Bubbling Up...12/1/2012

1) China after the Global Minotaur by Yanis Varoufakis

In the book’s penultimate chapter, I discussed the Soaring Dragon which, as everyone tells us, is waiting in the wings, purportedly to take over from the Global Minotaur (click here for a pdf copy of that chapter). In my concluding remarks, written back in January 2011, I wrote: “To buy time, the Chinese government is stimulating its growing economy and keeps it shielded from currency revaluations, in the hope that vibrant growth can continue. But they see the omens. And they are not good. On the one hand, China’s consumption-to-GDP ratio is falling; a sure sign that the domestic market cannot generate enough demand for China’s gigantic factories. On the other hand, their fiscal injections are causing real estate bubbles. If these are unchecked, they may burst and thus cause a catastrophic domestic unwinding. But how do you deflate a bubble without choking off growth? That was the multi-trillion dollar question that Alan Greenspan failed to answer. It is not clear that the Chinese authorities can.”

In the eighteen months that followed since those lines were written, events have confirmed the projected pattern. The table below reveals that the falling rate of Chinese consumption is continuing unabated. In 2011 of every one dollar of income produced, only 29 cents entered China’s markets. With net exports making a small annual contribution to domestic demand (even though they contribute greatly to the country’s capacity to invest and, thus, boost productivity), the onus falls increasingly on investment to meet the demand shortfall. However, as suggested in the avove paragraph, this emphasis on investment is a double edged sword, as it threatens to let the Giny out of the bottle in real estate markets, where bubbles have been looming threateningly for a while now.

	1990	1995	2000	2005	2009	2011
Private Consumption	49	44	45	40	34	29
Investment	35	42	36	42	48	58
Government Consumption	12	13	17	12	11	10
Net Exports	4	1	2	6	7	3

Composition of Chinese Aggregate Demand (Percentages of Gross Domestic Product). Source: National Bureau of Statistics of China

Woj’s Thoughts - Most economists agree that China needs to re-balance its economy away from investment and towards private consumption. China has made very little progress, if any, in this regard. As for the potential housing bubble, opinions are far more divergent. After a recent trip to China, my wonderful professor, Garrett Jones, remarked that families were using second homes as a savings vehicle but faced difficulty in abruptly moving their larger, extended families living under the same roof. While I respect that view, the growth of private debt to purchase homes leads me to side with Yanis.

2) When the Credit Transmission Mechanism Breaks… by Cullen Roche @ Pragmatic Capitalism

If you look at the 30 year mortgage rate closely you’ll notice a relatively steady inverse correlation between rates and new home sales.  That is, all the way up until about 2007.  Then, rates remain low and new home sales stay depressed.  The low rate transmission mechanism breaks.

Why does it matter?  This is exactly what we’d expect to see given the state of the balance sheet recession.  You see, demand for credit is very low because households are still recovering from the implosion in their balance sheets.  Instead of taking on more debt, households are paring back debt.  This is clear from yesterday’s NY Fed report on household credit trends.  And this is why monetary policy has been so broken in recent years.  The Fed can’t gain traction because their primary transmission mechanism is busted.  And the economy won’t feel quite right until this part of the monetary system starts working normally again….

3) Death of a Prediction Market by Rajiv Sethi

A couple of days ago Intrade announced that it was closing its doors to US residents in response to "legal and regulatory pressures." American traders are required to close out their positions by December 23rd, and withdraw all remaining funds by the 31st. Liquidity has dried up and spreads have widened considerably since the announcement. There have even been sharp price movements in some markets with no significant news, reflecting a skewed geographic distribution of beliefs regarding the likelihood of certain events.

…

It seems to me that the energies of regulators would be better directed elsewhere, at real and significant threats to financial stability, instead of being targeted at a small scale exchange which has become culturally significant and serves an educational purpose. The CFTC action just reinforces the perception that financial sector enforcement in the United States is a random, arbitrary process and that regulators keep on missing the wood for the trees.

4) The Different Paths of Greece and Spain to High Unemployment by Thomas Klitgaard and Ayşegül Şahin @ Liberty Street Economics 

The high unemployment rate in Greece is not surprising given the depths of its recession, but what explains Spain’s 25.8 percent unemployment rate given its much more modest downturn? One contributing factor is the fact that the composition of Spanish jobs made the economy vulnerable to dramatic job losses during a recession. In 2007, almost 13 percent of jobs in Spain were in construction, compared with roughly 8 percent in Greece and the euro area. Such a heavy weight on this sector made employment more vulnerable to a downturn given the fact that construction is the sector that typically experiences the steepest decline in a recession. Indeed, construction, as measured in the GDP accounts, fell 35 percent from 2007 to 2011, and the sector accounted for almost 60 percent of the decline in total employment over this period.

   Another contributing factor is the very high percentage of employees tied to temporary work contracts in Spain. Data from the Organisation for Economic Co-operation and Development show that 32 percent of employees in Spain worked under temporary contracts and 68 percent under permanent contracts in 2007. In Greece, 10 percent were on temporary contracts; the figure for Europe as a whole was 15 percent.

Woj’s Thoughts - Both countries suffer from excessive private debt that is being transferred to the public sector as the private sector attempts to deleverage. Considering the size of the housing bubble in Spain (the bust continues), the relatively large portion of jobs in construction before the crisis and decline in employment within that sector afterwards are no surprise. However, the percentage of temporary workers in Spain is striking (Does anyone know if this is tied to cultural or policy reasons?). As both countries attempt to move towards balance budgets, the downward trend in unemployment and GDP is likely to continue.