Biggest Threat, Inflation or deflation?

The FOMC said in its statement last month that the recovery “is likely to be moderate for a time.” Low rates of resource use and subdued inflation “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” their statement said. Central bankers have used the “extended period” phrase in statements since March 2009.

“such forward guidance would not limit the Committee’s ability to commence monetary policy tightening promptly if evidence suggested that economic activity was accelerating markedly or underlying inflation was rising notably.”

This information is coming from the minute released by the US Federal Reserve...

To my view it clearly shows that they will not allow high inflation to emerge - they have tool for that, increasing interest rates however it seems that they still fear the deflation threat which is still in the pipeline since it is much harder to fight...

So no high inflation or hyper inflation coming... In the worse case, if they have underestimated the recovery and the inflation threat, they could react the way they did in the late 80's, raising rates to very high level...

However I still think that we are heading (especially in Europe) to much more troublesome economical time ahead which will warrent low rates (something that could look like a japanese scenario or a German one with regard to the economical situation, interest rates and value of housing)

Finnish Sterling Bond

Finnish sterling bond issue leads trend

By David Oakley

Published: March 22 2010 18:22 | Last updated: March 22 2010 18:22

Finland has issued the first sterling bond by a government outside the UK in six years as record levels of debt make it harder for sovereigns to attract buyers in their domestic currencies.

The Finnish deal, which saw twice the demand for the £500m ($754m) raised, may pave the way for more similar transactions as other eurozone governments seek to diversify and attract new pools of buyers.

Myles Clarke, head of bond syndicate at RBS, said: “Countries such as Finland are looking to diversify and find other investors as issuance in eurozone debt rises sharply. This is a trend that is likely to continue.”

Finland paid only 3 basis points over the sterling London interbank offered rate in a five-year floating rate deal. This was cheaper than raising money in euros because of attractive terms in the basis swaps market. Finland immediately swapped the money raised back into euros, but at a cheaper rate.

A large chunk of the demand came from British investors, such as pension funds, Swiss retail investors and central banks. This is a different pool of investors to those who would typically buy Finnish bonds denominated in euros.

So far this year, three eurozone governments – Belgium, Italy and Portugal – have issued debt in dollars, with expectations that Germany, France and Spain are preparing to raise money in the US currency over the coming weeks.

With a record €1,000bn ($1,355bn) in issuance expected from eurozone states this year, sovereign debt managers are increasingly looking at different regions to attract buyers in a crowded marketplace. Last year, Germany, Spain, Belgium, Austria, Italy and Portugal launched dollar-denominated deals.

Barclays Capital forecasts that up to $20bn will be issued in dollars by eurozone countries this year compared with $12.5bn last year, $7.6bn in 2008 and only $2bn in 2007.

Although European governments are likely to choose the dollar for fund raising, the Swiss franc, the yen and sterling are also being considered.

Copyright The Financial Times Limited 2010. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.


http://www.ft.com/cms/s/0/66d9a250-35de-11df-aa43-00144feabdc0.html

"Old Europe"...The Finnish side in a picture

Number of persons aged under 15 in Finland’s population in 1875–2009

According to Statistics Finland, the number of persons aged under 15 in Finland’s population is the lowest in over 100 years.

This post should be put into context with what was said in a previous post: "Population Perspective"

"Red light" for the Housing Market

"IN 1625, Pieter Fransz built a house in Amsterdam’s new Herengracht neighborhood. As the Dutch Republic rose to global power in the 1620s—with Amsterdam developing the world’s first major stock market as well as commodities and futures markets—the price of the house doubled in less than a decade.

Over the succeeding three centuries, the price of Fransz’s house was knocked down by wars, recessions, and financial crises and rose again in their aftermaths (Shorto, 2006).

When the house changed hands in the 1980s, its real value, that is after inflation, had only doubled over the course of 350 years––offering a very modest rate of return on the investment."

"From a historical perspective, it is not the trend but the volatility in housing prices that is distinctive"

"Starting in the late 1990s, prices of houses in Herengracht, and more generally in Amsterdam, doubled in value in 10 years, only to begin another sharp decline. This recent run-up and correction in prices in Amsterdam was part of a global boom and bust in house prices.", loungani, March 2010

A good lesson can be draw out of this article - After all it's all about equilibrium, what goes above or below its long term average tend to correct toward it. Somehow this what I have been suggesting all along in this blog see this post.

1- The ostrich effect


I think humans somehow behave like ostrich, they derive a strategy based on a very limited amount of information and tend to extrapolate it: like the ostrich that put its head in a hole and thinks it's safe...

Instead, this blog try to give you a eye bird view, a 10 000 mile view that allow you to see the whole picture... at least not to become an ostrich.

2- The FeedBack Effect

"One reason house prices go up so rapidly is that the supply of housing cannot be adjusted quickly.

Another reason lies in the interaction of housing and financial markets. Because houses serve as collateral, an increase in house prices can have a feedback effect: once collateral values increase, banks are willing to lend even more to households, which feeds the house price boom.

This feedback effect can arise regardless of what caused house prices to go up in the first place—demand momentum, government policies such as low interest rates, or institutional changes that increase the availability of mortgage credit."

We are spot on with regard to the causes and the effect it created. Clearly the mortgage market grew faster than the supply of housing , then the wealth effect took hold pushing price higher and higher in a similar fashion as in the musical chair game; when the music ends, one is set to lose and lose big in this case.

3- The conclusion

"First, house prices in most countries still remain well above the levels observed at the beginning of the upturn in the early 2000s. Second, house prices remain above rents and incomes, which, as discussed above, often serve as long-run anchors for prices. (...)

"That leads to an uncomfortable conclusion: house prices in many countries still have room to fall."

I think it is clear that from this point any rise in housing price is only strenghtening the case for the current housing bubble, but more worryingly bigger it grows, more damage will be inflicted to the economy.

Higher inflation, A "Stark" View ...

"... While I do see the temptation for governments to ask for higher inflation in order to monetise the dramatic build-up of public debt, let us not forget that it serves to expropriate the income and wealth of the general public to the benefit of those who have lived beyond their means.

I can only reject the idea of raising inflation rates permanently. I would not like to imagine the consequences if, on top of the current financial fragilities and in an environment of high public debt, the general public were to lose trust in the purchasing power of money..." ,Jürgen Stark

This guy is a member of the Executive Board of the ECB (European Central Bank) and will most probably succeed Trichet as the next president of the ECB in 2011...which is reassuring, in term of inflation fighter thus will not allow a 70's type high inflation scenario (which is anyway not possible due to the population and growth configuration supported by a more globalisation business model).

So what? ... one will dare to say, somewhere in the background...

High debt, growing debt is unsustainable and it is what the current housing market is suggesting to do and so is the current way of living ... "beyond their means"...while salary are deflating or at best stabilizing ( stabilizing which is inconsistent with the current economical climate - one will discover that in the year or two to come)

Historical ...slump

"The Finnish economy experienced a decline last year that is deeper than any that has taken place in any single 12-month period since the Civil War which followed the country’s independence.

According to figures put out by Statistics Finland, total production in Finland declined by 7.8 per cent last year.

Only in 1917-1918 has total output declined by more.

Not even in the economic crisis of the 1990s, nor in the Second World War, did the Finnish economy fall as steeply in a single year as it did in 2009... read the rest@ hs"

... Not sure what will be the price to pay for that in the years to come... Any idea?

"... Meanwhile, Finland’s Minister of Labour Anni Sinnemäki (Green) said on Monday that she hopes that unemployment in Finland will peak by the middle of this year.

“If this does not happen, and if it does not peak until next year, we will be in serious trouble”, said Sinnemäki at a meeting of EU competition ministers in Brussels."

...Strange, who will be in serious trouble?... Any idea?

The Housing Market, a Population Perspective : Part 1

The outlook for the housing market ( and indirectly for the Finnish economy as a whole) in the longer term are pretty grim, due particularly to its demography and population characteristics.

I will try to highligh few areas that are of interest in this domain. Let's first project ourself in the future to understand how the population will evolve (Part 1) and then extract the causes of why it is that way (part 2) and its implication on the housing market (part 1 & 2).

This is a quick analysis, if you have some information or any interpretation you are welcome to enrich the discussion.

First let's look at the population as projected by the European Statistic Agency (View Source).

The projecton scenarios are based on assumptions for fertility, mortality and migration. The method used for population projections is the "cohort-component" method as stated in their web site.


Based on that raw data, here is a graph where I added important facts:


Based on the projection, one could clearly see that the need to build in greater amount new dwellings has no ground. Obvioulsy, some Finnish economists or politicians have been lately voicing the contrary - maybe to add oil to the fire to the current housing bubble?

So I want to highlight here, it is the fact that intuitively we would think that there is a need to build more and more housing since wrongly we think that the population will be greater in the future than now...we just extrapolate in a linear manner - (in)fortunately the human way of thinking is linear - we think in a very simple manner (it is even more true for politicians).

Moreover, this analysis takes the most optimistic perspective (not taking into account household formation which obvioulsy will drastically reduce the need of housing starts).

So what are the implications? are we building too much? would the supply excess the demand?

Let's have a look at the housing permit that were given for 2009 as found in Statistics Finland web site (view source) :



So no there is no excess supply and the contruction builder have understood it and have ramped down the number of construction. Most probably, they are looking abroad for keeping their shareholders happy or changing their business model into for example building railways or metro (guess who will win most of the contracts and who is going to pay for it?)...

Obviously at the end it all lies on one particular parameter : Immigration as we will see in part 2 the fertility rate in Finland can barely keep the population at the same level...so stop reading, act :->

Additionaly , immigration may also imply lower affordability level which could obvioulsy impact prices over time...

Chart of the Day: Central Government Liabilities

Stock of central government guarantees EUR 19,4 billion at the end of 2009. At the end of 2009 the stock of guarantees was 27 per cent higher than one year previously...

Central government guarantees include all guarantees for which the state is ultimately liable.

Guarantees to enterprises make up 49 per cent of the stock of central government guarantees. Guarantees granted to housing associations made up 22 per cent and those to households made up 16 per cent of the guarantee stock. Statistics Finland

...just wondering until then they will stop fuelling the housing bubble, maybe after the next major election?...

In the same worisome development, we have the following statement:

Minister of Housing Jan Vapaavuori (Nat. Coalition Party) sees signs of possible overheating in the housing market.

“I wouldn’t call this a bubble yet, but there are slight signs of concern in the air. In some growth centres, the situation is worrisome”, Vapaavuori said in Helsinki on Monday.

...so please refer to that ("Prophet of the past") to understand the real value of such statement.

Finnish Housing Market: Doom, Doom and Gloom?

"Although at present the U.S. economy continues to require the support of highly accommodative monetary policies, at some point the Federal Reserve will need to tighten financial conditions by raising short-term interest rates and reducing the quantity of bank reserves outstanding.

We have spent considerable effort in developing the tools we will need to remove policy accommodation, and we are fully confident that at the appropriate time we will be able to do so effectively.", Chairman Ben S. Bernanke on "Federal Reserve's exit strategy" Before the Committee on Financial Services, U.S. House of Representatives, Washington, D.C. February 10, 2010

I think what is said is of prime importance, especially the following critical words:
- "raising short term rates"
- "at the appropriate time"

This could lead to many potential scenario, which I could quickly highlight without going into much details - Obvioulsy it is based on the fact that the ECB (European Central Banks) mirrors with a lag the behaviour of the US Federal Reserve:

Scenario 1: The economy show futher signs of strengh, it signals an "appropriate time" to remove policy accomodation, the consequence would be to "raise short term rates"
-> the Finnish housing market readjust sharply due to an overwhelming amount of default, linked to the fact that the mortgage market is mainly on short term variable rates, that leads to futher weaknesses in the banking sector that may need governmment rescue.

Scenario 2: It is not an "appropriate time" as the economy shows signs of weaknesses and need to be further supported by an accomodative policy which means that tightening will not occur and "short term interest rates will not be raised"
->The Finnish housing market readjust sharply as the economy deteriorate further amid rising unemployment and plummeting banking profit that ultimately questions the solvability of the entire banking sector which will ultimately require government intervention that could jeopardize its credit ratings.

Scenario 3: The economy neither weaken nor show signs of growth. The "appropriate time" to withdraw stimulus is extended futher in time and "short term interest rates" stays lows in a similar japanese deflationnary scenario of the 1990's
->The Finnish housing market deflate at a snail speed. In real term housing price do not budge but a low inflation slowly but surely reduce its value overtime. Like the air of a bike tire that is left in a cellar for a very long period, it slowly deflates.

Scenario 4: well all in pictures...

Legal note: what is said in this article should not be taken as an advise for any decision you make on any type of investment. It is highly advisable that you do not consult banks but instead use common sense when making a lifetime decision. This article purpose is to trigger a discussion if any, and gather different perspectives. Whatever is said in this article should not be taken seriously and this account for comments too.

Finnish Housing Market and Psychology of a bubble

Above here the characteristics of a bubble, below is the trend of Finnish House price.

Guess what?

Finnish Housing Market - Biggest Bubble EVER?

THE Biggest bubble EVER, you have been warned... Of course, nobody knows in the next century there won't be one on such scale...regulators and investors never learn and greed seem to transcend time...

The last uprise was expected as discussed in the last blog article on the previous housing price release see link , so it was clearly expected to have such a rise and was in fact necessary to remove any doubt on the fact that we are clearly experiencing a bubble.

You don't have to be a genius to understand that the Finnish housing market is at a very critical level.

Heuu, about genius, is there one in the room?

“It appears that consumer faith and confidence in the economy has been channelled into the housing market”, says Anssi Rantala, head economist of the OP-Pohjola Group.

Rantala does not believe that the prices will continue to rise this year as sharply as at the end of 2009, especially in a situation in which unemployment is expected to continue to grow.

“Housing construction will start to recover gradually, and interest rates will rise. Another reason why the increase cannot continue at such a high rate is that people’s ability, and desire, to pay are limited”, Rantala says.

Had they not put his title, I would have guessed he would be working for the banking industry.

I need to chat with him...let me take my mobile phone .... "tut tut tut..."

"Mr Rantala?"
"This is HousingFinland on the phone, from the Housing bubble Blog"
"Coming back to your latest media comment, I would like to remind that historically speaking, when interest rates rise so do housing price... and instrumentally the economy"
"Don't you think that your arguments, the one you put forward in HS are flawed?"
"I beg your pardon?"
"bip bip bip..."

Apparently, it didn't like to debate... back to interest rates, when they rise, it simply mean that inflation become a threat (i.e salary rise, price pressure increase, and the economy is back to growth, etc...). I don't believe a second that such event will occur end of this year...on the contrary.

Now it doesn't mean that there are not cause that explain why the Finnish housing market is distorted...As I said earlier see link , the Finnish housing mortgage market is based on variable interest rates for an astonishing 90% of it.

Moreover Interest rates will stay low simply because the economy will resume shrinking, maybe end of this year and next year (maybe the next and the next). Current growth is based on borrowing future wealth...obviously there is a limit to that (see Spain, Greece). So stimulus and monetary effect will fade and the economy will resume its downward spiral as its foundation and its banking system is not sound.

Indeed, there is a price to pay for having allowed an economy to grow for about 20 years on ever increasing and ballooning debt level, failing regulation and greed- at some point, you reach the breaking point, and we have reached it.

For sure, interest rates will rise but not yet maybe in 4 (10?) years? when the deflation threat become smaller than the inflationnary/hyper inflationnary threat.

In addition, historically speaking, a massive correction should occur from both stock market and housing market (strangely, every 20 years, the economy transform itself for good or worse).

If one is hesitating whether or not to buy, it should ask itself: "is it safe to buy at an historical peak, a level even greater than the one witnessed during the 1990 bubble (inflation ajusted)?"

Maybe it will be worth to make a comparison between the Nasdaq bubble when euphoria took over all common senses and where banks advised private customers to invest in the stock market , even pushing them to borrow for buying stock... let's see the chart:



legal note: whatever it is said in this article is not of the responsability of the author , any reference to any entities may be accidental. Anything said above is not true and may be removed at any stage, at anytime (you like it or not) - the article above is meant for entertainment purpose and only targetted to trigger a smile or two...

Tap, Tap ... The "snow" palm 2010 is for ...

"Finnish bancassurer Tapiola said in a statement Tuesday its pension arm had raked in a 13.5-per cent return on investments last year after taking a 8.3-per cent hit the year before. ... the result was the best ever.", STT

Put the music on - even if you are at work ;-> (that will chill you out)- the text below will make even more sense.

Indeed, applaude the speculator of the year ...but let me remind (may I ?) that they made gain on the back of governments stimulus (tax payer's money) and central banks financial rescue(generosity) . This company only represent , the exact same type of company that created this mess (price speculation - oil/food -) and will flood its managers with record bonuses - in some cases.

While at the same time some earn less, or lost their job...."what a wonderful world" as my friend Louis would echo...

"I see trees of greed, red carpets too
I see them boom for them and them
And I think to myself what a wonderful world.

I see skies of green and clouds of black
The dollar blessed day, the dark sacred oil
And I think to myself what a wonderful world.

The color of money so pretty in the sky
Are also on the faces of bankers going by
I see speculators shaking hands saying how did you gain
They're really saying I love it.

I hear bankers smiling, I watch them bet
They'll earn much more than I'll never work for
And I think to myself what a wonderful world
Maybe I think to myself what a wonderful world?

Delusion

"I have the impression that many people, whether in the business sector, the financial markets, or in academic and political circles, think that the post-crisis world will be quite similar to the pre-crisis one in 2006-2007. In other words, they expect the economic recovery to bring us back to where we were before the crisis.

My feeling is that those who think like that are deluding themselves. The pre-crisis situation was not in equilibrium. It was not sustainable. The crisis occurred precisely because the situation was unsustainable, both within certain countries and globally.

If the world economy were to return to the pre-crisis situation, within a short time span a new crisis would be likely to occur because the same imbalances that led to the crisis would build up again. Considering some recent developments and behaviour, and considering the way certain policies are being discussed and the thinking of some key players, such a scenario does not seem that unlikely.", Lorenzo Bini Smaghi, Member of the Executive Board of the ECB, 18 January 2010

Another way to think of what has been said is to consider that the growth from 2003-2007 was based on illusion , an economy fuelled by an ever increasing amount of private debt that ultimately inflated all possible assets.

SO?

Well, my point is if 2003-2007 GDP growth, wealth creation was based on an illusion, what to think about housing price growth during that period?...

Not convinced?

Well, overall private wage are sharply falling (unemployment, furlough, bonus etc..), GDP has been on free fall in Finland wiping out the gain made during the period 2005-2007, interest rate is almost zero and has only one way to go...on top of that the economical situation's strengh is based on temporary measures (monetary and fiscal)...so you still think that price will go higher. Well my forecast for seeing a deflation of housing price in the next 2-3 years by about 30% (minimum) has never been so probable...

Convinced?

Finnish Competitiveness

"Wärtsilä has analysed its manufacturing footprint as announced in October. To adjust to the fundamental changes in the market Wärtsilä plans to reduce its manufacturing capacity.

Wärtsilä also plans to move the majority of its propeller production and auxiliary engine production to China, close to the main marine markets. The current propeller manufacturing in Drunen, and the component manufacturing DTS in Zwolle, both in The Netherlands, are planned to be closed.

The Wärtsilä 20 generating set production in Vaasa Finland is planned to be closed and moved to China in order to stay competitive in this market."

If you look at the chart above, Finland has never been so uncompetitive, since the past decade or so. Had Finland stayed with the "Markka", the Finnish currency before the Euro, they would have certainly devaluated it...but they can't.

The result is a slow but sure disappearance of the manufacturing from Finland to low cost countries like China as expressed by Wartsila in the above article. By the way, it is worth noting that China is artificially keeping its currency at low level which of course accelerate the "one way" globalization.

Obviously, the competitiveness is a function of the currency - the Euro - that is far too strong at the current time and of course wage growth agreement not inline with the current situation.