Tuesday's Top 10: Why Auckland's housing boom is not mostly about supply; Banks face over US$300 bln of losses from Treasuries slump; China's monstrous and delicate bubble; The outrageously crass Clive Palmer; Dilbert

Here's my Top 10 links from around the Internet at  midday today.

As always, we welcome your additions in the comments below or via email to bernard.hickey@interest.co.nz.

See all previous Top 10s here.

My must read today is #2 from former Goldman Squid man Gavyn Davies on the scale of the deleveraging task in China. #10 is fun too.

1. 'Change buyer expectations' - Westpac Chief Economist Dominick Stephens makes some excellent points in this month's Home Truths.

He argues the Auckland housing boom is not just about supply, as the Reserve Bank, government and most other commentators are saying.

It's also about demand and rational (or could they be irrational) expectations.

Stephens rightly points out the near 20% rise in Auckland house prices needs to be put in the context of a 1% fall in rents. 

If it was just a supply shortage, rents would be rising too, as they are in Christchurch. 

But they're not. So what is driving the Auckland housing boom? (And to be fair to Westpac it has not been dropping its credit quality and interest rate pants over the last year to turbo-charge lending growth: ANZ and ASB have been the most aggressive).

Here's Stephens:

A better explanation for the characteristics of Auckland’s housing market - low turnover, rapid sales, rising prices, falling rents - is widespread expectation of future capital gain. Owners are reluctant to sell because they expect better prices in the future, hence low turnover. Buyers are desperate to get in and enjoy capital gains, hence rapid sales and rising prices. Investors are keen to acquire properties despite low rental returns, hence falling rents.

Tenants would rather own, again pointing in the direction of falling rents and rising prices.

As to why there exists a widespread expectation of capital gain in Auckland, three candidate explanations spring to mind:

1. People believe that Auckland’s population and incomes will grow rapidly while insufficient houses will be permitted, creating a future sharp increase in rents that restores balance.

2. People believe that today’s low interest rates will last forever, thus allowing future generations to pay more for houses despite low rental yields.

3. The expectation is irrational (a bubble).

If physical shortages are not the main explanation for the behaviour of Auckland’s housing market, then building more houses will not necessarily change the market. I seriously doubt that the supply measures recently enacted by the Government will really change much. Prices are being driven by buyer expectations of future capital gain - we know this because prices have become divorced from rents. The key to changing the trajectory of prices is to change buyer expectations.

Me talking here. The best way to change those expectations is to engineer a surprise slump in the housing market with signficant and fast rises in interest rates. That's not going to happen under the current Reserve Bank Act and Policy Targets agreement, let alone the current government.

So we just wait for the bubble to get to really painfully expansive (and expensive) levels and for it to spill over into more widespread inflationary pressures and then watch the RBNZ react belatedly, potentially bursting the bubble in a much more dangerous way than a pre-emptive and early spiking of the bubble would have.  (Also see David Hargreaves' story on the Westpac report here).

2. Tip toe past the bubble - Former Goldman Chief Economist Gavyn Davies writes here in this FT blog about the enormous and delicate task the Chinese government faces in slowing down its fast-growing credit growth without crashing the economy. Definitely one for New Zealand to watch.

China is in the midst of a classic credit bubble. The ratio of total credit to gross domestic product has risen from around 115 per cent in 2008 to an estimated 173 per cent, an acceleration in credit expansion that has spelt danger in many other economies. Much of this has come in the poorly regulated shadow banking sector, where the annual rate of credit expansion exceeds 50 per cent. The Chinese authorities are signalling, correctly, that this must slow sharply.

The credit explosion has massively increased the debt service ratio in the economy, an indicator that the Bank for International Settlements says “reliably signals the risk of a banking crisis” (see BIS Quarterly Review, September 2012). The danger point for the debt service ratio, in a cross-country analysis of developed and emerging economies, was found to be around 20-25 per cent, while increases in the ratio of five percentage points or more were problematic.

Official figures for China are hard to find, but analyst Wei Yao at Société Générale says the ratio stands at about 39 per cent of GDP. This is considerably above the danger level, and much of the recent increase in credit is widely believed to have been used to extend the maturity of previous debts, another classic warning sign.

Davies thinks a Chinese Lehman moment is unlikely, but warns of a long and difficult slowdown.

The arithmetic required for a soft landing is once again formidable. Private investment growth needs to slow to about 4 per cent per annum in the next decade, compared to 10 per cent in the last, to achieve a successful rebalancing of demand and avoid wasted resources.

Why, then, will all this not lead to an acute financial shock? Recent stress in the Chinese money markets invites comparisons with the US in 2008, but this resulted from a deliberate signal from the authorities that excess lending in the smaller and shadow banks must cease. The large banks seem well capitalised, and are largely within the public sector, not the market economy.

With the public sector debt/GDP ratio just below 50 per cent, there is some fiscal space left to recapitalise the banks if needed. In previous episodes, the authorities have avoided disruptive bankruptcies and systemic banking failures. Unlike the rest of Asia in 1997, China has excess domestic savings, $3.5tn in foreign exchange reserves and no mismatch between the long-term domestic assets and short-term foreign liabilities of its banks.

No crisis, but a prolonged and difficult workout, is the most likely outcome.

3. US$1.2 trillion in cash - Despite the growth of electronic payments, the use of cash -- particularly US$100 bills -- has exploded since the Global Financial Crisis, Ezra Klein points out at the Washington Post. 

John Williams, the president of the San Francisco Fed, which oversees much of the central bank’s currency systems, has written recently on this topic. He describes the battle between electronic payment technology and the human desire for good old cash in worrisome times as a “tug of war.”

“From the point of the view of understanding what drives currency demand, historically we’ve tended to focus on alternative payments and technologies like credit cards and other payment systems,” Williams said. “The lesson of the last five years are that those trends can easily get swamped in the short run by swings and concerns about political stability and financial stability.”

4. Ouch - The sharp rise in Treasury bond yields in the last 8 weeks also means a sharp fall in their capital values. That is hurting banks, which stocked up on these Treasuries by the truckload over the last five years.

Bloomberg reckons these banks are now nursing almost a third of a trillion dollars in capital losses... Those banks aren't happy.

Higher yields could backfire and damp economic growth, according to Deutsche Bank AG.HSBC Holdings Plc (HSBA), Europe’s biggest bank and the parent of HSBC Private Bank, predicts that 10-year yields approaching 3 percent will slow the U.S. by hurting the housing market. That, and sluggish emerging economies, will underpin demand for haven assets, the bank said.

“This is a selloff that is more likely to preclude, rather than reflect recovery,” Deutsche Bank analysts including Dominic Konstam, the head of rates research, wrote in a note dated June 28. “Market turbulence could short circuit any virtuous circle dynamic that would ultimately lower unemployment and raise wages.”

5. Chinese buyers flood US housing market - At lease there was a housing bust there first...

Here's CNN with some startling figures, including that Chinese buyers spent US$12.3 billion on US houses in the year to March. About 70% of those deals were all done in cash... (See #3 above)

Most purchase the homes to raise their family and they pay special attention to the local school systems. Turley also has Chinese clients who buy homes for their kids. Last year, a family from Shanghai bought a condo for their daughter who was attending Stanford. The daughter has since graduated and now works at Google, he said.

Many Chinese buy homes through the U.S. government's EB-5 Immigrant Investor program, which is considered a fast-track to getting a green card. To qualify, foreigners must invest at least $500,000 in a business that provides or preserves 10 jobs. This could be a home that is part of a bigger business project, such as a condo complex. Nearly 80% of all EB-5 visas went to Chinese nationals in 2012, according to the government.

6. Australians have a reputation for uncouthness and crassness which is not richly deserved in my experience - Except for Clive Palmer, the coal miner cum politician. Here he is in outrageously good/bad form at BusinessSpectator:

In one recording, Mr Palmer twice told a CITIC Pacific executive to “tell your chairman to stick it up his arse”, The Australian reported.

CITIC Pacific, as part of CITIC Group, forms part of China's international investment arm and CITIC Group is among the world's largest companies.

“I've had enough of you, so just pack up all your f..cking gear and get back to China,” Mr Palmer reportedly told the executive. “You people give me the shits. And if you continue to not pay your way we are going to throw you off to the point where we close your project down,” he reportedly continued.

“I'm chairman of this f..cking company, and I don't want to ring up little shits like you because you won't pay your bloody, your bloody rates or pay your rent.”

7. Partay, Partay, Partay - The first bunch of Kiwisavers are getting ready to retire. So what are they going to do with their money? Go on a holiday, it seems in this Stuff report of a Colmar Brunton survey.

Half had spent, or planned to spend within the first few months, at least some of their savings, most popularly on holidays (61 per cent of spenders) followed by home improvements or new housing (37 per cent) and major purchases such as a car or boat (32 per cent).

Around one in seven said they would use their KiwiSaver savings to pay off debt.

8. Cheap at the price - This excellent Bloomberg ranking tool shows New Zealand's petrol price at NZ$2.22 a litre (US$6.69/gallon) puts us at 30 on the list of the most expensive countries for petrol. Turkey is at the top at almost  NZ$3.33/litre. In Venezuela it costs 1.3 NZ cents a litre. There are riots in Turkey and big queues in Venezuela. I prefer our prices.

9. It's always about demographics and ageing populations - I think this is an important idea that isn't considered nearly enough. Here's Rob Arnott and Denis Chaves at IndexUniverse with their view and some great charts.

Favorable trends in the size and composition of populations have helped to fuel the rapid economic growth experienced in the developed world over the past 60 years, and their reversal plays a crucial part in the current rapid deceleration in developed world growth.

We forecast growth in Real Per Capita GDP (holding everything else constant) for every five-year interval between 1950 and 2050, based on the demographic linkages observed in the 1950–2010 data spanning 22 countries. These are not “normal” GDP growth rates, they are abnormal GDP growth rates, reflecting the impact of a demographic tailwind or headwind.

The danger is not in the slower growth. Slow growth is not a bad thing. It’s still growth. The danger is in an expectations gap, in which we consider slower growth unacceptable. If we expect our policy elite to deliver implausible growth, in an environment in which a demographic tailwind has become a demographic headwind, they will deliver temporary outsized “growth” with debt-financed consumption (deficit spending). If we resist the necessary policy changes that can moderate these headwinds, we risk magnifying their impact.

10. Totally the most amazing rocket test ever - The SpaceX Grasshopper rocket takes off vertically and then very carefully lands back in the same spot with the help of some very fancy sensors and computers.

On June 14, SpaceX's Grasshopper flew 325 m (1066 feet)--higher than Manhattan's Chrysler Building--before smoothly landing back on the pad. For the first time in this test, Grasshopper made use of its full navigation sensor suite with the F9-R closed loop control flight algorithms to accomplish a precision landing. Most rockets are equipped with sensors to determine position, but these sensors are generally not accurate enough to accomplish the type of precision landing necessary with Grasshopper.

Grasshopper is a 10-story Vertical Takeoff Vertical Landing (VTVL) vehicle designed to test the technologies needed to return a rocket back to Earth intact. While most rockets are designed to burn up on atmosphere reentry, SpaceX rockets are being designed not only to withstand reentry, but also to return to the launch pad for a vertical landing. The Grasshopper VTVL vehicle represents a critical step towards this goal.