e. a more balanced form of “capitalism”.  Unlike U.S. corporations, large German companies have labor represented on their corporate boards.  Unions in the private sector still are viable entities as they have a vested interest in long term success of companies.  After the integration of East and West Germany a lot of very difficult labor reforms took place, and German wages have adjusted downward to compete globally.  Obviously the country has a benefit from the “lower than it would if Germany was independent” currency, but Germany seems to be doing a lot of things right economically.  One area is in unemployment where the German rate has been below America’s for quite some time.  This was highlighted in 2010 when I asked if we could dare to learn anything [Oct 1, 2010: German Unemployment Down to 7.2% after Peaking at 8.7%; Can we Learn Anything?]

BusinessWeek takes a closer look at one intriguing part of the German model: German style vocational apprenticeships.  Would they ever be accepted in the U.S.?  Most likely not – at least in the current environment – where corporations would push back against the added cost (and regulation), and the view on businesses are more as independent global entities rather than part of American society.  That said, I have read of a few individual companies starting small pilot programs of this type but nothing large scale.

Either way, it’s an interesting question to ask if they would benefit the society as a whole versus the current system of students taking on enormous debt for “going nowhere” degrees, concurrent with corporations complaining of a lack of applicable skills in the workforce.   In a perfect “free market” students should be figuring out on their own what those skill sets are that are needed in the U.S. corporate world and putting themselves into those type of educational programs to benefit – but there seems to be a disconnect somewhere in the chain.  Since the Germany model has education designed by industry rather than “the ivory tower set” there is a lot to be said for this form of training, and a substantial benefit to companies.  But certainly someone has to pay the cost of it.   It also puts to question the larger system in the U.S. – should large business care about the domestic economy at all or is it simply profit at all cost with little worry about the impact of a local economy?  With a global labor pool these questions are much more important than they would have been 50 years ago where business was much more tied to the country they were located in.

• In a world of high youth unemployment, where the supply of skilled labor often fails to match employer demand, Germany believes help can be found in its Dual Vocational Training System (TVET)—a time-tested economic model now incorporated into the Federal Republic’s law. This program, many supporters believe, is the reason why Germany has the lowest jobless rate among young people of any industrialized nation in the world—around 7 percent or 8 percent. With so many Americans struggling to find employment after graduating high school and college it might be worth asking: Can the German approach be brought to the U.S.?
• The German concept is simple: After students complete their mandatory years of schooling, usually around age 18, they apply to a private company for a two or three year training contract. If accepted, the government supplements the trainee’s on-the-job learning with more broad-based education in his or her field of choice at a publicly funded vocational school.
• Usually, trainees spend three to four days at work and one to two in the classroom. At the end, the theory goes, they come out with both practical and technical skills to compete in a global market, along with a good overall perspective on the nature of their profession.
• They also receive a state certificate for passing company exams, designed and administred by industry groups—a credential that allows transfer to similarly oriented businesses should the training company not retain them beyond the initial contract.
• The advantages are clear. TVET ensures there’s a job ready for every young person enrolled in vocational school, because no one is admitted unless an employer has already offered a training contract. No job offer, no admission. In this way, there is less risk of heartbreak when years of hard work in university go unrewarded by an unforgiving market. Students also know what they’re getting before the first day of class. This contrasts with the U.S., where many young individuals take on exorbitant amounts of debt to attend college and grad school, only to find no placement on the other end
• But the apprenticeship model faces significant obstacles in the U.S.  “Thus far, the U.S. corporate sector does not see technical and vocational training as one of its key responsibilities,” says Andreas Koenig, Head of Section, Vocational Training & Labour Markets at the Economic Development & Employment Department in Germany. “It is therefore not yet ready to invest in technical and vocational education and training that goes beyond a few weeks of induction or learning on the job.”
• Indeed, a need to change the culture of the industrialized world is a point Koenig and his colleagues made repeatedly during a presentation of the TVET model at the German Mission to the U.N. in New York last week. To create an effective system, many advanced nations must lose the stigma attached to vocational and technical school as a fallback for those who have failed in higher education.  Rather, the training system should be embraced because it works, as the German youth unemployment rate shows.
• Also standing in the way of the dual system’s acceptance is the antiregulatory fervor shared by many American corporations. As Yorck Sievers from the German Chambers of Industry and Commerce points out, efforts of private industry must be harmonized to fund and make the system effective. Companies would have to accept state oversight of training, which generates overhead expenses.
• But to proponents, the immediate cost pays for itself in the form of a more skilled economy. “German VET builds competence and real ability in blue and in white collar jobs,” writes Sievers, who says the trainees benefit from their acquired technical abilities in a globalized market economy. “They find jobs easier these days, get paid better, and work under much better conditions.”

Tags: Applicable Skills, Apprenticeships, Businessweek, Enormous Debt, German Companies, German Model, German Unemployment, Global Entities, Housing Bubble, Implosion, Individual Companies, Pilot Programs, Private Enterprise, Quite Some Time, Relative Stagnation, S Corporations, Term Success, Vested Interest, Viable Entities, West Germany
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Hugh Hendry On Europe: “You Can’t Make Up How Bad It Is”

Thursday, May 3rd, 2012

At The Milken Institute conference yesterday, Hugh Hendry delivered his usual eloquent and critical insights on the state of Europe. Beginning with the statement that “All of Europe has defaulted”, the canny-wee-fella (translation: shrewd and cautious young chap) explained that “The political economy in Europe is such that the politicians chose to default on their spending obligations to their citizens in order to honor the pact with their financial creditors and so as time goes on, the politicians are being rejected.” Between France’s election of Mr. Hollande and Luxembourg’s ‘when times get tough you have to lie’ Juncker, Hendry says the only inspiration for Europe is fiction as “you just can’t make up how bad it is” as he goes on to discuss the precedent for a way forward, the grotesque distortions of fixed exchange rate regimes, why Weimar happened, why the transfer union will never happen, Ayn Rand’s reality, and fear politicians are feeling.

The entire discussion is well worth watching for a sense of the underlying reality in Europe.

The underlying reality that what the European monetary union is about is not about preventing a third so-called European civil war, it is essentially about making someone (France, Germany or both) a Great Power, a European Hegemon, and a global player.

Starting at around 12:00, Hugh begins his must-watch discussion…

And begins again at around 30:00, Hendry discusses the British perspective on the impeccable logic of the German mind and why the transfer union will never happen in Europe…and why Wiemar happened…

At around 46:00, Hendry addresses Germany’s emerging housing bubble (and why it won’t occur) and the two forms of leverage in the world.

From 52:40, Hendry takes on the view of (disagreeing with) a weak USD and the US being supplanted as a global leader

Hendry confesses to not being able to finish reading Ayn Rand’s Atlas Shrugged at around 1:02:00 and explains why (apart from its length and lack of pictures)…noting that is too depressingly real in its description of the world we live in today…

We have reached a profound point in economic history where the truth is unpalatable to the political class – and that truth is that the scale and magnitude of the problem is larger than their ability to respond – and it terrifies them.

Concluding at 1:10:10 – “we are single-digit years away from the most profound market clearing moment”

(h/t Stock Bitch)

Tags: Ayn Rand, British Perspective, Creditors, Critical Insights, Distortions, European Monetary Union, Exchange Rate Regimes, Fella, Global Leader, Global Player, Hegemon, Hollande, Housing Bubble, Hugh Hendry, Impeccable Logic, Juncker, Milken Institute Conference, Pact, Political Economy, Politicians
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Keep Your Eye on Institutional Cash

Monday, April 2nd, 2012

I find the assets of institutional money-market fund, published by the Fed on a weekly basis, an extremely useful tool in determining the direction of the U.S. stock market. Institutional money-market funds comprise approximately 65% of all money-market funds but to focus on liquidity in terms of value per se may be misleading, though, as the asset allocation including liquidity of retirement funds is highly regulated. The actual liquidity of regulated funds in terms of value is therefore likely to grow in line with the overall value of retirement funds in rising stock markets.

Although not scientifically correct, I express the institutional money-market funds as a percentage of the total U.S. stock market capitalization as represented by the Wilshire 5000 Price Index as a proxy of total institutional funds to get a better picture of institutional fund liquidity, and named it the institutional liquidity ratio. In the graph below it is evident that the liquidity ratio remained virtually unchanged from 1991 to end 2000, meaning that liquidity moved in line with the broad stock market. Since the end of 2000 the face of fund management changed as five major events rocked investors: 1) the ICT bubble finally burst; 2) 9/11; 3) U.S. corporate scandals; 4) the housing bubble; 5) Lehman/great financial crisis. The events in 1, 2 and 3 took the liquidity ratio to 15% while the Lehman Saga and the subsequent global financial crisis saw the liquidity ratio peak at 35%.

Sources: FRED; I-Net Bridge; Plexus Holdings.

The value of the liquidity ratio lies in its smoothed annualized growth rate that is calculated by using linear smoothing �’ similar to how I estimate ECRI in calculating the smoothed annualized growth rate of the WLI.  When the growth rate surged in the third quarter of 2000 it indicated a change of heart by fund managers as they upped their liquidity at the cost of stocks, resulting in the ensuing bear market in stocks. When they slashed their liquidity levels in favor or stocks in the second quarter of 2003 it happened to be the bottom of the market. In 2006 the first warning signals appeared as the growth rate of the liquidity ratio turned positive. In the fourth quarter of 2007 the growth rate of the liquidity ratio jumped as institutions again favored liquidity ahead of stocks. When the growth rate of the liquidity ratio turned negative again, indicating that institutions were again favoring stocks, the downtrend in the S&P 500 since the start of 2008 was finally broken. It is also clear that the institutions have favored equities ahead of cash since then, except for a slightly positive move in the liquidity ratio’s smoothed growth in October last year.

Sources: FRED; I-Net Bridge; Plexus Holdings.

At this stage it is evident that despite calls from some of my fellow commentators that another bear market is in the offing, the institutions continue to favor stocks ahead of cash.

What I find most interesting as well is that the smoothed annualized growth rate of the liquidity ratio is more reliable than the WLI smoothed annualized growth rate. The liquidity ratio did not give the same false calls in 2010 and 2011 as the WLI did. To my mind the liquidity ratio is a comprehensive indication of institutions’ feeling towards all risk markets, while the WLI is probably a fixed weighted index of the risk markets and does not necessarily reflect institutions’ attitude towards risk assets.

Sources: FRED; I-Net Bridge; Dismal Scientist; Plexus Holdings.

I always wondered what following Robert Shiller had with his PE10 that is based on 10-year trailing earnings. Well, the following graph says it all.

Sources: FRED; Robert Shiller; I-Net Bridge; Plexus Holdings.

It is noteworthy that the liquidity ratio started to increase many weeks before the stock market’s rating was slashed at the start of 2008. That is because the institutions watch the Conference Board’s Consumer Confidence Index very closely and adjust their liquidity ratios according to the main indicator of the underlying economy! (Please note the reverse order of the liquidity ratio in the graph.)

Sources: FRED; I-Net Bridge; Plexus Holdings.

My conclusion is not to call a bear market at this stage. It does seem that the market is overextended, especially if one looks at the gap between consumer confidence and the liquidity ratio. In a recent article I also warned about the PE10 getting ahead of itself, but we could be in for a prolonged period of an overbought stock market.

Tags: Asset Allocation, Bear Market, Change Of Heart, Corporate Scandals, Fund Managers, Global Financial Crisis, Housing Bubble, Institutional Fund, Institutional Funds, Institutional Money, Liquidity Ratio, Mining, Money Market Fund, Money Market Funds, Price Index, Retirement Funds, Stock Market Capitalization, Stock Markets, U S Stock Market, Wilshire 5000, Wli
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Defence That Pays: Dividend Equities as a Long Term Strategy

Thursday, March 29th, 2012

Defence That Pays
Dividend Equities as a Long-term Strategy

by Alfred Lee, CFA, CMT, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management Inc.
alfred.lee@bmo.com

March 29, 2012
Recent Developments:

• Despite the global macro-economic concerns that remain, year to date, investors have clearly favoured risk-assets as improving sentiment has led global equity markets to rally with significant breadth. Although, investors should not put too much focus on day-to-day headlines, last Thursday’s reading of Europe and China’s weak Purchasing Managers Index (PMI), shows how the global economic recovery remains vulnerable. While we have become more optimistic over the mid-term, we still remain concerned on the structural issues remaining over the long-term, and is why we continue to recommend that investors do not throw caution to the wind.
• News of Greece’s debt restructuring several weeks ago, has put concerns on the backburner; although we believe Greece’s solvency issues remain over the long-term. On a short-term outlook, this has lifted a major overhang on the equity markets. Investors should note, however, that credit default swap (CDS) prices of Portugal still remain elevated (Chart A). Moreover, China’s potential housing bubble and inflation handcuffs the nation’s ability to implement a wholesale monetary easing policy. Thus, unlike 2009, China will not be able to shoulder the global economy.
• The year-to-date rally in risk-assets hinges on whether U.S. economic data can sustain or continue to build positive momentum. Although we have increased our recommended allocation to Canadian equities, we still remain defensive in our composition. Concerns on China should weigh on some commodity-based equities over the short-term, so we recommend that investors look at non-cyclical areas such as dividend paying equities in Canada.
• In addition to being more defensive in nature, lower bond yields should lead investors to look to dividend paying equities to source yield. Currently, the 10-year government bond yield is less than the dividend yield of the S&P/TSX Composite Index (TSX) (Chart B). An aging demographic searching for income distributions should provide a further tailwind for dividend paying equities over the long-run.
• Improving economic data has also recently led the yield curve to shift upwards (Chart C), which has negatively impacted bonds, especially those of longer maturity. As we have become more bullish on equities over the short- and mid-term, investors may want to consider reallocating some bond exposure to dividend paying equities as a way of maintaining overall portfolio yield while decreasing duration risk. Investors should keep in mind that equities and fixed income do react to risk in different manners and therefore should keep in mind their overall portfolio risk composition.

Investment Idea:

• Investors may want to consider the BMO Canadian Dividend Equity ETF (ZDV) as an efficient way to gain exposure to a basket of 50 large and some mid-cap Canadian dividend paying stocks. Currently, the underlying portfolio yields 4.5%, diversified across eight different sectors and a management fee of only 0.35%. In addition to being eligible for a dividend reinvestment plan (DRIP) like our other BMO ETFs, ZDV pays a monthly distribution. We continue to recommend defensive holdings such as ZDV as core positions and more cyclical oriented themes around the peripheral as more tactically oriented themes.

Chart A: CDS Prices on Portugal Remain Elevated

Source: BMO Asset Management Inc., StockCharts.com

Chart B: Canadian Bonds Yielding Less than Canadian Equities

Source: BMO Asset Management Inc., Bloomberg,

Chart C: Yield Curve Shifting Upwards Will Impact Fixed Income

Source: BMO Asset Management Inc., Bloomberg

*All prices as of market close March 27, 2012 unless otherwise indicated.

Disclaimer:
Information, opinions and statistical data contained in this report were obtained or derived from sources deemed to be reliable, but BMO Asset Management Inc. does not represent that any such information, opinion or statistical data is accurate or complete and they should not be relied upon as such. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.

BMO ETFs are managed and administered by BMO Asset Management Inc, an investment fund manager and portfolio manager and separate legal entity from the Bank of Montreal. Commissions, management fees and expenses all may be associated with investments in exchange-traded funds. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns including changes in prices and reinvestment of all distributions and do not take into account commission charges or income taxes payable by any unit holder that would have reduced returns. The funds are not guaranteed, their value changes frequently and past performance may not be repeated.

Tags: Alfred Lee, Asset Management Inc, Backburner, BMO, Canadian, Canadian Equities, Canadian Market, Caution To The Wind, Cmt, Credit Default Swap, Debt Restructuring, Economic Concerns, ETF, ETFs, Global Economy, Global Equity Markets, Global Macro, Housing Bubble, Investment Strategist, Purchasing Managers Index, Structured Investments, Swap Cds, Term Outlook, Wind News
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World Bank Warns of Economic Crisis in China; Only 3% Growth for Decade Says Michael Pettis

Friday, March 2nd, 2012

A World Bank report to be released next week warns of an economic crisis in China unless state-run firms are scaled back. The Wall Street Journal discusses the report in New Push for Reform in China

An exclusive preview of an economic report on China, prepared by the World Bank and government insiders considered to have the ear of the nation’s leaders, offers a surprising prescription: China could face an economic crisis unless it implements deep reforms, including scaling back its vast state-owned enterprises and making them operate more like commercial firms.

“China 2030,” a report set to be released Monday by the bank and a Chinese government think tank, addresses some of China’s most politically sensitive economic issues, according to a half-dozen individuals involved in preparing and reviewing it.

The report warns that China’s growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the “middle-income trap.” A sharp slowdown could deepen problems in the Chinese banking sector and elsewhere, the report warns, and could prompt a crisis, according to those involved with the project.

It recommends that state-owned firms be overseen by asset-management firms, say those involved in the report. It also urges China to overhaul local government finances and promote competition and entrepreneurship.

China’s Difficult Transition From an Unsustainable Growth Model

Peak oil, a housing bubble, bad debts and over-reliance on investments with no genuine economic feasibility guarantee China’s current boom is not sustainable. China bulls are in for a ride awakening when various bubbles pop.

As for recommendations, the report  proposes a sharp increase in the dividends that state companies pay their owner (the government) in order to boost revenue and pay for new social programs.

Does China need to increase competition, break apart, and privatize the state-owned monopolies?
Or should China simply increase the dividends?

I vote for the former as does Michael Pettis at China Financial Markets.

Via email, Pettis says:

The report is good as far as it goes, but it doesn’t go far enough. Of course increasing SOE dividends to the government for use in social programs will transfer wealth from the state sector to the household sector, but if the total profitability of the SOE sector is less than one-fifth to one-eighth of the direct and indirect subsidies transferred from the household sector, as I have argued many times, then even 100% dividends is not enough to slow the transfer significantly, and remember the transfers have to be reversed, not merely slowed. This proposal falls in the better-than-nothing category, but just.

What we really need are much more dramatic transfers, for example wholesale selling of assets, with the money used either to clean up bad loans or delivered directly to households. According to the article, however, “neither the World Bank nor the DRC proposed privatizing the state-owned firms, figuring that was politically unacceptable.”

This is the problem. The best solution for China, economically, seems to be off limits because it will be politically difficult. In that case the second best solution, a gradual build-up of government debt as growth slows for many years, is the most likely outcome.

And how much will growth slow? The World Bank report apparently doesn’t say, but the consensus has been slowly moving down towards 5-6% annual growth over the next few years.

That’s better than the crazy numbers of 8-9% most analysts were predicting even two years ago (and some still are), but it is still too high. GDP growth rates will slow a lot more than that. I still maintain that average growth in this decade will barely break 3%. It will take, however, at least another two or three years before a number this low falls within the consensus range.

And by the way when it does, metal prices should fall sharply. Copper prices have done reasonably well in the past few months as Chinese buyers have restocked, as we suggested might happen to our clients last fall. With the recent easing we may see more strength in copper over the next month or so, but I have little doubt that within two or three years copper prices are going to be a whole lot lower than they are today. Chinese investment demand simply cannot hold up much longer.

Sad State of Political Acceptability

The report makes feeble recommendations to ensure the proposals are “politically correct”. This is a bad practice for three reasons.

1. You only damage your own credibility
2. You presume perhaps incorrectly what is politically acceptable
3. You plant false hope that incorrect solutions will work, when it’s clear they will not

It would be far better list the alternatives and the limitations of those alternatives, then provide an honest assessment rather than assume something cannot be done. Unfortunately, telling people what they want and expect to hear is the sad state of political pandering everywhere.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Asset Management Firms, Bad Debts, Banking Sector, Chinese Banking, Chinese Government, Competition And Entrepreneurship, Difficult Transition, Dozen Individuals, Economic Crisis, Economic Feasibility, Economic Issues, Economic Report, Growth Model, Housing Bubble, Michael Pettis, Peak Oil, Slowdown, State Owned Enterprises, Unsustainable Growth, Wall Street Journal
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Chanos: How China Could Fail the World Economy

Wednesday, February 22nd, 2012

1. Hedge fund manager Jim Chanos says slowing demand in China will continue and may have ripple effects around the global economy.

2. China skeptic Jim Chanos says the air has already started to come out of China’s housing bubble.

Source: CNNMoney, February 21, 2012.

Tags: China Air, China Economy, China Housing, Economy China, Global Economy, Hedge Fund Manager, Housing Bubble, Jim Chanos, Ripple Effects, Skeptic, World Economy
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Marc Faber: Money Printing Dictates Market Movements

Sunday, December 18th, 2011

The following is a partial transcript of Jim Puplava‘s great interview on Financial Sense with Marc Faber, author of the Gloom Boom & Doom Report. In a wide-ranging interview, they discuss inflation, China, gold, war, resource scarcity, democracy, education, market volatility and the importance of diversification. Click here to listen to the audio interview.

Jim Puplava: Marc, I want to begin our discussion with a topic you have addressed in several recent newsletters, which is the decline in morality and ethics within the financial system and within society. In your opinion, is this the result or consequence of cheap money and currency debasement.

Dr. Marc Faber: Well I think to some extent yes, because it’s created a tremendous wealth inequality and at the same time, it created tremendous power in the financial sector. So the combination of the two was certainly a contributing factor. And if you read about the history of hyperinflation in the world, in each case there was a tremendous decline in morality.

Jim Puplava: Marc, I have known you for several years now since we first met at the San Francisco Gold Show. And since I have known you, you have been very consistent on your views on inflation. Given the severity of the financial crisis, and the deflating asset prices that we have seen—for example, real estate in the United States, and now we have seen even the pull back and decline in a merging markets—have you altered your views or changed them in any way, given the recent downturn in many of the emerging markets.

Dr. Marc Faber: Well if we understand inflation as a monetary cause, in other words, you increase the quantity of money and of debt, then obviously, we have inflation in the system. Now Mr. Bernanke, he was under the impression that he could just drop dollar bills onto the United States and revise the housing bubble. But the problem with this view is that if you drop the dollar bills, in other words if you increase the quantity of money, it does not necessarily have to revive all asset prices, and all prices at the same time. So housing did not respond, but as you know since March 2009 equities have rebounded on the S&P from 666 to now 1200, and at the same time we have significant price increases in the system in insurance costs and in educational costs. There was a statistic recently published that the turkey this year for Thanksgiving would cost 13.4% more than a year ago. Nobody can tell me that they think there is deflation in the system. And I see that myself, because I travel a lot that there are leakages—when you print money in the U.S. it does not have to generate inflation in the U.S., it can generate inflation in India or China, or in Vietnam or in Hong Kong, or in Singapore. In that sense, there was a lot of inflation.

Jim Puplava: You know, as a believer in devaluation and currencies, I was recently reminded of this last Wednesday. Tuesday evening Marc, I read several well-known respected technicians like John Rokes, Stan Winestein, and Paul Desmond. And they were talking about the breakdown of the markets. And before I went to bed Tuesday night, the futures were down. Lo and behold, I wake up the next morning to the news of China lowering its bank reserve requirements, and then we got a love-fest to Central Bankers and new money printing. I thought of something I heard you say, that whenever markets fall, 20% or more, Central Bankers will immediately engage in a new round of money printing. And that’s exactly what happened.

Dr. Marc Faber: Yes, I mean the market keeps going up at the present time because of easing measures and today because of the rumors or the statements that the ECB is one way or the other, in one form or the other would essentially bailout Europe. So this has not really to do with economic fundamentals, which are not particularly good, but it has to do with money printing.

Click here for the full transcript.

Source: Jim Puplava, Financial Sense, December 7, 2011.

Tags: Asset Prices, Cheap Money, China Gold, Debasement, Democracy Education, Dollar Bills, Dr Marc Faber, Education Market, Financial Sense, Housing Bubble, Hyperinflation, Importance Of Diversification, Jim Puplava, Market Volatility, Money Printing, Morality And Ethics, Partial Transcript, Resource Scarcity, San Francisco Gold, Wealth Inequality
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Down With Europe (Roubini)

Friday, November 11th, 2011

by Nouriel Roubini, via Project Syndicate

November 11, 2011, NEW YORK – The eurozone crisis seems to be reaching its climax, with Greece on the verge of default and an inglorious exit from the monetary union, and now Italy on the verge of losing market access. But the eurozone’s problems are much deeper. They are structural, and they severely affect at least four other economies: Ireland, Portugal, Cyprus, and Spain.

For the last decade, the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) were the eurozone’s consumers of first and last resort, spending more than their income and running ever-larger current-account deficits. Meanwhile, the eurozone core (Germany, the Netherlands, Austria, and France) comprised the producers of first and last resort, spending below their incomes and running ever-larger current-account surpluses.

These external imbalances were also driven by the euro’s strength since 2002, and by the divergence in real exchange rates and competitiveness within the eurozone. Unit labor costs fell in Germany and other parts of the core (as wage growth lagged that of productivity), leading to a real depreciation and rising current-account surpluses, while the reverse occurred in the PIIGS (and Cyprus), leading to real appreciation and widening current-account deficits. In Ireland and Spain, private savings collapsed, and a housing bubble fueled excessive consumption, while in Greece, Portugal, Cyprus, and Italy, it was excessive fiscal deficits that exacerbated external imbalances.

The resulting build-up of private and public debt in over-spending countries became unmanageable when housing bubbles burst (Ireland and Spain) and current-account deficits, fiscal gaps, or both became unsustainable throughout the eurozone’s periphery. Moreover, the peripheral countries’ large current-account deficits, fueled as they were by excessive consumption, were accompanied by economic stagnation and loss of competitiveness.

So, now what?

Read the Complete Article

Copyright © Project Syndicate

Tags: Account Deficits, Competitiveness, Current Account, Divergence, Economic Stagnation, Excessive Consumption, Fiscal Deficits, Housing Bubble, Ireland Italy, Italy Greece, Last Decade, Last Resort, Market Access, Monetary Union, Periphery, Private Savings, Project Syndicate, Public Debt, Roubini, Surpluses
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China’s Housing Bubble: New Evidence

Friday, July 15th, 2011

by Christian Dreger and Yanqun Zhang, via VoxEU.org

15 July 2011

For a while now, analysts have been arguing there is a bubble in China’s property market. Using records from 35 major cities this column finds evidence of a housing bubble. It compares house prices to cointegrated fundamentals and finds that property in China is in general overvalued by around 20% – and even more so in the boom towns.

For many observers, the Chinese economy has been spurred by a bubble in the real-estate market, probably driven by the fiscal stimulus package and massive credit expansion (Nicolas 2009). For example, the stock of loans increased by more than 50% since the end of 2008.

In reaction to the global crisis, the government urged banks to increase lending (Cova et al. 2010). Mortgage loans have played a significant role, as they account for one third of total lending activities. Banks have provided easy credit for housing development, probably without sufficient evaluation of risks. In addition, state-owned enterprises have stimulated the development, having access to low-cost capital and believing they are too big to fail.

There are several indications that the market might have overheated in recent years. In some cities, buyers are picked up by the seller in a lottery. The rapid increase in house prices triggers exuberant expectations and speculation. Some real-estate developers have started hoarding houses by delaying their sales hoping for higher profits. Due to higher-price expectations, families are stretching to pay prices at the edge of their means or beyond.

To dampen the evolution, the People’s Bank of China has increased its nominal interest rate. The Chinese government has also introduced measures to combat record prices, including mortgage rates and down-payment requirements for second homes. In some cities, house owners are restricted in new house purchases. Many state-run mortgage lenders have cut mortgage discounts. Additional taxes on property are in the pipeline. While housing prices in the first-tier cities stopped rising further, they are still at record levels. Housing prices are not only a problem from an economic perspective, they’re also an issue of the people’s livelihood that can affect social stability. Households with average income increasingly feel that they cannot afford to buy a house (Deng et al. 2009).

A burst of a house-price bubble can be harmful for the real economy. Due to the low leverage, the risk that people are not able to fund their mortgage commitment might not be very high. However, housing investment accounts for 10% of GDP, and is crucial for economic growth. Because of the integration of China into the world economy, a bursting bubble can cause negative spillovers to other countries, particularly in the Asian region. The challenge for the government is to scrap out speculative activities without  killing an engine of GDP growth.

While accelerating house prices may indicate the presence of a bubble, its existence is rather controversial. Urbanisation trends, rising incomes, and low interest rates may all have triggered the rising prices. The ongoing trend for smaller families may have created strong demand. For many Chinese, especially for young couples, renting an apartment is not very popular. The regulation system does not give tenants much protection. Renters will lose their apartments if the home owner decides they want the building for a different use. Due to fast economic growth, millions of Chinese join the middle class each year, thereby contributing to high housing demand. Because of high saving rates, many households are able to buy a house with cash and are rather independent on mortgage loans. In addition, the uneven development across the regions has enhanced the housing demand in first-tier cities where there are better living conditions, more job opportunities, and better public resources. Overall, high house prices may be in line with the fundamental socioeconomic factors (World Bank 2010).

New evidence on the bubble’s size

In recent research (Dreger and Zhang 2010), we use a dataset for 35 major cities to estimate the size of the bubble relative to the equilibrium level implied by the panel cointegrating relationship. We suggest that positive deviations from the long run might indicate the presence of speculative bubbles. However, many analysts have argued that a bubble has emerged only in recent years, probably spurred by the recent fiscal stimulus package (Wu et al. 2010). Hence, the evidence can be misleading if the cointegration relationship is considered over the entire period. In a first step, we estimate the long-run relationship only up to some point in time. The fundamentals include real per-capita income, real interest rates, real land prices and population. Cointegration between these variables and the real house price can be established. City fixed effects are embedded to control for unobserved heterogeneity.

In the second step, the house price evolution is predicted over the rest of the sample, i.e. the last two years, where perfect foresight is assumed with respect to the fundamentals. This gives an estimate of the fundamental development of house prices, and the size of the bubble can be addressed. As an exception, land prices are held constant throughout the forecasting horizon to reduce endogeneity problems.

Our results indicate the presence of a house-price bubble. In Figure 1it can be seen that increasing imbalances have emerged over the past two years. For example, real house prices in Shanghai have been 28% above the long run equilibrium in 2008, and 35% in 2009. While the evidence is similar for Beijing, the increase is more spectacular in Shenzhen. Compared to the cointegrating relation, real house prices are overvalued by 66% in 2009, after 23% in 2008. In general, the bubble is more pronounced in the special economic zones and the south-eastern coastal regions. Overall, the size of the bubble is 20% in 2008 and 25% in 2009, regardless of whether GDP or population weights are applied.

Figure 1. House price bubble in major Chinese cities

Note: Size of the bubble expressed in% of the fundamental value implied by the cointegrating relationship.

Further analysis indicates that changes in real house prices cause inflation, but not vice versa. In contrast, there is no causality from house prices to GDP growth. Therefore, a decline in house prices may contribute to a lower inflationary environment without huge negative effects on real economic development.

References

Cova P, M Pisani, A Rebucci (2010), “Macroeconomic effects of China’s fiscal stimulus”, Inter American Development Bank, Working Paper 211.

Deng L, Q Shen, L Wang (2009), “Housing policy and finance in China: A literature review”.

Dreger C, Zhang Y (2010), “Is there a Chinese real estate bubble? Regional evidence and implications”, DIW Discussion Paper 1081.

Nicolas F (2009), “The global economic crisis. A golden opportunity for China”, Institut Français des Relations Internationales, Asie Visions 15.

World Bank (2010), China Quarterly Update, March.

Wu J, J Gyourko, Y Deng (2010), “Evaluating conditions in major Chinese housing markets”, NBER Working Paper 16189.

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Tags: Bank Of China, Boom Towns, Chinese Economy, Chinese Government, Credit Expansion, Dreger, Fiscal Stimulus, Global Crisis, House Prices, Housing Bubble, Housing Development, Mortgage Discounts, Mortgage Lenders, Mortgage Loans, Nominal Interest Rate, Price Expectations, Rapid Increase, Real Estate Developers, State Owned Enterprises, Stimulus Package
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Vancouver Housing Prices Pass New York and London as Chinese ‘Move’ In

Wednesday, May 18th, 2011

by Trader Mark, Fund My Mutual Fund

Pardon the pun in the title, simply could not resist.

Quite a fascinating article in Bloomberg, as it seems the recent clampdown on property in China has led many to head east (well …..to the “west”) spiking the already red hot Vancouver housing market.  One that already had the warning flags last summer. [Jun 30, 2010: BW - Vancouver, Canada: Housing Bubble North of the Border?]  One (of a myriad) of reasons you could see the U.S. housing market getting out of control was the complete disassociation between median incomes and housing prices.   [Dec 6, 2007: What Should Median Housing Prices be Today?]   To say this has happened as well in Canada – and especially Vancouver – is an understatement.  That said, they have the same very loose monetary policy, and an influx of buyers – many of them cash – from outside the country itself, so it is definitely setting up an interesting scenario.   One wonders what happens when their central bank actually begins to raise rates in earnest.

At this point, using the measure above (median household income to median price), Vancouver is now more expensive than New York or London.  And I am sure a lot less investment bankers work there, than in either of those 2 locales.

Some of the growth measures in this story seem nearly impossible – looks like some mass herding effect out of China and into Canada…

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• Vancouver’s Royal Pacific Realty had such a surge of business during the first two weeks of February that agents and assistants worked day and night shifts to find homes for Chinese buyers visiting during the Lunar New Year.  “It was unprecedented,” said Royal Pacific Chief Executive Officer David Choi.
• Sales of detached homes, townhouses and condominiums in metropolitan Vancouver jumped 70 percent in February from January, to 3,097 units from 1,819, and were up 25 percent from a year earlier. In March, sales climbed 32 percent from February. Sales increased by 80 percent from two years ago.
• Buyers from mainland China are leading a wave of Asian investment in Vancouver real estate as China tries to damp property speculation at home. Good schools, a marine climate and the large, established Asian community as a result of Canada’s liberal immigration policy make Vancouver attractive, said Cathy Gong, who moved from Shanghai to the Shaughnessy neighborhood on Vancouver’s Westside about three years ago.
• China, where home prices rose 28 percent in Beijing and 26 percent in Shanghai last year, has taken steps to curb property speculation within its borders.  Premier Wen Jiabao placed curbs on mortgage lending, boosted down-payment requirements and limited the number of purchases.
• In 2010, Vancouver had the third-highest housing costs among English-speaking cities worldwide. Only Hong Kong and Sydney, another magnet of Asian immigration, were more expensive.
• Vancouver’s median home price of C$602,000 ($618,000) was 9.5 times the annual median household income of C$63,100. Canada had a 4.6 national multiple, making it “seriously unaffordable,” while the U.S. at 3.3 was “moderately unaffordable,” the study showed. To be affordable, the multiple must be 3 or less.
• Vancouver was more expensive than San Francisco, London and New York by that measure.
• Unlike London or New York, “we don’t have enough jobs with high incomes to justify” the home prices, said Ladner. He noted Australia has placed restrictions on foreign home ownership.
• Holidays in China have been a popular time to look for houses in Vancouver. Sales picked up in October during China’s weeklong national holiday, said Winnie Chung, a Royal Pacific agent who represented buyers or sellers in C$285 million of home sales in 2009 and 2010 combined.

• Mainland Chinese are buying houses primarily in Vancouver’s Westside, boosting the median sales price to C$2 million in the district known for its wide boulevards, beaches, expansive parks and stucco Tudor mansions.
• “Our office has done 50 sales this year, which is pretty incredible,” said Vancouver realtor Tom Gradecak at his office in Point Grey, where he has one colleague who speaks Mandarin and Cantonese and is hiring a second. “Half of those sales are from mainland China.”
• Some buyers acquire multiple homes, one to live in and others for investment, said Chung, the broker. Her clients made their money in a variety of businesses, she said, including mining, stainless steel manufacturing and real estate. About 10 percent of them speak English, she said.
• Westside home prices rose 77 percent during the past five years through April amid the housing collapse in the U.S.
• In 2010, the average home price in greater Vancouver rose 14 percent from 2009.
• The current group of Chinese homebuyers in Vancouver is the third “wave” from Asia since 1990, following Taiwanese and Hong Kong immigration, said Manyee Lui, a veteran Vancouver realtor. “People from mainland China are the new immigrants,” Lui said.
• Chinese buyers frequently are absentee owners, wealthy businessmen who buy second or third houses for their wives and children while continuing to live in China for work.   “You see a lot of these satellite families,” said Chow. He said it’s not unusual to see college-age kids of wealthy Chinese parents driving Bentleys, Maseratis and Porsches around the Westside.
• Low interest rates inflated home prices and created a bubble, said Lawrence Wong, an immigration lawyer with many Chinese clients. “There is this psychological fear that ‘Ok, if I don’t get into the market, I might not be able to get in later on,” said Wong.

Fun random fact….

• Starting about 18 months ago, so many homeowners applied to change the last two digits of their addresses to remove or shift the number 4, which in Chinese sounds like the word for death, or add the numeral 8, which is considered lucky, that Vancouver began turning down some requests, said Bonnie Lee, addressing coordinator for the city.

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Tags: Bloomberg, Canada Vancouver, Canadian Market, Chief Executive Officer, Clampdown, David Choi, Disassociation, Housing Bubble, Housing Market, Influx, Investment Bankers, Lunar New Year, Median Household Income, Median Incomes, Median Price, Monetary Policy, Night Shifts, Pacific Realty, Townhouses, Understatement, Vancouver Canada
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