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A country breakdown as global growth accelerates: US, UK, China, Sweden

By Edward Harrison

Today’s second commentary

The data on the global economy continue to improve. The US expansion has continued, Europe is exiting recession and China’s growth his defying expectations of a slowdown. All of this portends well for 2014. Part one of the data and analysis follows below.

I am making this commentary today because there has been so much data out on the global economy that I believe I need to add a few words to supplement what I wrote about the US economy earlier today. In the end, the data should add to your optimism that we are fully ensconced in a cyclical recovery that will continue through 2014, not necessarily without problems. I intend to take this on a country-by-country basis and sum up at the end tommorrow.

United States

I wrote a fairly comprehensive post on the US earlier today so I am not going to say much here. I do want to add a few thoughts on US banks and mortgage lending, however. There was a post in the links from Yves Smith which pointed to home equity loan problems for US banks based on a Reuters analysis. The gist here is that US banks still need to write down a lot of second liens and home equity lines of credit on their books. Somehow, US banks have been able to avoid these credit writedowns, which analysts like me have long anticipated. In that sense, I see this story as old hat. Moreover, US bank accounting gains are near a record. And with the yield curve steepening, I believe the banks will be able to take these losses in stride and still increase credit lending to the mortgage market. But the Reuters report points out that borrowers are increasingly missing payments. So we should keep a watch on this as a potential canary in the coalmine for US mortgage problems and the concomitant decline in credit and retail sales growth.

On this same topic, it bears noting that rents in the US are skyrocketing as increasingly first-time homebuyers are priced out of the market. This is leading to protests against gentrification in San Francisco fuelled by dot com wealth. I see this social problem as very much related to the lack of wage growth that pervades this cyclical upturn, as I tweeted last night.

I am optimistic that the recovery will continue. However, I am not optimistic that we will get wage growth. I anticipate releveraging will end in tears at the end of this business cycle.

China

In China, we are now seeing a re-acceleration in growth rather than a further slowdown. Even analysts who are optimistic on global growth like Mohamed El-Erian believe that China’s growth will slow, dragging down overall global growth. PIMCO estimates that Chinese growth will come in at the 6.75 – 7.25% range, down from 7.8% over the past year. But the latest figures tell a different story. Retail sales for November were up 13.7% year-on-year, higher than the 13.3% recorded the previous month. Growth in Q3 had already ticked up to 7.8% after a two-quarter slowdown. So what we need to see is where industrial production comes in. The latest figures show a slowdown to 10.0% y-o-y growth in November, down from 10.3% in the previous month. Government infrastructure spending, while up nearly 20% in the last year, is also marginally slower. On net, I think this outlook is neutral to positive in terms of China’s growth momentum. The country will meet its 7.5% growth target.

Why do I think growth is re-accelerating? Net interest income. Traditionally, higher rates are seen as a drag on growth because it increases discount rates, lowering demand for credit. And China’s rates have increased as the government attempts to slow the housing market. For example, Chinese 1-year paper returns 4.06% while comparable South Korean paper returns only 2.6%. In an overheated market, increasing rates accelerate overheating by adding interest income. The reasons are clear: asset prices are rising by much more than the funding costs of acquisition  in an overheated market. Punters rationally enter this market on credit in anticipation of further price increases which will more than offset funding costs. The higher interest rates therefore only serve to add interest income and thus accelerate the credit dynamic.

This is exactly what we saw in the US during the housing bubble. Greenspan’s conundrum was that he expected his baby step increases in rates to slow the market when the opposite seemed to occur. The reason for this is that interest income trumps increased borrowing costs when asset prices are rising briskly. The only way interest rates can slow this dynamic is if they rise very, very quickly, ending the mania psychology of expected future price gains.

Britain

The expectation of unrealistically high future price gains is a classic hallmark of bubble psychology. This is the kind of dynamic that we see starting to develop in the UK. In Britain, house price growth expectations are at a 14-year high – and this includes expectations during the bubble years. The number of other indicators that Britain’s housing market is robust are numerous: house prices are rising at the highest annual rate since the bubble, house prices are rising are rising at ten times the pace of wages, house price increases are driving homebuilding to the highest levels since the bubble, and the housing boom is even luring German homebuilders out of Germany to London. The Council for Mortgage Lenders is forecasting mortgage lending to rise by 195 billion pounds in 2014 and 206 billion pounds in 2015, up from 170 billion pounds this year. These numbers speak to not just a boom, but overheating.

The National Housing Federation believes this is pricing out a whole generation of fist-time home buyers. And The FT’s John Plender warns of “housing bubble risks”. This is clearly the result of low rates and the policy skew toward housing. And it has been successful in increasing house prices, but the downside I see is that it has made housing less affordable and leveraged up household balance sheets. As in the US, this will be a headwind in the next downturn given that living standards are expected to bel lower in 2015 than in 2010.

The good news here is that the excess is limited to London and the southeast. The bad news is that the housing price uptick is limited to London and the southeast! Where this goes is anyone’s guess. But for now, Britain is one of the high flyers in Europe in terms of growth, adding to momentum in the global economy.

Sweden

Sweden has seen a lot of the house price inflation and household debt problems that we have seen elsewhere. Lars Syll points out, for example, that household debt in Sweden has doubled as a percentage of GDP since 1980. Apartment prices have more than doubled since 2000, and increased 14% in the year to October alone. Robert Shiller and Nouriel Roubini have been particularly noteworthy in calling attention to this problem (link in Swedish). Yet, influential economists like Lars Svensson are out saying there is no bubble in Swedish housing. Lars Syll calls Svensson a bubble denier and compares his comments to Irving Fisher’s from 1929.

I am with Syll on this one. I don’t believe there are a lot of bubbles out there yet. Shares are overvalued but we aren’t in an equity bubble. Corporate bond yields are low but I wouldn’t say it’s a bubble. On the other hand, housing is a different story. But the Swedish house price situation is definitely a bubble. Yesterday’s Bloomberg article on the psychology of the market is very illuminating and bears a striking resemblance to the psychology on display during America’s housing bubble.

Now, this has been going on for some time. I presented a video on Sweden’s boom economy in 2010. Robert Shiller said Sweden has a bubble nearly two years ago. In January, the Economist flagged Sweden as having one of the more overvalued housing markets. Subsequent analyses in June and this past month validate the Economist’s view. And I highlighted household debt as Sweden’s weak link in February. So all of this is old hat. The good thing for Sweden is that the level of overvaluation seems modest compared to some of the other markets like Norway or Canada. The bad thing is that Sweden’s real economy is already showing signs of stress.

In Sweden, GDP growth figures were worse than expected at 0.1% for Q3 2012 following a 0.3% rise in Q2. 0.4% had been expected. GDP contracted in Q2. Industrial production fell in October 1.7% compared to September and 5.0% compared to the year ago level. These numbers were worse than expected. The figures are dominated by the electronics and chemical sectors. So the time series has some volatility. Nonetheless, the heady growth days are over in Sweden. And now Sweden is in deflation. House prices continuing to rise so steeply with this economic backdrop speaks to a bubble and one that is ripe for popping, irrespective of whether the overvaluation is much lower than Norway’s or Canada’s. I see Sweden as a canary in the coal mine for what to expect in terms of the interplay between post-crisis downturns and household debt. A benign outcome would be a good sign for other countries.

I am going to leave it there and pick up with the rest of Europe and Japan tomorrow.

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Edward Harrison 7783 posts 575 comments

Edward Harrison is a senior Editor at Bloomberg. He is also the founder of Credit Writedowns newsletter, a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

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