MACROECONOMICS
Never as much as now the two main economies in the world, those on which our investments and savings depend, are going through a period of time diametrically opposite.
On one side the chinese economic boom which seems to have reached the end point. On the other side, the USA seems to be succeeding in soft landing, or sensibly reducing inflation, maintaining full occupation and a thrilling economy.
Should this be exactly what happens, it is going to be an historical moment in time.
The most widely spread forecast shows that the US economy is heading towards exceptional growth, probably around a 5% and 6% GDP increase. On the contrary, China is fighting to reach even half of this result. At the end of this year, the US GDP could be double the Chinese one.
If this is going to be the final result, it will surely fortify the American record on the world economy. With peace from all the runner-ups and multi-polarists.
But, aside from macroeconomic suggestions, there is a real economy sector which shows this situation more than others between the two giants: the real estate market.
The chinese real estate bubble
It looks like one of the rites of passage from economy en route to development to consolidated economy is the bursting of a real estate bubble. The real estate in China is worth almost a third of the GDP and it is a gigantic bubble that is bursting beneath the weight of a big quantity of debts carrying along investment funds and local administrations. The debts coming from enterprises, central government and local administrations go over 300% of the GDP. This is not the end of the Chinese model. The enormous liquidity available for the central government should allow it to cover it all. But it is not going to be easy, and surely not harmless. The consequences will be seen on the GDP performance in the next few years.
As a matter of fact, for the first time in 30 years, the Chinese GDP could go below 5%.
What happened to Chinese real estate?
A summary of the previous episodes…
Evergrande, Country Garden and other real estate moguls are failing due to the big debt collected during the time of rapid urban development. Today, China is facing a downfall in demand for accommodations. The Chinese families have reduced the number of their kids, have lower salaries and have less hopes for their future.
The real estate sector represents over 25% of the economy, and investors are worried about the crisis targeting the market could bring down the whole economy and Chinese financial system. However, the experts state that the debts collected by Evergrande and other companies do not stand as a systemic risk for banks.
As a matter of fact, these developers have financed their acquisitions of land mainly by ‘shadow’ investment vehicles as trust funds and saving products. As a consequence, the bond between banks and real estate companies is not that tight, and this reduces the risk of a similar impact to the one related to the crisis sparked by Lehman Brothers bankruptcy.
Welcome to the club, the demographic crisis and other Chinese problems.
Not only the bursting of the real estate bubble shows that China is now a consolidated economy. The push to demographic increase has come to an end: last year, the Chinese population registered its first decrease in 60 years and has been overtaken by India as the most populated country on earth. The increase in unemployment among young people has reached levels never seen before, which does not favor either fertility or an improvement in buying properties. The exportations, due to geopolitical tensions with the USA and Europe, are declining. The private consumerism only forms 38% of the Chinese economy, which is still highly dependent on the State and exportations.
Future opportunities?
It is known, after years of crisis new opportunities come up. It will be interesting to verify how the Chinese leadership will be able to overcome such a crisis and which opportunities will open up for western investors.
Based on Professor Carlo Altomonte, political economy teacher at Bocconi University in Milan, interviewed by Il Corriere, Beijing will need to consider a meaningful plan of liberalizations to allow the economic machine to start again. Should this be the case, the investment opportunities will not be lacking.
USA, the Soft Chimera is materializing
In the meantime, across the world, Jerome Powell and the FED are succeeding with the impossible… sensitively reducing inflation by increasing rates without killing the American economy. With full occupation and an increase of the GDP in the third trimester is foreseen to be +6%.
Careful, if the soft landing will be real, it will be needed to rewrite the main economic manuals!
Jerome Powell’s bet
Which was the FED’s bet? The central American bank bet that the combined and opposite of a strong and consistent increase in rates together with an expansive fiscal policy of the Biden administration, would have avoided the downfall of occupation and therefore strong recession. An economy dragged by the internal demand and state investments would have found its opposite in the credit reduction and increase of money costs. This way the economy would have had to slow down, without failing. In particular, regarding inflation, the rate increase would not have created unemployment but would have lowered the job opportunities available controlling the salary increase. The reasoning behind this was, if you only have one job opportunity available, you will not negotiate too long on the salary.
We need to consider that, contrary to the BCE, the FED must defend the dollar and combat inflation, and defend occupation and economic growth. The FED has been on a very dangerous journey, a real bet.
How did the real estate made in USA react
Also for the American real estate there have been bubble bursting conversations. A decade of consistent increase of values with post-pandemic peaks of around +20% year on year, was looking like a dramatic end would come.
However.. that was not the case.
What really happened and why did the bubble not burst?
The mortgage rates increased to 6% then to 7% and now they could reach 8%. This caused the demand to freeze. Very few people can afford such rates in America to buy a house.
As a matter of fact, currently in the USA, renting costs 50% less than buying!
The demand is as low as it has ever been, nonetheless prices are not falling. They go lower but do not fall. How is this possible?
This is due to the nature of first home mortgages in the USA after the huge crisis of 2008. Which is the reason why the bubble did not burst after all.
In 2008, the majority of mortgages were set at a variable rate and when the first 2/ 3 years of fixed rates expired, the house of cards collapsed. Now, as a consequence of 2008, the majority of mortgages have a 30-year fixed rate.
So, the majority of real estate properties currently under mortgage have advantageous rates as they were signed before the FED imposed restrictions. This is why the market did not collapse. However, it is the same reason why there are no houses for sale. Whoever wishes to move houses will not do it as it would mean doubled mortgage rates. As a consequence there are so few houses for sale that someone would buy one even if the rates are at such astronomical levels. This characteristic determines the missed prices’ fallout parallel to the transaction’s fallout.
Opportunities for the future?
Prices have not fallen, but are diminishing. At the same time rents are as high as they have ever been with a light correction. This leads to a Cap Rate which starts getting interesting again, especially in specific areas. Moreover, rates this high for so long have created an enormous unissued demand. A house, a place to live, is a primary need. Not being able to afford one will not cease the need for one. As soon as the FED will invert its monetary policy and the rates on mortgages will go down, this unissued demand will reflect on the market kick starting a new real estate cycle. This will determine interesting Capital Gain opportunities in the medium run.
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