Monday, 23 February 2009

A Credit Bubble That Can Only Deflate

Over the past two decades, the system has seen household and corporate debt grow to historical level.

It all started in the beginning of the 80's, had a parabolic growth in that same decade to only readjust in the beginning of the 90's but to only continue, even stronger, its madness course.

Nothing, nobody has managed or was willing to stop this historical debt creation.
-the Politicians kept being re elected, so this situation was seen as politically favourable.
-the bankers were amassing an astonishing amount of money, blinding them into thinking that this was solely due to their foresight and competence.
-the regulators, were supportive, pressurized to let the market regulate itself only to found out that they created the perfect ground for the development of this current crisis.

So the reality is different, the accumulation of greed, incompetence and blind liberalism imploded on its own weight: Today we are witnessing the most serious financial, economical and political readjustment over a a century.

Some statistics to understand the extent of the problem:

Over the past decade, Finland's population has increased by 153,135 persons, or three per cent.

In ten years, the number of passenger cars has increased by over 600,000, or 32 per cent.

Over the same time period the number of dwellings has gone up by 13 per cent.

Households in Finland are getting more and more indebted. Their rate of indebtedness, that is, credits relative to disposable income, went up to 103 per cent last year, which is higher than ever before. In 1997, households' debts amounted to 59 per cent of their disposable income

The consumption of alcohol has gone up by 1.8 litres, or 26 per cent, per capita in ten years.

An update on the housing market or the economy in general

The building permit for residential is on free fall since 2006. One could argue that the peak was reach in 2000, which could be significant in term of what kind of correction we could get.

History has clearly shown that a price downturn is highly correlated with a decrease of building permits (here on this chart, from 1992 until 1996).

Needless to say that until we see a pick up of these building permits, the housing market will continue its readjustment in term of price.

Consumption was allowed to be maintained at a high level up to mid-2008. Credit expansion by banks, competition between banks and a lack of regulation can partly explain that. Since then, consumers are cutting drastically their consumption. It will most probably push economists to review downward economical prospect: I still think Bank of Finland is highly unrealistic in his prediction.

Psychology and unemployment are the two factor that will speed up the housing market downturn. The latest consumer confidence supports that view. The report is pretty bleak, in fact it is the worse since the last "short" Finnish depression.

Debt deflation

Finally governments and policy makers can only mitigate the effect triggered by the deflation of debt: household and corporates need to deleverage, see their saving rate increase and their risky credit appetite shrink. That will trigger a sharp reduction of capacities pushing higher unemployment, a unavoidable evil that will, at some point, converge toward a natural equilibrium (sustainable debt, lower prices, supply and demand match) ...we are still far from it.

In such environment, all assets price will readjust and such process has already started:
-the stock market, usually readjust the first and very fast and it did since late 2007
-the housing market, usually readjust with a lag and very slowly so it did since mid 2008 and will probably continue for the next four or more years.


Anton said...

Thanks for the article!

If we look at the sector debt, it is a percentage of GDP...GDP has now gone down so much and government are now going to take much more debt.

pretty bleak!

Anonymous said...

There seem to be some facts presented the article "The Looming Collapse of European Banking," at

If they are true, Euro would "drop," while I really do not know what is/are the comparisons for the mention "drop." Dollar would drop too, even with a faster speed. Compared with Gold? yes, but the price of gold has been and will be heavily manipulated by the central banks and some big institutions. They would intend to make gold "not reliable" to the investors when their paper notes is in credibility crisis, whenever they could. Compared with real estate? Maybe, but it would be event more complicated. Take the Finnish housing as an example, could we say that a smart way to prevent the loss of our wealth during the coming Euro paper note crisis is to buy and keep housing property as soon as possible? Yes, housing is going "done," but when compared with the CURRENT Euro paper note. Finnish housing price and Euro value, which one would drop quicker under the current world crisis? Yes, money should be the king under the current situation, while some worthless paper note may be not. It is very much appreciated , if someone could clarify on these questions!

HousingFinland said...

The dollar is strengthening because of capital repatriation, and maybe because of the sense that their central bank and system is perceived as stronger thus still the appetite to hold dollars versus emerging market currencies.

The Euro is strengthening thanks in part to France and Germany, the pillar of Europe. Germany has not had any property bubble while in France household are not as indebted like anglo-saxon or nordic countries.

But sooner or later, if the action taken by the Federal reserve seems to be impotent against this massive credit bubble, the dollar will most probably start its downward trend...

Today, if I had to keep a currency, it will be Euro, no doubt about that.

I don't get your Housing price vs Euro analogy...Do you have money in other currency than Euro, and that is why you worry?

Housing price in Euro will fall, no doubt about that but viewed in other currency in fact it is possible that either price keep raising or stay stable (that would mean that foreigner won't be buying anytime soon).

For example:
In the UK, price fell by 20% in sterling term, but around 50% in euro term.

I'm not even talking in US dollar since price have plummeted by 30%-40% and having the euro strengthening 20% you get as well a discount of 50%

So If I had to invest in property, I will look abroad as price have been divided by two...the same is applying in Sweden whose currency has lost about 30% in 6 month agains the Euro.

So from UK, US, Swedish or even Russian point of view, housing price in Finland have seen a sudden parabolic rise (a bit like in 1990's?).

That's the reason, I'm saying do not count on foreigner to bail out a sinking Finnish housing market.

Now what concern us if Finnish housing market in Euro term. The economy is contracting very fast, lots of company are going to close door or go belly up, whatever the good intention of the government, thus putting a quite chaotic housing situation: people do not buy when unemployment is rising and company fighting for survival.

Anonymous said...

Thank you very much, HousingFinland, for your quick clarification!

Actually, what concerned me is the huge amount "money"/water injected and to be injected worldwide. This seems to be true for Euro economic zone as well. The multiple trillions of injections would only be possible after the central banks start (1) printing their paper notes, (2) borrowing from others, or both. '(2)' seems to be a less possible way to go for many, ultimately for all. The same applies to the Euro zone too.

Given the huge tide of the created cash notes (not wealth), we would face hyper-inflation soon, as you pointed out some time ago. So, my question is "How to protect one's wealth (give it is in Euro cash) from the damage of the looming hyper-inflation?" By keeping Euro notes, gold, or something else?

HousingFinland said...

"Given the huge tide of the created cash notes (not wealth), we would face hyper-inflation soon,"

Take the example of Japan, they flooded the market in the past 20 years (see the M1, , check their money supply, they as well flooded their system with cash)...result, 20 years of deflation and interest rates near zero.

At the moment, at least next 2 years, i think no risk of inflation whatsoever...the credit build up over almost 30 years is deflating and cannot be offset by policy makers or government.

So at this year I stick to the deflation scenario. Next year should be the same, but it's better to be pragamatic.

One sign when high inflation show signs of apparition is when the government Bond yield(10 years, even 2 years) start to go higher, higher than 5%...

We have not even seen the full impact of deflation so why worry about hyper inflation?

Anonymous said...

Yes, I agree with you in general.

Just concerned of the Finnish nature of the highly coordinated price fixing anywhere, and among the gov and the few existing providers, plus the very simple and often patriotically-abused normal Finnish people. For example, the Yle24 said today, "The price of food in Finland is inching up at a record speed of over 10 percent a year."

Someone once said, "There is no border between deflation and inflation. They could swap in the same day..." Now, there might be a bit risk that the world is pursing an even bigger bubble, like what has happened repeatedly. They know that a paper note is just a piece of paper at the end.

By the way, the Japan example may not be directly applicable to Europe and the States, due to the rather different mentality...

Thanks a lot for your information and analysis in "A credit bubble that can only deflate!" I learned from it.

Andrew said...

Paul krugman believes that Japan did not follow thru with the actions needed to prevent deflation.

What we are witnessing in the US today is a reluctance to follow thru on the actions needed to prevent deflation.

Therefore deflation becomes more and more possible.

And yet given the correct actions it is more or less impossible.

>>The multiple trillions of injections would only be possible after the central banks start (1) printing their paper notes, (2) borrowing from others, or both.

1. I would guess that printing cannot be done fast enuf.

2. There is nobody to borrow from

But it does not matter. the central banks works by providing an 'I owe You'. The central bank can enable all banks to be solvent by providing IOU's.

One trillion of IOU can be sent electronically to any bank that the feds think deserves one trillion dollars.

More or less nothing needs to be printed and nothing needs to be borrowed from a person with money.

However if people lose confidance in our systems then nothing can be done. We would be doomed then.

The doom moment is getting closer i admit. If it happens there will be no nice investment environment for people to spend their money in later. There will just be chaos and a fight to survive.

HousingFinland said...

Andrew, now you become even gloomier than me, how can it be.

I always been thinking that this crisis was a very serious and never bought the politicians or finance minister positive argument all the way the way in 1929-1932, politicians and economists behaved the same way, always trying to make think to common people that the economy was sound...

It is true that if they do not stop the crisis from amplifying, I'm afraid the consequences could be disastrous:
-in term of social cohesion, we are already seeing right party beginning to be popular and I think it will only increase if unemployment is not capped.
-All assets will lose value thus feeding itself into the deflationary spiral.

One thing about Gold, I though one ask a question about it once.

Gold is about 1000$/oz, if it breaks that level, then we will hear in the media and other mean that gold will reach 2000 or even 3000, then we will certainly have a Gold bubble as we had a oil bubble one year ago (remember people were telling that oil will go to 200, no it is a fraction of that).

I just now try to warn you no to follow the crowd when this happen...

I think the best outcome will be to allow the deleveraging to happen and fast. To allow weak corporate to disappear (Countering what Mauri Pekkarinen is suggesting: "a socialist states").

Unemployment will increase but the structure will be strong and clean to restart at a moderate path and again rehiring will occur, a little bit the scenario of 1992.

Now if the government will try to bail out everybody and try to keep unemployment artificially low, then there will be a risk that the country will take too much debt and will be unable to fulfil its creditor and that will be clearly the end.

But I think Katainen is smart enough, not to make such mistakes...

Anonymous said...

The interaction of the forces behind the deflation and inflation might actually create hyper-stagflation following the many trillions of "digital" injection.

Here may be a micro-symptom already:

Rapid Rise in Finnish Food Prices

published yesterday 01:21 PM, updated today 07:22 AM

The prices of basic foodstuffs including grains, meat, fish, vegetables and milk products have increased sharply. In the past year, grain prices have risen nearly 60 percent, pasta product prices are up by a third and rice costs some 20 percent more than before.

Falling fuel and raw energy prices across Europe have not led to downward price pressure on food in Finland as they have in other EU states, according to Statistics Finland.

“In Europe, only Iceland has outpaced Finland when it comes to rising food prices,” says Martti Luukko of the Finnish Consumers’ Association.

Luukko says that primary production composes a minor share of food prices. However the secondary production phase and grocery stores take the lion’s share of the price sticker.

Experts say there may be something wrong with competition on the food market.

”Is it perhaps an issue of competition not being entirely effective?” asks Luukko.


Yes, people are getting poorer quickly, but some others need to make money always, actually huge amount of money when there is the digital injection. Gov also like the looking better GDP number... What else could we think about than a hyper-stagflation?

HousingFinland said...

Regarding Food, it has nothing to do with hyperinflation...

It is a problem that Finland itself has created:

-Lack of competition where you have 2 twins K and S that are controlling the market.
-Most probably price fixing as price have evolved in the same way.
-VAT reduction anticipation.

Food Price rise in the beginning of the year is incompatible with some underlying condition such as a collapse of energy and food raw material (cereals-wheat, oat, barley, oils-transportation).

As I already said previously, it was a gross mistake for the government to pre-announce a reduction of VAT, the consequence have been clear: food producers increased prices.

I have witnessed the sharp rise of price of certain fish like Kuha or other...They were imported from Estonia, yet the price almost double within few years.

Result: I stop eating Kuha...I won't fall into the supermarket inflation game.

The problem is the fact that the media have hammered continuously food inflation expectation, so the consumer has accepted thus not changed its behaviour.

But I think we have reached the tipping point. I expect food price to decline in the month ahead...for many concrete reason. They can now import cereals, meat and milk from either Sweden or Russia at about 50% discount compare to last expect to see price plummet...well don't wait until got to eat :->

This government should break the K and S market monopoly and give for free land to external competitor such as Carrefour, why not Wallmart to extend their retail chain in Finland.

So what we are going to have is Stag-Deflation and surely not hyper-stagflation as you are suggested.

Shineah said...

I don't want to hijack this thread, but allow me to get back to a point earlier made. I, too, am worried about the amounts of money governments are currently injecting into failing businesses. look at Obama who is becoming mad trying to bail out the American automobile market etc when clearly, it isn't going to survive.

I suppose the problem here is, as always, the fact that politicians play whatever game keeps them afloat. Obama needs the support of the car makers and steel workers. I do think the world would be a better place if politicians would actually be economists. ;)

Andrew said...

Housing Finland

My views have not changed so much. I am more bearish but i already was bearish - you just could not see it though.

I think you underestimate the way securitization and lack of bank regulation have changed our world in a way that is now going to cause much pain if your laizzez faire 'desirable deflation' takes hold. the banks were hopelessly over levered.

Some experts say something like 80% of bank lending has dissapeared from the british isles as places like ireland and icelands banking systems run back home.

You are talking about argmageddon in finnish banking etc.

Without the zero interest rates and fiscal stimuli this will not be some easy opportunity to profit from deflation

Be careful what you which for.

Billpete002 said...

Hey all, I am generally a liberal libertarian when it comes to economic issues. But I read an interesting article today about Keynesian economics and how the "debt spending" really did work. This surprised here is a professor of mine and I quote "But I just found out one other thing wrong. The unemployment series
using tradition BLS methods from the 1930s and reiterated by Stanley
Lebergott (the guru of unemployment statistics up to the 1950s)
counts all government employees of the WPA and other New Deal
programs as UNEMPLOYED.

Michael Darby wrote an article about this for the JOURNAL OF
POLITICAL ECONOMY (available via the library through JSTOR) in
February of 1976 entitled "Three and a Half Million US Employees Have
Been Mislaid: An Explaination of Unemployment, 1934-41.

His unemployment rates for 1934 - 1943 are:

16.2, 14.4, 10.0, 9.2, 12.5. 11.3, 9.5, 6.0 [1941], 3.1, 1.8.

THe data used by Amity Shlaes and the Wall Street Journal editorial
page are the Lebergott series which has unemployement (1934-41) at:

22.0, 20.3, 17.0, 14.3, 19.1, 17.2, 14.6, 9.9

These two sets of figures are very important in arguing the point
that Keynesian economics DID WORK during the depression to the extent
it was used. E. Cary Brown's work shows that measured at the full
employment level, federal deficit spending was much too low to
counter-act the downdrafts of the depression ---

The fact that deficit spending was insufficient to end the depression
(but did push the economy in the right direction) does not prove
deficit spending "doesn't work" --- World War II had very large
deficits and it definitely "worked" to end the depression.""

What do you all think?

Anonymous said...

Here is story ;-)

Wall Street Economics

Young Chuck moved to Texas and bought a donkey from a farmer for $100.
The farmer agreed to deliver the donkey the next day.
The next day the farmer drove up and said, ‘Sorry Chuck, but I have some bad news, the donkey died.’
Chuck replied, ‘Well, then just give me my money back.’
The farmer said, ‘Can’t do that. I went and spent it already.’
Chuck said, ‘OK, then, just bring me the dead donkey.’
The farmer asked, ‘What ya gonna do with a dead donkey?
Chuck said, ‘I’m going to raffle him off.’
The farmer said ‘You can’t raffle off a dead donkey!’
Chuck said, ‘Sure I can. Watch me. I just won’t tell anybody he’s dead.’
A month later, the farmer met up with Chuck and asked, ‘What happened with that dead donkey?’
Chuck said, ‘I raffled him off. I sold 500 tickets at two dollars apiece and made a profit of $898.00.’
The farmer said, ‘Didn’t anyone complain?’
Chuck said, ‘Just the guy who won. So I gave him his two dollars back.’
The farmer said, ‘Then, how about the other 499?’
Chuck said, ‘They were so exited, and some of them returned to Finland. They would introduce the game to their people...’

Chuck now works for Morgan Stanley in their OTC Default Derivative Department.

Rui said...

Compare with stock market, buying house is a very good investment.

Compare with high rent, buying house is a wise choice.

Due to low interest rate, paying back loan become easier and easier. I am very satisfied with current interest rates trend, thing just getting better every day, soon we will see under 1% housing loan interest! That means interest + monthly maintenance cost under 300 Euro for me. There is no way I can have this standard of living condition if I use only 300 Euro a month for rent.

HousingFinland said...

Hi Shineah,

Thanks for your comment and I agree with it all.

The government have to be very careful and allow the readjustment to happen, a structural and massive change in the economy is undergoing, nothing can stop that...throwing tax payer money to try to stop it, will be only lost money, will reduce the confidence of the citizen in the government and will make things worse.

To Andrew,

No one want "to profit" but instead to protect itself. Getting away from the stock market and doing nothing was such a protection in the deflating stock market (same will apply for housing, why buying at the top?)...