Mish's Global Economic Trend Analysis

China Manufacturing PMI Softens Again, In Contraction For 6 Months; Defaults and Deferrals on Commodity Contracts; As Long As Pigs Have Wings
Cash Crunch Hits Greece, Government Stops Paying Pharmacies, In Turn Pharmacies Make Patients Pay Full Cost
Housing Debate: Economist Gary Shilling Expects Another 20% Drop, PIMCO's Mark Kiesel's Says Time to Buy; Mish Says Debate a "Mixed Bag"
Flight to Safety: German 2-Year Bonds Yield Hits Zero; Eurozone Officials Tell Countries to Prepare for Greece Exit
Japanese Debt Downgraded by Fitch; No Urgency for Japan (Until Sudden Panic Hits)

China Manufacturing PMI Softens Again, In Contraction For 6 Months; Defaults and Deferrals on Commodity Contracts; As Long As Pigs Have Wings

Posted: 23 May 2012 11:13 PM PDT

Defaults and Deferrals on Commodity Contracts

The Financial Times reports China buyers defer raw material cargos

Chinese consumers of thermal coal and iron ore are asking traders to defer cargos and – in some cases – defaulting on their contracts, in the clearest sign yet of the impact of the country's economic slowdown on the global raw materials markets.

The deferrals and defaults have only emerged in the last few days, traders said, and have contributed to a drop in iron ore and coal prices.

A senior executive at another large trading house also confirmed there had been defaults and deferrals in both thermal coal and iron ore.

China's economy grew 8.1 per cent in the first quarter from the same period of 2011, the weakest rise in nearly three years but still pointing to a so-called soft landing.

Fantasyland Scenario

Pray tell how or why does any of this portend a soft landing?

The next two paragraphs are more realistic.

Other key economic indicators followed by Chinese policy makers, including electricity consumption, rail cargo volumes and disbursement of bank loans, point to a sharper slowdown, suggesting the risk of a hard landing.

Soft commodities such as soybeans and cotton have also seen Chinese customers default in the past two weeks, a trader at a third global trading house said.

China Manufacturing PMI Softens Again, In Contraction For 6 Months

China shows modest deterioration in operating conditions during May according to HSBC Flash China Manufacturing PMI.

Commenting on the Flash China Manufacturing PMI survey, Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC said:

"Manufacturing activities softened again in May, reflecting the deteriorating export situation. This calls for more aggressive policy easing, as inflation continues to slow. Beijing policy makers have been and will step up easing efforts to stabilize growth, as indicated by a slew of measures to boost liquidity, public housing and infrastructure investment and consumption.

As long as the easing measures filter through, China will secure a soft landing in the coming quarters."

"As Long As Pigs Have Wings"

The question of the day is: How does Markit find these perpetually bullish clowns every month for every country?

Here's my "as long as" thesis: As long as pigs have wings, they will fly.

I am amused that the vast majority of economists still have not figured out that pigs don't have wings and neither does the China soft landing theory.

For further discussion, please see 12 Predictions by Michael Pettis on China; Non-Food Commodity Prices Will Collapse Over Next Three to Four Years; Nails in the Hard Landing Coffin?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Cash Crunch Hits Greece, Government Stops Paying Pharmacies, In Turn Pharmacies Make Patients Pay Full Cost

Posted: 23 May 2012 05:59 PM PDT

The Troika wants Greece to make another cut in health-care spending including drugs. However, the government is already not paying pharmacies. In turn pharmacies demand 100% payment or patients do not get drugs. Please consider Greeks pay full price for medicines

Millions of Greeks are being forced to pay full price for essential medicines because the state health system has run out of cash to pay pharmacies for supplying prescriptions, health officials said on Wednesday.

Pharmacy owners staged a 24-hour nationwide strike to press the government to start paying arrears of €250m for prescriptions issued in March and April after last-minute talks on Tuesday between Panagiotis Pikrammenos, the prime minister, and union officials broke down.

The dispute highlights Greece's mounting cash flow problems amid recent political turmoil. While the finance ministry achieved spending targets agreed with international lenders, social insurance funds used up half their annual budget allocations in the first four months, according to official figures.

"There is a cash crunch. … The state has stopped funding [the National Organisation for Health Care Provision] EOPPY, and they have stopped paying us," said an official from the PanHellenic Pharmaceutical Association. 'We cannot continue to subsidise the health service out of our pockets."

The move to make patients pay the full cost of prescription medicines started last month when state payments were suspended as Greece headed for elections. Pharmacies are owed a total of €520m by EOPPY and other social insurance funds for prescriptions supplied in the past year, the same official said.

Patients who previously paid prescription charges of between 10 and 25 per cent are now having to pay the full price for medicines, including those used to treat cancer and heart conditions, and seek refunds from social insurance funds that are members of EOPPY.

More Blood From Turnips

Greece is going to miss its next budget targets and in response will have to hike taxes or cut more spending. More tax hikes will mean more business failures and still lower revenues.

Just what does it take for the idiots in Brussels to see that Greece is insolvent and the current plan to extract more blood from turnips cannot possibly ever work?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Housing Debate: Economist Gary Shilling Expects Another 20% Drop, PIMCO's Mark Kiesel's Says Time to Buy; Mish Says Debate a "Mixed Bag"

Posted: 23 May 2012 10:25 AM PDT

In a Housing Showdown on Bloomberg TV, Economist Gary Shilling & Mark Kiesel Go Head-to-Head.

Housing bear Gary Shilling and housing bull Mark Kiesel of PIMCO debated the state of the U.S. housing market on Bloomberg Television's "Street Smart" with Trish Regan and Adam Johnson.

Shilling said that housing prices will decline 20% this year because "there are 2 million inventories, both visible and shadow inventories, over and above normal working levels", which is "a tremendous overhang." He went on to say that "excess inventories are the mortal enemy of prices."

Kiesel justified his bullish stance on the market, saying that, "all inventories you look at, whether new existing or shadow, they are coming down" and "there is only 144,000 new home sales for sale. That's at a 49-year low."

Transcript

Kiesel on purchasing a home in California and whether he's having buyer's remorse:

"No. I will say it is a little chaotic because there are a lot of boxes around. I think after renting for six years, my view is that housing prices have fallen about 35% and the inventories are coming down and banks are starting to lend again gradually. U.S. housing looks very cheap relative to international housing. I feel good about putting some money into housing right now."

Shilling on why housing prices will decline 20% this year:

"Because of excess inventories. We estimate that there are 2 million inventories, both visible and shadow inventories over and above normal working levels. That is a lot. Back in normal times, we built about a million and a half houses a year, so two and a half million is a tremendous overhang. Excess inventories are the mortal enemy of prices. What may happen here is that now that the robo signing flap is settled and the big banks settled for $25 billion with the various state attorneys general and the federal government, they have been holding off on foreclosures because they had enough bad PR. Now they have settled that, I think they will go back to foreclosures. The National Association of Realtors says that when foreclosed houses are sold, they sell at a discount of 19% to existing houses and that drags everything down when you get a big dumping of these houses on the market. I'm looking for another 20% decline and that is what it would take to bring them back to the long-term averages. They go back to 1890 in terms of median single-family house prices."

Kiesel on how he factor in those inventory levels:

"Currently, we have 2.5 million homes in existing inventories which is down in the last seven years from 4 million. There is only 144,000 new home sales for sale. That's at a 49-year low. The existing inventory is at a seven-year low. If you look at the shadow inventory, there were 3.6 million homes that were 90+ days delinquent two years ago. Today, there is only 2.9. All inventories you look at, whether new existing or shadow, they are coming down."

Shilling's response:

"They are coming down, but they are still huge…Yeah, they are down, but when you count in the shadow, and particularly this category that the Census Bureau has, which are houses held off the market for other reasons, very descriptive. This includes foreclosed houses that are vacant, but not yet sold. It includes houses that people have listed, but they couldn't stomach the bids they got so pulled them off the market. You count all of that in and you are still over a working inventory of about 2.5 million. You are still 2 million above that when you count everything in."

Kiesel on what number he's tracking:

"What I was quoting was the 90+ day delinquencies. If you add that with the foreclosures, you do get to the 3.9 level. The thing about housing is that it's very much a regional market. The homes that your viewers and people actually would want to buy, you need to look at the existing inventory that is quality. Go out and look for a house now. There is less quality inventory on the market today than a year ago. That shadow inventory will get absorbed quicker than you think because the implied rental yields is roughly 5%-12% in a lot of markets, so investors will line up. Gary, I respect your work and I read your books and if housing goes down 20%, I will back up the truck and likely PIMCO will, too."

Shilling's response:

"That's right. At that point the percentage underwater of mortgages would go from now 23% to our estimate is 40%. The equity of people who have mortgages which has come from almost 50% in the early eighties to 17% would go down to about 7%. Virtually nobody with a mortgage would have any equity. What that would do to consumer spending to say nothing to mortgages and mortgage-backed securities derivatives, that is pretty heavy duty stuff. That is recessionary kinds of things. We think that will happen over the next three-four years, one way or the other."

Kiesel on whether employment levels are at a stage at which consumers are feeling confident enough to make an investment in buying a home:

"If you look at it, we have added 2 million jobs in the private sector over the last year. Confidence is picking up. The U.S. economy is doing well in numerous states and sectors like energy pipelines, technology, autos, manufacturing. There are many areas in the country where there is a housing shortage. The shadow inventory and the amount of homes underwater, there are 11 million homes but it is concentrated really in three states: Arizona, 61%, Florida, 45%. Yes, there are some weak areas, but the fact is that in certain areas, housing is picking up and prices are going up and so again, it's very regional."

Shilling's response:

"You and I can remember almost a decade ago as this problem was developing and we were on top of it and you were too, that people initially said, the problem was only in subprime mortgages and those are loans that luckily people will never have to meet. Then, they said it is only in Arizona and Florida and Phoenix. Then as it expanded, they said it is bicoastal, don't worry. Everyone else is safe. Tip O'Neill said that all politics is local and you can say the same thing about real estate. Somehow, the composite, the national numbers are made up of those local pieces. There are a lot of shortages here or the other place. That I think is begging the question, overall, there is still a tremendous excess inventory."

Kiesel on whether he'll lower his assumptions about the economy:

"We are looking at basically 1-1.5% real GDP, but you don't necessarily need superfast GDP to get housing to recover. Housing again is down 35%. The inventories are coming down. We are gradually employing more people. Housing relative to other asset classes—equities, bonds—looks attractive."

Shilling on the New York-area housing market and whether Wall Street money not being what it used to be has affected real estate:

"I think it very much does. If you look at what is happening to the stock markets and related securities in the last month--if this continues, I think we will see a lot of softness in Manhattan and in the Hamptons and other places influenced by that. If you read off the employment verses GDP curve, if you're looking at even 2% real GDP growth, that says that the unemployment rate would chronically rise about 1% point a year."

Kiesel on the West Coast housing market:

"Housing is very much based on jobs, based on consumer confidence. We were in the subprime capital of the world in parts of Orange County and we can show you houses that are down 50-60%. In my neighborhood, housing prices fell 20-30% from the peak. The economy is not a recession, we are growing, and banks are flush with cash willing to lend gradually and the Fed is set to reflate. The key here is that you want to own a hard asset in a world of very low to negative real interest rates where the Fed is going to print money. You have to own something tangible."

Kiesel on the opportunity cost of buying a home:

"I think stocks are looking at basically nominal GDP, which is 4% plus dividends of maybe 2, so you are looking at 6. There are rental yields in housing out there above that. Plus, you get the benefit of actually living in the house. From my perspective, I still think that housing beats a lot of asset classes."

Kiesel on whether PIMCO is looking at housing as an alternative to bonds:

"We own non agency mortgages and those securities benefit from a housing recovery. If Gary is right and we do see housing prices go down 20%, the U.S. will be one of the cheapest housing markets in the world. It is already near one of the cheapest."

Shilling's response:

"Actually, it would take a 22% decline in median single-family house prices to bring them back to the long-term trend that Bob Schiller has identified going back to 1890. That has been corrected for CPI, general inflation, and for the tendency for houses to get bigger over time. That would bring them back to the norm. They might seem cheap but there are only where they would have been for over a century."

End-Transcript

Debate a "Mixed Bag"

Mish Points

I do not think the bottom is in. Yet, I doubt another 20% decline is coming nationally.
Some high-priced markets may see huge declines, other areas may have already bottomed.
Inventories are down but still high, especially if one counts shadow inventory and pent-up demand for retiring boomers to downsize.
Shadow inventory and changing demographics will suppress prices for a long time. Student debt will suppress housing formation for years to come as well.
Attitudes have changed. Housing is once again considered a place to live, not a retirement savings plan.
Exuberant attitudes reached a multi-decades peak in 2005. Some overshoot to the downside is expected and it will take years for attitudes just to return to normal.
I side with Kiesel on the idea that "housing beats a lot of asset classes." In relative terms it is certainly possible to envision housing declines of 10% and equity markets declining 33% or more. While not a prediction, that seems like a reasonable possibility so forget about relative terms and concentrate on the absolute.
In absolute terms, housing is only a very good buy in areas at or near bottom, and then only if one has a stable job.
Looking ahead, where are home prices going even after they bottom? My answer is nowhere fast. Yet nowhere fast, is likely to beat equities.
Gold is a very nice hedge here against many possibilities.

One thing is for sure, when attitudes change to "it's better to rent" (and they have), a bottom is reasonably close.

This is how I currently see things.

click on chart for sharper image

For further discussion, please see New American Dream is Renting; Reflections on Renting Houses, Cars, Books, Clothes; Will Rentership Fuel the Next Boom? What About Home Prices?

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Flight to Safety: German 2-Year Bonds Yield Hits Zero; Eurozone Officials Tell Countries to Prepare for Greece Exit

Posted: 23 May 2012 07:57 AM PDT

The once taboo subject of a Greek departure from the eurozone cracked in the past couple of weeks, primarily with threats to Greece.

Today the exit discussion dam broke wide open as Eurozone tells members to make contingencies for "Grexit"

Euro zone officials have told members of the currency area to prepare contingency plans in case Greece decides to quit the bloc, an eventuality which Germany's central bank said would be "manageable".

Three officials told Reuters that the instruction was agreed on Monday by a teleconference of the Eurogroup Working Group (EWG) - experts who work on behalf of the bloc's finance ministers.

"The EWG agreed that each euro zone country should prepare a contingency plan, individually, for the potential consequences of a Greek exit from the euro," said one euro zone official familiar with what was discussed.

For the first time in more than two years of debt-crisis meetings, the leaders of France and Germany have not huddled beforehand to agree positions, marking a significant shift in the Franco-German axis which has traditionally driven European policymaking.

Instead, new French President Francois Hollande met Spanish Prime Minister Mariano Rajoy in Paris to discuss policy, before the pair travel to Brussels for the 1800 GMT summit.

A German two-year debt auction gave a stark illustration of how money is dashing for safe havens. Investors snapped up the 4.5 billion euros of paper on offer even though it came with a zero coupon - offering no return at all.

One proposal on the table is for the euro zone's rescue funds to be allowed to recapitalize banks directly, rather than having to lend to countries for on-lending to the banks.

But that is another idea with which Germany is uncomfortable, even though Merkel said on Tuesday a way should be found to dismantle banks across borders, a possible nod to a pan-euro-zone bank restructuring scheme

Here is one for the surprising candor and honesty department:

Dutch Prime Minister Mark Rutte said "The hard truth is that there are no magic solutions to solving this crisis. We will all have to keep our spending in check, pay off our debts and swiftly introduce healthy reforms. This is what will kickstart growth."

The one major thing missing is that bondholders, not taxpayers need to take a substantial hit. Only after equity holders and bondholders are 100% wiped out should any public funds come into play.

Addendum:

Reader Donn replies "public pensioners should take a haircut before taxpayers in general", an idea of considerable merit.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

Japanese Debt Downgraded by Fitch; No Urgency for Japan (Until Sudden Panic Hits)

Posted: 23 May 2012 01:02 AM PDT

With Japan's public debt about to hit 240% of GDP, Fitch Downgrades Japan's Sovereign Rating

The ratings agency Fitch on Tuesday lowered its assessment of Japan's sovereign credit to A+, an investment grade just above the likes of Spain and Italy, and criticized Tokyo for not doing more to pare down its burgeoning debt.

Japan's public debt will hit almost 240 percent of its gross domestic product by the end of the year, Fitch warned.

The new rating also heightens the pressure on Prime Minister Yoshihiko Noda to rein in spending and raise taxes at a delicate time, when the Japanese economy is still recovering from natural and nuclear disasters last year.

Mr. Noda has warned that Japan could eventually face a debt crisis akin to that afflicting Europe and is staking his job on a plan to double the consumption tax rate to 10 percent by late 2015. That increase, he has argued, is necessary to pay for soaring welfare costs and pension payments.

But lawmakers even within his own party have attacked the plan, saying it would put a damper on growth just as Japan's recovery gets on track. Even if Japan does double its sales tax, the revenue will most likely not be enough to balance in the medium term.

According to the statement, Fitch lowered Japan's long-term local currency rating to A+ from AA. It also cut the country's foreign currency rating to A+ from AA. Fitch said the outlook was negative for both.

The A+ rating puts Japan four notches below the ratings of other major economies like the United States, Britain, France and Germany, which all retain the top AAA rating from Fitch. Japan's grade is now just one notch above Spain's and two above Italy's, countries that have struggled in the European debt crisis. Two other global ratings agencies, Standard & Poor's and Moody's Investors Service, lowered Japan's credit rating last year.

No Urgency for Japan (Until Sudden Panic Hits)

As Japan's debt careens out of control, Keynesian clowns do not want to do anything about it for fear of hurting the recovery. They have been saying the same thing for over 20 years.

Nonetheless, the rally cry remains No Urgency for Japan to Deal With Debt.

With Japan awash in cheap funding provided by domestic savings and local banks continuing to park their cash in government bonds, analysts tell CNBC the country faces no urgency in dealing with its rising public debt, despite the latest ratings cut by Fitch.

The likelihood of a Europe style debt crisis for the world's third-largest economy remains low, say analysts, because over 90 percent of government debt is domestically owned.

"For as long as Japan's debt is well-held by local savers and local investors - 93 percent - the impact, I think, on risk assets is going to be quite marginal," John Woods, Chief Investment Officer, Citi Private Bank told CNBC's "The Call" on Wednesday.

Those low yields, however, also mean policy makers are under no pressure to deal with total debt that is more than twice as large as the country's $5 trillion economy. Japan's government has submitted plans to double the sales tax by 2015 but the law could split the ruling party and force early election, according to Reuters.

"As long as these yields remain at such historically low levels, the impetus for the government to meaningfully change and reform its environment is going to be quite limited," Woods said.

Thomas Bryne, senior vice president at Moody's Investor Service, said on CNBC's "Asia Squawk Box" Wednesday that his firm had issued plenty of negative commentary since it downgraded Japan in August last year.

"We're concerned about the slippage in exports, perhaps the slippage in current account surplus, probably more concerned about the slippage in the fiscal deficit and we also note that attempts to put Japan on a long-term sustainable fiscal track are still partial and tentative," he said.

"As Long As ..."

The words "as long as" appeared twice in the above article. The key phrase was "As long as these yields remain at such historically low levels ...".

Japan will go from no sense of urgency to panic urgency in a short sudden burst. Unfortunately, I cannot tell you when. However, I can say that the slippage in exports and current account surplus is very important.

Given Japan's aging demographics, pension plans became net sellers of bonds last year.

For now, Japanese corporations purchase enough bonds to stem the tide. However, if exports collapse or interest rates rise significantly for any reason, the party will be immediately over.

Bear in mind that "significantly" means a mere hike in the 10-year rate to 2.5% or so, perhaps less. Such a hike would consume 100% of Japan's revenues just to meet interest on the national debt.

At that point, whenever it is, the choice for Japan will be print or default. Either way, panic will set in along with a full-blown global currency crisis.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
Click Here To Scroll Thru My Recent Post List

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Mish's Global Economic Trend Analysis

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