Brexit negotiations are likely to prove a very uncomfortable ride for UK consumers as Russell Napier of Eric, the online research platform, warned last week:
□ ”Public sector debt remains at near-historic highs (in peace time!) and for the first time this public sector debt comes with a private sector bubble
□ Credit card debt is rising at its fastest rate in a decade — 9.3% in the year to February
□ Unsecured debt as a whole is rising at more than 10% and some 6,300 new cars are bought on credit in the UK every day”
Companies and investors already face growing uncertainty as March 2019 approaches, as discussed on Monday. UK consumers now face similar challenges as their spending power is further squeezed by the pound’s fall in value since June, as the chart confirms, based on official data:
UK earnings for men and women have been falling in real terms since the financial crisis began in 2008
Male earnings are down 5% in £2016, and female earnings down 2%
Since June, unsurprisingly, cash-strapped families have had to raid their savings to fund consumption
New data shows the UK savings ratio hit an all-time low of just 5.2% last year – and was only 3.3% in Q4
One key issue is that monetary policy has reached its sell-by date, with Retail Price Inflation hitting 3.2% in February as a result of the pound’s fall. Interest rates may well have to rise to defend the currency and attract foreign buyers for government bonds. Foreigners currently fund more than a quarter of the government’s £2tn ($2.5tn) borrowing, and cannot easily be replaced.
Unfortunately, these are not the only risks facing the UK consumer. As I feared in June:
“ Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
This will also undermine the London housing market by removing the support provided by these high-earners
In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”
Lloyds, the global insurance insurance market, has just announced plans to move an initial 100 out of 600 jobs to Brussels, so that it can continue to serve EU clients. Frankfurt, Paris, Amsterdam, Dublin and Copenhagen are also lining up to offer attractive deals to companies wishing to maintain their EU passports to trade. And last month saw an ominous warning from JP Morgan Chase CEO, Jamie Dimon:
“The clustering of financial services in London is hugely efficient for all of Europe. Now you’re going to have a de-clustering, which creates huge duplicative cost which is expensive to clients. Nevertheless, we have no choice.”
Dimon’s warning was reinforced on Tuesday by the leader of the powerful European People’s Party in the European Parliament, who told reporters 100k financial services jobs would likely relocate from London due to Brexit:
“EU citizens decide on their own money. When the UK is leaving the EU it is not thinkable that at the end the whole euro business is managed in London. This is an external place, this is not an EU place any more. The euro business should be managed on EU soil.”
Until now, many consumers have been cushioned from the fall in real incomes by the housing bubble. But as I discussed in December, the end of such bubbles is normally quite sudden, and sharp:
Worryingly, UK house prices fell in March for the first time in 2 years
The Bank of England also reported that mortgage approvals are falling
And normally, lower mortgage volume leads to lower house prices
Certainly it would be no surprise if prices did now start their long-overdue collapse, as highly-paid financial professionals start to leave the UK. One key indicator – the vastly over-priced 9 Elms development – now has an astonishing 1100 apartments for sale. And if the housing market does collapse, then recession is inevitable.
The key problem is that consumers do not have many options when the economy moves into a downturn. New sources of income are hard to find if mortgage costs start to rise. All they can do is to cut back on spending, and boost their savings – to help them cope with any future “rainy days”. This in turn creates a vicious circle as consumption – over 60% of the economy – starts to fall.
There are therefore no easy answers when trying to plan ahead for likely storms. But being prepared for a downturn is better than suddenly finding oneself in the middle of one.
London’s housing market was always going to have a difficult 2017. As I noted 2 years ago, developers were planning 54,000 new luxury homes at prices of £1m+ ($1.25m) in central London, which would mainly start to flood onto the market this year.
They weren’t bothered by the fact that only 3900 homes were sold in this price range in 2014, or that the number of people able to afford a £1m mortgage was extremely limited:
□ The idea was that these would be sold “off-plan” to buyers in China and elsewhere
□ They had all heard that London had now become a “global city” and that it offered a safe home for their cash
□ There was also the opportunity to “flip” the apartment to a new buyer as prices moved higher, and gain a nice profit
Of course, it was all moonshine. And then Brexit happened. As I warned after the vote, this was likely to be the catalyst for the long-delayed return of London’s house prices to reality:
□ “Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
□ There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
□ This will also undermine the London housing market by removing the support provided by these high-earners
□ In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven””
Confirmation of these developments is now becoming evident. A new study from the Bruegel research group suggests up to 30,000 bank staff and £1.5tn of assets could now leave London, as it becomes likely that the UK will not retain the vital “passport” required to do business in the Single Market after Brexit. This would be around 10% of the estimated 363k people who work in financial services in Greater London.
They will also likely be more senior people, able to afford to buy London homes with cash from their annual bonuses, rather than the more junior people who need to rely on a mortgage based on a multiple of their income. And there is no shortage of tempting offers for these bankers, with Frankfurt, Paris, Amsterdam and Dublin all lobbying hard for their business.
Now, another threat has emerged to prices, in the shape of China’s new capital controls. China has seen its foreign exchange reserves tumble by $1tn over the past 18 months, due to its revived stimulus programme. January data showed they were now just below $3tn, perilously close to the $2.6tn level that most observers suggest is the minimum required to operate the economy. As we have reported in The pH Report:
□ China has now banned the use of the annual $50k foreign currency allowance for foreign real estate transactions
□ It has also banned State-Owned Enterprises from buying foreign real estate valued at $1bn+
The rationale is simple. The country can no longer afford to see money disappearing out of the country for purposes which have nothing to do with the real needs of business. And the impact on London’s property market (and that of other “housing bubble” cities such as New York, Singapore and Sydney) could be huge, as Chinese have been the largest buyers of new residential homes globally according to agents Knight Franks – and were responsible for 23% of commercial deals in central London last year.
Central London prices fell last year by 6%, and by 13% in the most expensive areas according to agents Savills. And now London’s Nine Elms development (pictured) at the former Battersea Power Station has just revealed a serious shortage of new buyers.
It was intending to build 3800 new homes, and originally found an enthusiastic response back in 2013 when the first 865 apartments went on sale. But 4 years later, just 1460 homes have been sold in total – and yet residents are supposed to be moving into the first phase later this month. Even worse, 116 of these original sales are now back on the market from buyers who no longer wish, or can afford, to take up residence.
Some of these buyers have already taken quite a hit on price. As property journalist Daniel Farey-Jones reports, one anxious seller originally listed his apartment for sale at £920k. Having failed to sell, he had cut the price by Friday to £699,995 – a 24% reduction.
Nine Elms is just one of many sites where developers are anxiously watching their cash flow, and hoping a flood of new buyers will rush through the doors. Sadly, they are not the only ones who may soon be panicking.
In recent years, large numbers of home buyers – many of them relatively young and inexperienced – have been persuaded to buy unaffordable homes on the basis that London prices could never fall. I fear that, as I have long warned, they are now about to find out the hard way that this was not true.
Last year it was the oil price fall. This year, there is no doubt that the US dollar has taken centre stage, alongside the major rise underway in benchmark 10-year interest rates. As 2016′s Chart of the Year shows:
The US$ Index (black) has risen 12% since May against other major currencies (euro, yen, pound, Canadian dollar, Swiss franc, Swedish krona), and is now at its highest level since 2003
Benchmark 10-year US interest rates (red) have almost doubled from 1.4% in July to 2.6% today. They are back to 2013-4 levels, when the Fed proposed “tapering” its stimulus policy
Clearly something quite dramatic is now underway.
In currency markets, investors are voting with their feet. It is hard to see much upside in the European, Japanese or Canadian economies in the next 12 – 18 months. Europe is going to be gripped by the unfolding crisis over the future of the euro and the EU itself, as it moves through elections in The Netherlands, France, Germany and probably Italy. By March, the UK will be on the Brexit path, and will leave the EU within 2 years. Japan is equally unattractive following the failure of Abenomics, whilst Canada’s reliance on commodity exports makes it very vulnerable to the downturn underway in the BRICs (Brazil, Russia, India, China).
Investors are also waking up to the uncomfortable fact that much of today’s borrowed money can never be repaid. McKinsey estimated global debt at $199tn and 3x global GDP at the start of 2015, and the total is even higher today.
As I warned a year ago in “World faces wave of epic debt defaults” – central bank veteran), there is no easy route to rescheduling or forgiving all this debt. Importantly, central banks are now starting to lose control of interest rates. They can no longer overcome the fundamentals of supply and demand by printing vast amounts of stimulus money.
This is the Great Reckoning for the failure of stimulus policies in action.
THE RISES WILL CREATE “UNEXPECTED CONSEQUENCES” FOR COMPANIES AND INVESTORS
These moves are critically important in themselves as the dollar is the world’s reserve currency, and US interest rates are its “risk-free” rates. Unsurprisingly, interest rates are already now rising in all the other ‘Top 15′ major economies – China, Japan, Germany, UK, France, India, Italy, Brazil, Canada, S Korea, Russia, Australia, Spain, Mexico. Together, these countries total 80% of the global economy.
The rises are also starting to create unexpected “second order impacts”. For example, many companies in the emerging economies have large US$ loans, which appeared to offer a cheaper interest rate than in their home country. Suddenly, they are finding that the cost of repayment has begun to rise quite rapidly.
This happens in almost every financial crisis:
People become excited by the short-term cost of borrowing – “Its so cheap, just $xxx/month”
They totally forget about the cost of repaying the capital -”I never thought the dollar would get that strong”
There were $9tn of these loans last year, according to the Bank for International Settlements. Many were to weak companies who are likely to default if the dollar keeps rising along with US interest rates.
In turn, these defaults will also have unexpected consequences. Lenders will suffer losses, and will be less able to lend even to stronger companies. Higher borrowing costs will force consumers to cut back their spending. This risks creating a vicious circle as corporate interest costs rise whilst revenues fall.
China is the obvious “canary in the coalmine” signalling that major problems lie ahead.
The Wall Street Journal chart shows 10-year rates have risen despite central bank support
Its total debt is around $27tn, or 2.6x its GDP, due to housing bubble and other speculation
The central bank now has to sell its US Treasury holdings to support the domestic economy
In turn, of course, this pushes US rates higher, as rates move inversely to bond prices
China used to hold around 10% of US debt, and was the largest foreign holder. Japan holds similar amounts, and is also stepping back from purchases due to the growing exchange rate volatility.
Nobody else has the financial firepower to take their place. The only possible replacements – Saudi Arabia and the Gulf countries – have seen their incomes fall with the oil price, whilst their domestic spending has been rising. This means interest rates and the US$ are likely to carry on rising.
Higher rates will further weaken the US economy itself, particularly if President Trump launches his expected trade war. In the important auto market, GM has just announced production cutbacks next month due to falling sales, despite the industry having raised incentives by 21% to nearly $4k/car. GM’s inventories are now 25% higher than normal at 86 days versus 69 days a year ago. Housing starts fell 7% last month, as mortgage rates began to rise.
And then there is India, the world’s 7th largest economy and a leading oil importer. Its rates are now rising as shocked investors suddenly realise recession is a real possibility, if the currency reform problems are not quickly resolved.
These risks are serious enough. But they are very worrying today, due to the steep learning curve that lies ahead of all those who began work after the start of the Boomer-led SuperCycle in 1983.
They assume that “recessions” are rare and last only a few months as central banks always rescue the economy.
Only those who can remember before the SuperCycle know that markets and companies should have long ago taken fright as these risks began to develop
This is why the rise in the US$ Index and US 10-year exchange rates is 2016′s Chart of the Year.
One thing that “everyone knows” in China’s Tier 1 cities is that property prices can never go down. As one resident told the South China Morning Post:
“The only thing I know is that buying property will not turn out to be a loss. From several thousand yuan a square metre to more than 100,000 yuan. Did it ever fall? Nope.”
He and his wife got divorced in February, in order to buy a 4th apartment in Shanghai for 3.6m yuan (US$530k) on the basis that “ If we don’t buy this apartment, we’ll miss the chance to get rich.” And as I noted back in September, his view of the market is technically correct:
“It is also easy to forget that housing was all state-owned until 1998, and still is in most rural areas. Urban housing was built and allocated by the state – and there wasn’t even a word for “mortgage” in the Chinese language. Not only have home-buyers never lived through a major house price collapse, they have also had few other places to invest their money”.
But whilst bubbles always last longer than anyone expects, in the end they have to burst. Today, for example, unremarkable pieces of land in Shanghai are being sold at $2000/sq foot ($21500k/sq metre), nearly 3 times the average land price in Manhattan, New York.
And one sure sign that the bubble is ending, comes from the fact that “everyone” is now getting divorced in order to buy those 2 extra apartments – which will make them rich, as the Weibo picture shows.
Everyone has realised that a divorced couple can buy an extra 2 apartments with only a 30% deposit – and benefit from zero property tax. As a result, prices have risen 30% so far this year in the Tier 1 cities. Even more remarkably, prices for undeveloped land are higher than for existing apartments on neighbouring plots.
And mortgages, which only began to exist in the past 20 years, accounted for 71% of all new loans in July/August this year, compared to just 23% of new loans in 2014.
The bubble also highlights the growing split between President Xi and Premier Li over the future of stimulus policies. As China Business Review notes:
“While the State Council has always controlled economic policy, Xi has been gradually taking economic matters into his own hands since the State Council’s failures following the stock market crisis last summer. Li was noticeably absent from the Economic Situation Expert Seminar hosted by Xi in Beijing July 8, and was also sidelined at the Beidaihe Conference in August. Xi’s rejection of Li‘s stimulus approach further explains the torrent of measures issued in early October to limit housing purchases and curb overheating in the economy….
“Since August, it is increasingly common to see corruption cases featuring real estate conglomerates like Vanke and Dalian Wanda publicized…. it appears the anti-corruption campaign is being extended to deal with the housing bubble crisis.”
China’s stimulus policies since 2008 mean that it now has $25tn of debt in an $11tn economy. And as Deutsche Bank’s chart above shows:
It now takes $450bn of debt to create 1% of GDP growth in China (even using the “official” overstated GDP figures)
Back at the height of the US subprime bubble, it took $350bn of debt to generate 1% of GDP growth in 2007
China’s wealthiest man, Wang Jianlin, said recently that China’s real estate market is “the biggest bubble in history”
He warned that prices are falling “in thousands of small cities”, even whilst they still rise in the large cities
Another worrying feature is that much of the financing for the bubble has been done in the shadow banking sector, via Wealth Management Products. As US financial magazine Barron’s warned at the weekend:
“These WMPs are starkly reminiscent of the bad mortgage-backed paper in the U.S. that metastasized in 2008 into a full-blown global credit crisis.”
So here’s the question. Would you, if you were Chinese and married, get divorced today in order to buy new apartments? Or would you have already got divorced, and be sitting back waiting for prices to rise ever higher? Or would you be shaking your head in wonder, and fearing that “this will not end well?”
China’s housing market has always been about marriage since it began in 1998, until recently that is. The reason, as I noted a while ago, is that:
“70% of China’s women regard “housing, a stable income and some savings” as vital for any man wanting to get married.”
Women have the upper hand when it comes to accepting marriage proposals, as there are now 33 million more men than women in China. Sadly, the 1 child policy meant that parents often selected girl babies for abortion – even as recently as 2004, there were 121.2 boys born for every 100 girls.
It is also easy to forget that housing was all state-owned until 1998, and still is in most rural areas. Urban housing was built and allocated by the state – and there wasn’t even a word for “mortgage” in the Chinese language. In the absence of a proper social security safety-net, fathers of the prospective bride have often focused on the man’s material prospects in terms of housing and finance. His personality and morals have been seen as less important, as the China Marital Status Report described in 2010.
Another piece of this complex jigsaw flows from the relative novelty of the private housing market. Not only have home-buyers never lived through a major house price collapse, they have also had few other places to invest their money. Capital controls have made it difficult for ordinary people to invest outside the country, and they have been frightened away from the stock market by the bubbles that have occurred.
By comparison, bricks and mortar have seemed “a safe bet”. And certainly, one unusual feature of the market is that mortgage levels are relatively low:
Even today, a minimum deposit of 20% is required for a mortgage, and around 15% of buyers simply pay cash
Homeowners have made major gains since 1998, as prices have doubled every few years in Tier 1 cities since then
So many family members are able – and happy – to lend money to buy a home when a boy wants to marry
They will lend all or most of the money required, usually on the basis of the gains they have made in the past
China’s housing market isn’t therefore, vulnerable to the same problems as created the US subprime disaster of 2008.
Its problem is that buyers have only ever seen good times, Everyone now expects prices to continue to rise forever. Speculation is now becoming dominant, as people have never known prices to fall. Property developers are also happily building more stock, even though the market is already vastly over-supplied. China currently has around 4 years’ worth of unsold housing stock, and inventory of “nearly-complete” homes is often not included within this figure.
Central and provincial governments have tried to slow the rises. In the Tier 1 city of Shenzhen, for example, they introduced a rule that a family could only own 2 homes. But instead of reducing sales, couples have simply divorced in order to get round the restriction, as financial journal Caixin reports:
“About 45% of homes sold in Shenzhen last year were bought by people who had avoided curbs on home purchases by filing for divorce, according to a study by the Shenzhen branch of China Banking Regulatory Commission. Investigations found homebuyers often use sham divorces and falsified pension and medical insurance plans to make them appear eligible to purchase a new home, a person with knowledge of the study told Caixin.
“The number of couples who actually got divorced was over 20,000, the local banking regulatory body said, but it did not say how many filed a divorce in order to get a new home. Under a regulation in place since March 30, 2015, a family can buy only up to two homes in Shenzhen. In addition, buyers are required to come up with a 40% down payment for the second, compared with a 20% down payment for a first home. The regulation began amid a housing boom, particularly in Shenzhen. By filing for divorce, a couple can circumvent such restrictions as each of them is considered members of separate families under government rules.
“More than 66,000 new homes were sold in Shenzhen last year, up nearly 60% from 2014, while housing prices soared by more than a third in the same period to over 33,400 yuan (US$ 5,000) per square meter, official statistics show. More than 20,000 couples in the southern city filed for divorce last year, up 46% from a year earlier, government statistics show. However the local banking regulatory body did not say how many of the couples simply registered a divorce in order to buy a home.”
Logic suggests reality must overtake the speculation at some point. Yet China’s property market has defied logic for so long, nobody can be sure when the bubble will burst. But certainly, the rush to divorce in Shenzhen, in order to buy even more homes, suggests we are now getting quite close to its end.
London house prices are one of the major faultlines in the debt-fuelled Ring of Fire created by central banks stimulus policies:
- It is crazy to have created a situation where potential buyers are asked to pay hundreds of thousands of pounds to buy even very basic apartments in unfashionable area
- It is complete madness that developers are now building 54000 supposedly luxury homes in central London that will sell for at least £1 million ($1.56m)
- As I discussed earlier this year, these developments cannot possibly work, as only 3900 homes were sold in this price bracket in 2014
The Greater London region is also quite out of line with the rest of England, as the chart above shows – presented by Merryn Somerset Webb at this year’s MoneyWeek conference. Everywhere else apart from Brighton (effectively now a London suburb), has seen prices either fall or remain stable in inflation-adjusted terms. Prices in the northern half of the country are down by 20% or more.
And now it seems the bubble is starting to burst. London’s biggest development – on the River Thames at Nine Elms – is reportedly now seeing a wave of “flat-flipping” as investors try to sell unbuilt properties before the crash comes. Nine Elms has 20k units under construction, which have attracted speculative buyers eager to take a financial position rather than buy a property. As one agent told the Financial Times, it had become:
‘Singapore-on-Thames’. Buying off-plan was the ultimate option play for a lot of the buyers [who are] Asian. You only need to put down 10% and then see how the market goes. A lot of buyers are effectively taking a financial position rather than buying a property”
And another commented that:
“The Nine Elms area is particularly prone to speculative buyers: It’s a dog-basket of developers all whacking stuff up, all jam-packed against each other, and walking out of the door and trying to find a pint of milk is really hard. Looking at what’s coming out of the ground, I wouldn’t want to live there and not many people we talk to want to buy down there.
“Investing for capital appreciation rather than yield is gambling. If you can find some other patsy then my advice would be absolutely to sell. As long as the music keeps on playing, everyone is happy, but at some point the music stops.”
This mirrors the famous pre-Crisis comment of Chuck Prince, then CEO of Citi, who dismissed worries in 2007 about sub-prime lending by saying:
“We see a lot of people on the Street who are scared. We are not scared. We are not panicked. We are not rattled. Our team has been through this before. We are “still dancing“”
History, as American author Mark Twain noted, may not exactly repeat but it does rhyme. Anyone who still thinks London property might still be worth buying has been warned.