Double Dip or No? A Misguided View

Economy Avoids Recession Relapse as Data Can't Get Much Worse - Bloomberg

This article from last night on Bloomberg.com appears to miss the point and misstate the truth about the US and world economy. It states in blunt terms that the economy is so bad that it could not possibly enter into a second recession.

I think it actively tries, in best Polyanna fashion, to give us some perverted optimism. "We at the real floor of the economic cycle now, really, really." It does not attempt to respond directly to the critics of this point of view like Krugman and Roubini. Instead, it makes arguments such as "the markets have already priced in even worse economic numbers than we have today" and "growth will be 'subpar' for a prolonged period". Not good enough.

The real crisis is on Main Street now, not on Wall Street. Whether the markets have properly accounted for trends in macroeconomic data is besides the point. It does not help the long-term unemployed and it does not improve industrial capacity utilization rate. It doesn't help the large numbers of families still threatened with foreclosure.

We in the (temporarily?) economically healthy third world have a lot at stake in the US addressing its economic situation honestly and strategically. We cannot separate ourselves from the US's problems so easily. This misguided attempt at instilling confidence in the policymakers if not the economic reality does not help either the US or us.

Real Estate’s Gold Rush Seems Gone for Good - NYTimes.com

The New York Times this morning has this analysis of housing as an investment. They are coming on board to the view that recovery from the supervaluation of residential real estate that has exploded in the years since its peak in 2005.

In fact, I've argued this point since I wrote an article for Money magazine in 1987, as I was skeptical of the behavior of my fellow (at the time) Californians. They made the eternal growth assumption and were starting the trend of taking out additional loans against their houses to pay for expendables such as cars, vacations, big screen tv's, etc.

I'm sorry to blow my own horn here and I feel enormous sympathy for homeowners who have lost so much in the recent past. Many of my good friends in California are in this position. They have been swept up in the societally accepted story/myth/wisdom of eternal market optimism. This concept that we follow stories rather than facts is well described in George Akerlof and Robert Shiller's book of last year, Animal Spirits.

As part of my skepticism on the Brazilian economy, I have expressed a number of times my concern that we are following the First World in belief in this myth of eternal growth in real estate. I believe the conditions exist here for the housing bubble to burst just as it has done elsewhere. Problem is, our economy is relatively more fragile and our prosperity of much shorter duration than the U.S. or Europe. The impacts of burst bubble could return us to the instability of the 1980's and early 90's.

Read this article. It's worth your time.

Real Estate’s Gold Rush Seems Gone for Good - NYTimes.com

The Point of No Return - Magazine - The Atlantic

The Point of No Return - Magazine - The Atlantic

This is a very important article on the future of Israel and the possibilities for war and for peace in the Mideast, having to do with the threat posed by the Iranian drive for nuclear weapons. Very much worth reading

Reboot the World, not just America

I have argued to my students in São Paulo since early 2009 that if the US government and the European Union did not make a serious commitment to stimulus, the Great Recession could continue to plague the entire world for a full decade. I have been increasingly dismayed about the trend towards deficit reduction in Europe and the US that could trigger just the kind of ongoing recession that that I feared. Now, the Daily Beast has published a manifesto by prominent economists, called Reboot America, that calls for a continuation and expansion of economic stimulus as the key to bringing the world economy out of its lethargy.

This lethargy is dominated by the very slow recovery in employment in the United States and Europe. As well, although we have had major corrections in the hyperactivity in the domestic real estate and financial markets in these regions, there are still enormous bubbles in the personal finance sector (credit cards, etc.). The housing sector in the US continues precarious with more than 10% of domestic mortgages in some degree of default. (Sorry, I lost the reference to this.)

A year ago, we were all Keynesians. Europeans and Americans were united in following his dicta in planning their recovery from the market meltdown and the crash in demand and employment. Now, however, both sides of the North Atlantic are fearful of the budget deficits they are running. The US deficit exceeds $1 trillion, a lot of money by any accounting. But, if we are going to follow Keynes' policies for recovery, we need to follow them until we have recovered. As the Reboot American economists put it, "Making deficit reduction the first target, without addressing the chronic underlying deficiency of demand, is exactly the error of the 1930s." Indeed, we are making the same error that President Franklin Roosevelt made in 1936, with the recovery just starting. He began to focus on cutting expenses and deficits, with the obvious targets being the recovery programs that his administration created in 1933 and 1934. As a result, the Great Depression continued until World War II.

Republicans in the US do not want to accept the longer-term burden of paying for the recovery through taxes. Likewise, Germany and other conservative forces in Europe are scared that European national economies, like those of Spain and Greece for example, will be unable to pay off their obligations. As has been shown in the past, future growth will be able to pay off these obligations of recovery. The most recent US example of this was the deficit reduction during the Clinton Administration that put the budget in surplus after decades of hand-wringing about deficit reduction.

Why am I, in Brazil, interested in this question (beyond my being an American citizen)? Because of a set of well-structured financial market controls, Brazil largely avoided the Great Recession. Our recovery, both in financial markets and on Main Street, was relatively rapid. Today, our problem seems to be an excess of growth that could spark anew our typically Latin bugbear, inflation. We are concerned here because the US and Europe have traditionally represented our largest export markets. Now, China is displacing our traditional trade partners. However, this trade is focused on minerals and other raw materials. With the US and Europe, our trade is more balanced and allow us to develop our industrial and service sectors more than our extraction and agricultural sectors. Brazil's future depends on transforming our economy to one that demands that we bring our public education system to an acceptable standard and that we invest in technology and infrastructure. We are currently benefitting from world demand for the kinds of extractive resources in which the country abounds, but it is still the same type of economy that Brazil has lived with for at least three hundred of its five hundred year history.

So, if we believe that Keynes provided a correct description of how to emerge from a recession, then we need to remain committed to it until it works. When we are told by our doctors to take antibiotics to cure an infection, they always tell us to take the entire course of medicine and not to cut it off in the middle even if our symptoms of infection fade away. The same good advice holds here.

Israel and the Flotilla

At this point, two days after the Israeli Navy's assault on the Turkish ferry and the other vessels attempting to head to Gaza, we all recognize that the Netanyahu government is in damage control mode. Whether the assault in international waters was justified or not is no longer the point. At a minimum, it was mishandled.

Even Israeli military officials are now saying their intelligence was faulty. However, other Israeli commentators speak of the government's "self-righteousness", its "fear", even its stupidity. Both Israeli and international commentators lament the public relations trap that Israel willingly entered into, giving the "activists" all the victimhood they really sought, while further tarnishing Israel's international reputation.

It is easy for Israelis and Israel's supporters to hide behind the claim that the ships had terrorists aboard. However, it's beside the point. The presence of terrorists, even the head of the IHH, sponsor of the operation, was part of the goad to get Israel to overreact. The point is that managing provocations such as this has been part and parcel of Israel's survival for more than six decades.  What has happened to that skill?

At this point, two perspectives are needed. One is to look back on this operation in the form of an inquiry for the government and military to assess how to balance their security and international public relations needs. In the past, Israel was a master at this art. Now, it is the Palestinians, particularly Hamas and Hezbollah, that direct this orchestra.

The second is to look forward to repair the damage done to the country's reputation. Israel's leaders need to visit all its friends rapidly with a message that is not based on insecurity and truculence (the responses I've read so far, even from Shimon Peres, President of Israel and Nobel Peace Prize winner). Friends seem few and far between. Some transparency and detail would help too - why the government felt the assault on the ships was necessary in international waters, what it suspected it ships were carrying and why it had these suspicions. Because so far, the photos from Ashdod of wheelchairs and teddy bears among the cargo being released for shipment to Gaza are not very convincing that an immediate threat existed that demanded this type of commando operation.

Particularly, the value of the Gaza blockade should be assessed to see if this rigid measure is really restraining the importation of rockets (its supposed aim) into the territory. Operation Cast Lead existed to respond to the attacks by rockets stocked by Hamas and its allies while the blockade existed. While it was a "disproportionate" (a word used primarily by Israel's critics) response to the rockets, it effectively stopped them and has brought a much higher degree of calm to south central Israel.

Could Israel not achieve the same results through ship contraband inspections within Israel's maritime zone? With such a relaxation of the blockade, Egypt would not be as tempted as it must currently be to let the smuggling tunnels (the major source of entrance for weapons into Gaza) expand their activities. As well, it would represent a response to this morning's opening from Turkey to restore its positive relationship with Israel and perhaps offer a compromise that would put this episode, which everyone, everywhere, finds lamentable.

As a confirmed Israel supporter and Zionist, I am troubled. We need more friends and supporters internationally to pursue the goals that are really necessary for the long-term survival of the State of Israel.

Oil, Innovation and Risk

I was very impressed by Kenneth Rogoff's essay today in various papers about the larger implications of the BP disaster in the Gulf of Mexico. He had the foresight to question Brazil's ability to handle its oil reserves safely. This includes both the known and obtainable reserves and the now famous "pre-sal" (i.e., even deeper and harder to obtain) reserves that President Lula is touting as one of the great successes of his administration.

The economics of the pre-sal oil aside, can Petrobras and its drilling contractor partners really handle the technological problems and risks that are involved in bringing this oil to market. We know that Petrobras is currently undercapitalized - because it is in the market seeking new capitalization. One of the lessons of the BP experience is that attempts to manage risky assets such as deepwater oil without sufficient capital to fund controls systems and pay for their monitoring courts disaster.  Can Petrobras really assuage public concern about these risks? As Rogoff puts it in his article, "Will Brazil really risk its spectacular coastline, now that everyone has been reminded of what can happen?"

The other point that Rogoff emphasizes is regulation of the manner in which the technological innovations are applied to obtain the resources. Clearly in the case of BP, the Minerals Management Service of the US Department of Energy was not managing in any way that would suggest that it understood the risks involved with the technology nor with BP's management of the Deepwater Horizon platform.

I also find Rogoff's linkage of the BP disaster with the regulatory and financial technological meltdown that enabled the current economic recession compelling. Both disasters involved applications of poorly understood, highly risky new technologies (drilling technology and well shut down procedures in one and new financial instruments in the other) and lack of sufficient government regulation to protect society as a whole.

This article is very much worth reading.

More Fuel on Bubble Fire

In yesterday's post, I made the point that the building materials industry would have problems meeting all the various needs for materials in the next five years due to the pressure of major infrastructure projects such as the Olympics and World Cup along with the increase in demand for housing.

Today's Estado de São Paulo leads with a story about the lack of manpower in industry, lending some support to my position. The story shows the shortfalls in a range of industries, including construction, steel, woodworkers and even the automobile industry that was reducing work force numbers until last year's reduction in the IPI tax.

One of the points that national industry leaders such as Jorge Gerdau make is that the education system is failing to provide enough trained young workers to meet the needs of the growing economy. It will be impossible in the long run to fix the Brazilian economy without first providing the educational opportunities to prepare young Brazilians for the skilled jobs that lead to enjoyment of a higher quality of life.

The logic works quite simply: insufficient skilled workers leads to insufficient supply of building materials (especially complicated components of housing systems), which in turn leads to increased prices for scarce housing units.

The government's populist impulse emphasizes making financing available for housing through the Caixa Econômica, without assuring the people they are trying to please that there will be sufficient units at a fair price to occupy.

Housing Bubble in São Paulo?

The world economic crisis got its start due to housing speculation. My BBS colleague Ricardo Torres and I have been considering what is going on in the local housing market here in São Paulo. Here are some of our thoughts.

Housing markets in major world capitals are living through a depressed period resulting from the crash and recession that started in 2007. Prices of residences in New York, London, Paris and other major world cities have tumbled and are proving very slow to recover. This contrasts sharply with the stock and other capital markets in these centers, which recovered rather rapidly (until 2 weeks ago).

In São Paulo and other Brazilian cities, the housing market has been expanding during this same period and so far continues its growth as demand rises and supply is slower to respond. However, as with all economic trends, at some point, a serious correction will come.

Housing prices go up and down for a variety of reasons related to demand factors such as the availability of financing and increases in family income, others related to the perception of housing as an investment and still others related to ability of the housing industry to supply product.

Demand factors first. For the first time, Brazil has developed a viable housing finance system, parallel to the housing finance system in use in North America and Europe. Consumers can take out loans secured by the residence they occupy in large numbers for the first time in Brazilian history. The legal impediments that previously reduced the ability of a lender to foreclose on a property have largely been removed. This has opened significant lines of credit, especially through the Caixa Econômica, that is enabling Brazilians to buy residences with borrowed funds with reasonable payments. This is particularly opening opportunities for the emerging and rapidly expanding Classe C market and increasing demand throughout São Paulo and other urban centers.

Second, there is a high degree of confidence in the Brazilian economy, both within and outside the country. Brazil did suffer a recession in 2008, but it was much more the marolinha that President Lula predicted than the tsunami that most analysts feared. Family income has continued to grow and unemployment in São Paulo is at historically low levels. This obviously creates more demand for units and for a “succession” effect. Families throughout the region want to improve their living situation. Thus, families seek both “better” neighborhoods and larger units. The pressure on prices moves them steadily and rapidly upwards. An informal survey of brokers in Jardins, Higienópolis and Morumbi indicates that, in these bairros, prices may have as much increased by 50% in the past year.

With the emergence and rapid growth of an emerging middle class ("Classe C" in local parlance) in São Paulo, the pressure to trade up increases. Previous residents of Mooca, Vila Leopoldina, Vila Romana and other similar bairros seek larger units in more prestigious neighborhoods. The owner of a sobrado in these neighborhoods happily sells to an incorporadora and opens an opportunity for families in Classe C.

Perhaps because of the demand pressures, Brazilians’ understanding of the nature of housing is changing as well. A family’s principal residence is a special type of asset. Families have tended to remain in their houses for many years focusing on creating a stable environment for the growth of their children. This period may extend for multiple generations. However, the experience in other countries is being repeated here now. We are starting to view housing not as a special kind of asset that we do not trade like a share of stock, but rather as fungible with all our other investments. We are starting to see people “flipping” housing units, rapidly buying and re-selling units to either trade up or invest a portion of the proceeds in other types of assets (stocks, fixed income investments). This is a dangerous indication that we are entering a speculative “bubble” that parallels the experience in property crashes in the United States and Europe and can only end in tears.

A further contributing factor to this bubble trend is that investors are beginning to see housing as a viable alternative investment to organized capital markets. There have always been investors who have focused on housing units and who live from the rental proceeds of these units. An increasing number of investors today in São Paulo view housing units as investments that should be bought and sold rather than held for the long-term. They look at housing units in terms of short-term appreciation in value and sell on these terms. This behavior as well contributes to a speculative mentality that will destroy wealth in the long run rather than create it.

Prices are rising as well because of limits on supply. The most obvious supply limit is land availability. Jardins and Higienópolis, for example, have little land remaining that can be developed for apartments. This makes these remaining parcels very valuable and expensive.

As well as the price of land, construction necessarily lags far behind demand. From the time a developer obtains a parcel, designs a building, obtains approvals and can initiate the sale of units, a period of 1 to 3 years can elapse. Then, there is typically a two-year construction period before the units can be occupied. This time lag, in itself, creates pressure on prices. Thus, the delay between the time that consumers perceive the value of a neighborhood until the time that developers can deliver units puts an increased price pressure on the existing units that goes beyond the scarcity factor. This too represents a speculative pressure on prices.

Finally, the situation of new housing construction is only going to get worse over the next decade. TheWorld Cup, the Olympics and the PAC II (President Lula's development program, Mark II) are all predicted to create severe shortages in construction materials. The ability of the building materials industry expects to double in size between now and 2016. However, this increased demand for materials for these special programs and for infrastructure development will put further price pressures on residential construction. This has already been reflected in significant increases in the IPCC, the construction price inflation index.

We believe that the current housing situation in São Paulo, and possibly in other capitals, shows signs of a speculative bubble due to these pressures. And, like all bubbles, it will burst at some point. At that point, who will reap the whirlwind?