In Korea…

“SEOUL, Nov 4 (Reuters) – Housing prices across South Korea will rise in 2010 for a sixth consecutive year and by the fastest pace in four years, an industry association research agency forecast on Wednesday.” (when do industry association representatives ever say anything else?) , “Kookmin Bank said on Monday housing prices rose for a seventh consecutive month in October from the previous month following a six-month decline.
http://www.forbes.com/feeds/afx/2009/11/04/afx7082777.html

In Singapore…

“Demand for private homes has experienced “strong growth” and unchecked price gains may expose the property market to risks in the global economy, the Monetary Authority of Singapore said in its Financial Stability Review today.”, “This comes after property prices rose 15.8% in the third quarter of this year, the most in 28 years, after dropping 25% in the previous four quarters.”
http://www.bloomberg.com/apps/news?pid=20601087&sid=aqr8hthy9z5k&pos=5
http://www.propertywire.com/news/asia/soaring-property-price-fears-200911133672.html

In China…

“Chinese real estate figures out on Tuesday show investment in the sector was up 18.9 per cent in October, while property sales soared 48.4 per cent year-to-date.”, “This is further evidence that strong bank lending and easy liquidity conditions are creating an overheated property market.”
http://ftalphaville.ft.com/blog/2009/11/10/82486/more-on-that-overheating-chinese-property-market/

In Hong Kong…

“Statistics compiled by CB Richard Ellis, an estate agent, show that prices of high-end flats have risen by 40% since January, and are now just 13% below their 2008 pre-crisis peak. Some are once again priced at record levels.”
http://www.economist.com/businessfinance/displaystory.cfm?story_id=14816657

In Taiwan…

“Nov. 13 (Bloomberg) — Taipei’s residential prices may rise 15 percent in 2010″ (That’s right – one random dude’s guess is apparently worthy of an entire news article at a major news agency)

http://www.bloomberg.com/apps/news?pid=20601087&sid=ayxWM98dXAjA&pos=7

“Wealthy Taiwanese eye luxury homes in the south”

http://www.chinapost.com.tw/business/asia/b-taiwan/2009/11/13/232610/Wealthy-Taiwanese.htm

Also repeated here in the Taipei Times (Thanks Michael).

In fact, the Taipei Times also adds this little nugget: “Taiwan joined Singapore, Hong Kong, India and China in moving to prevent excessive property-market swings, after falling interest rates drove prices higher.”

So… wait a minute… how long have Taiwanese rates been low? (Answer: a long time). And how long has it been known that low interest rates cause asset bubbles (Answer: a long time – 80 years, at least). So why wasn’t this rapidly put in place when prices were swinging UP, effectively stealing the future earnings of the youth of the country and handing them to the old? Oh wait, maybe I know… taxes are higher when property prices are higher… and taxes go lower when property prices go lower.

So who do Asian economists blame for these Asian bubbles?

“Fed May Cause Next Crisis, Hong Kong’s Tsang Suggests”

http://www.bloomberg.com/apps/news?pid=20601080&sid=aU3AiTc_Q_vk

What a surprise.

“Where is the money going — it’s where the problem’s going to be: Asia,” Tsang said. “You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals.”

Oh dear, poor little Asia. At least they’re making serious progress in placing the blame elsewhere – the next stage of the crisis hasn’t even happened yet and yet it’s clearly America’s fault.

Summary & My Opinion.

Asian housing propaganda (’houses always go up!!!’) is once again filling the newspapers. Meanwhile, local governments pour money into the economy, keep interest rates low, and fail to regulate their housing and asset markets properly.

Yet when this all goes wrong it will be America’s fault apparently.

Hmm. My view is that a lot of people who failed to learn a lesson in 2008 are going to get burned again. More banks went bust in the USA this year than in any previous year, and losses are continuing. While modest GDP growth has been achieved in some countries thanks to a huge stimulus spending program and low interest rates, there is no indication that the world is really out of crisis yet. So why are people once again paying record prices to buy little piles of bricks and wood? I have no idea. It seems crazy.

Funny, really, you’d think people who were predicting 3 significant figures of accuracy would be ashamed of not even getting the first significant figure right, and would avoid repeating their mistake. Apparently not.

Not that it matters, since the real harm to Taiwan’s economy is almost certainly bigger than either of these numbers. I have trouble imagining how Taiwan and Japan’s exports can drop by similar amounts, and yet Japan reports a GDP hit many times times bigger than Taiwan. Doesn’t add up.

http://www.taipeitimes.com/News/editorials/archives/2009/11/08/2003457915

As you may know, historically, economists/financiers seem to have held the view that although Japan had horrific government debt relative to the size of its economy (GDP), this was ‘OK’ since it was all lent by Japanese citizens (because of the high savings ratio). This meant the debt could be easily be repaid at any time by inflation, i.e. printing new money to pay back old debt.

Unfortunately, the debt was never repaid, it just grew and grew. It proved hard to generate inflation, and now all those people who provided the government with money via savings, are getting old, and they want to spend their savings.

So the Japanese government is trying to roll over some 250% of GDP into foreign borrowing instead of domestic borrowing at the worst possible time (i.e. when every other government and business in the world desperately wants to borrow money too).

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6480289/It-is-Japan-we-should-be-worrying-about-not-America.html

This should be interesting to watch.

(Britain is in a slightly similar situation, though with a growing population, lots of recently acquired debt, and a negative savings ratio which has now recently turned positive).

Since that post, the Shanghai stockmarket has fallen almost 50%.

The FT article (linked above) is quite interesting. It’s becoming quite normal to see 5% drops each day in the Chinese stockmarkets.

Of course, I’m quite sure everyone will pull their money out NOW rather than 6 months ago, before it was too late. People are quite amazing at doing things badly with money.

Actually, though, if I had money in the Chinese stockmarket, I’d pull it out now anyway. It’s still overpriced. Unless the government takes actions to prop it up, I think it could quite easily reach a much lower (and more reasonable) price in the future.

UPDATE:

1. I notice that October 2007 was also when Warren Buffet massively sold out of Petrochina at a huge profit. The company’s share price has since fallen 60%.

2. Apparently the Chinese government is now modifying the stamp duty (share tax) laws to try and keep the market afloat. Why are price drops seen as a bad thing? Who knows.

An ETF is just a form of index tracking fund, that can be bought and sold as though it was a company. Index tracking involves copying the performance of a group of shares, usually a well known group. For example, an index might contain the largest 500 companies in a particular country (the SP500, DAX or FTSE100, for example).

If you think of ETFs as a pretend company listed on the stockmarket, that performs like the average company in the market, you wouldn’t be a mile from the truth. For example, “ISF” is the name of one ETF, whose share price mirrors the level of the FTSE100. It also pays out the same dividend as the companies in the FTSE100, on average (less a fairly small annual charge).

Internationally, ETFs have been available to the public for a few years, and you can purchase ETF shares corresponding to almost any major stockmarket index: America, Europe (or individual countries in Europe), Asia (or individual countries in Asia), …

Unlike a mutual fund, ETFs don’t have an upfront charge to buy in units of the fund; nor an exit charge; and typically, ongoing annual charges are tiny – 0.4% per year being easily achievable on most major indices.

So why do I bring this up today? Well, for about a year I’ve been trying to find a way to invest in ETFs from Taiwan, so that my Taiwanese friends can enjoy the almost magical returns of passive, long-term-buy-and-hold index investing.

To date, I’ve only found ‘fake’ ETFs available through some Taiwanese banks – where “ETF” has been included as part of the name of a traditional mutual fund, to try to make it sound trendy, new and fashionable. These ‘ETFs’ aren’t worth spitting on; they’re not tradable like real ETFs; there’s often no real attempt to actually replicate a well-known index; they have high annual charges; and remarkably, they typically have costly entry and exit charges.

However, the Financial times reported today that the Taiwan Stock Exchange is to list more than a dozen real ETFs mirroring the indices of countries all across the world.

This is great news if you’re living in Taiwan, and especially if you’re limited to investing in Taiwan. These ETFs will offer an ‘easy to get in, easy to get out’ way of investing in index trackers, and at low cost – no upfront costs besides a small share dealing charge, and a tiny annual management fee.

For anyone who just wants to invest in international stockmarkets, but doesn’t want to learn about shares or funds or fund managers, this is a great choice. Also, there’s bucketloads of evidence that passive index trackers outperform traditional actively managed mutual funds, after charges are taken into consideration, so this is really a superbly effective way to invest spare money.

Anyway, please don’t take my word for any of this – this is a blog post, after all, not financial advice. Still, I’d recommend to anyone with some spare dosh, currently living in Taiwan, that it would be well worth your time to learn a little bit about ETFs.

41292387 (match all the digits for the grand prize of $2 million NTD).

32971009 (prizes for matching 3 or more digits starting at the right hand side).

39376966 (prizes for matching 3 or more digits starting at the right hand side).

50336841 (prizes for matching 3 or more digits starting at the right hand side).

One amusing quote worth picking up on:

“The main reasons for failed FamilyMart franchises are long working hours and a lack of employees,” said Hsu Shu-ching (徐淑卿), manager of the convenience store chain’s franchise department.

Oh I see! So it’s not because we have directly competing convenience stores positioned literally every 5 metres along every street in the country, selling identical goods at identical prices? :)

Taiwanese clothes store…

NNT is one of the few authors in Finance I take seriously; the others being Warren Buffett, and Benjamin Graham. His books, ‘Fooled by Randomness’ and ‘The Black Swan’, are must-haves for any serious finance nut. Besides his theoretical savvy, NNT is a damned funny read, as you’ll see in this article.

I admire his guts. Remember, he is up against the entirety of financial academia as well as the bulk of the finance industry – stating out loud that the most basic theories in Finance are flat out wrong. Fortunately for him, he happens to be right.

Furthermore, he is in very good company. Anyone who has read ‘the superinvestors of Graham and Doddsville‘ will have become well aware that the core theories of finance are based on utterly absurd premises.

Here’s a sneak preview… enough to whet your appetite.

Last August, The Wall Street Journal published a statement by one Matthew Rothman, financial economist, expressing his surprise that financial markets experienced a string of events that “would happen once in 10,000 years”.

A portrait of Mr Rothman accompanying the article reveals that he is considerably younger than 10,000 years; it is therefore fair to assume he is not drawing his inference from his own empirical experience but from some theoretical model that produces the risk of rare events, or what he perceives to be rare events. (NNT, FT.com)

Click here for more.

But even taking these imaginary profits into consideration we’re looking at forward PERs of 60. 60! My mind can hardly cope. And yet rock solid American, British and European blue chip companies with pedigree histories can be bought on PERs ranging from 7 to 20 (i.e. 1/3 to 1/9 the price!). Another nugget: house prices have risen 13-fold in some areas in less than a decade. 13-fold. I think it’s a fairly safe bet that wages haven’t kept up.

I was going to write a blogpost about this, but I’ve been spared the need by some fellow market enthusiasts. Michael Turton has gathered up a couple of great sources of info on this topic, and you can read all about it here. It’s a good read, and he has provided links to Newsweek and David Webb’s sites. I strongly recommend you take a look if you’re in any way interested in the state of China’s economy.

Fruit and vegetables: subjectively, seem to be about 10% more expensive.
Yoghurt drinks: up 20%.
Bus travel: From $15, to $18 – and given the hassle of carrying lots of $1 coins, that’s arguably an increase to $20! That’s 33%!
Baked items: Noticably more pricey, around 10%.
Electricity bill: Through the roof (even though the electricity has been turned off!).

So far, I’ve only been in a couple of small shops – and I am not looking forward to my weekly spend at the supermarket if this pattern of price increases holds up. Thankfully, my rent has stayed the same this year, which is nice as it represents a big part of my spending.

Of course, economists might look at this and scoff – what about the many items that didn’t go up in price, which I didn’t mention – cans of ‘Vitali’, for example? What about the expensive items that take up a lot of people’s money, like flat-screen TVs, that usually go down in price over time?

The first point would be fair – we tend to notice changes more than things staying the same, and it is easy to build a skewed view of reality for this reason. But in regard to the second point: well, I wouldn’t really care if cars or flat-screen TVs came down 10% in price in the last 2 weeks – and I doubt very much that they did. Generally, I don’t make many discretionary purchases*, so my ‘personal price inflation’ is probably more like that of a old person – just the basics, thanks!

It seems though that on this occasion, the economists would probably agree that a bit of slightly higher inflation is appearing. The Taipei Times reported today that inflation jumped this month.

And from the China Post:

And that’s just in one month! Some of the other measures of inflation show it to be rocketing up fast for manufacturers as well as consumers:

Scary. Typical bank interest rates at around 2-2.5%; broad annual inflation** at up to 6.25%, and with a 1-month jump of anything up to 5% depending on what you’re buying. Watch your spending carefully, because there’s a very real chance your wage rise this year won’t come close to covering the increase in the cost of living.

Links: Michael Turton has recently written about Taiwanese food prices, here.

* discretionary purchase = ‘things you want / things you choose to buy’.
* non-discretionary purchase = ‘things you need / things you have no choice about buying’.
** I recommend being a bit wary of all government inflation figures – not just Taiwan’s! I believe they will be understated by their design, since it is in most government’s interests to report low inflation rather than high inflation. I instead suggest estimating your own personal inflation using a standardised ’shopping basket’.

More Asian economics over at toshou…

Pushed by high-priced apartments and suites, the price of housing in Taipei City has continued to rise, increasing from NT$460,400 per ping (3.3m2) in the first quarter to NT$489,400 per ping in the second quarter, the report said.

You need to read between the lines carefully with housing data, to see what is really being said. Here, the claim is made that the price of housing has ‘continued to rise’ and that the housing market has ‘continued to boom’. But what is really given here?

- Asking price? (initial price sought?)
- Agreed price? (final price negotiated?)
- Achieved price? (the money that ends up in the bank, including transactions that fall apart?)

In fact, it’s the first; and this is often not a reliable measure of what is happening in the market (whether rising, falling, or stagnating). If I told you that X amount of Chinese food went on the ‘market’ today, and that Y of it sold – do you think it would be the ‘average’ priced piece of food that sold? Or probably more of the cheap stuff? It’s very much the same with housing, and in housing markets with low turnover, you often find a ‘two-speed’ market forms. A two-speed market is where high-priced sellers sit and wait for a year at a time, while lower-priced sellers clear their properties in weeks.

Here, we see that the collective value of housing ‘went up’, and also that the number of houses on sale went up too – in fact, considerably more. Let’s do the math:

1st quarter: 19,663 units collectively priced at 214.8 bn = 10.9 million NTD per house on average.
2nd quarter: 25,335 units collectively priced at 248.1 bn = 9.8 million NTD per house on average.

Implied quarterly drop in average asking price: 10%.

Quarterly turnover? Down from 30.14% to 27.43%. Doesn’t sound like much does it? But that means houses have rapidly gone from ‘10 months to sell’ to ‘11 months to sell’. This is particularly interesting, given that the number of estate agents needed to achieve that lower level of turnover was vastly higher than in the first quarter! (see the original article)

Being honest, I don’t think ‘mixed’ quite describes that performance. I don’t think ‘housing boom continues’ quite catches it either. In fact, I think completely frakkin awful far better describes a 10% drop in price and 10% drop in turnover – in just 3 months!

Consider also, this was as we entered the summer – which in almost every country of the world is one of the best times of year to sell a house, as opposed to a bone-chilling winter! Of course, I’m sure someone will write to tell me that Taiwanese people in fact LOVE going out to view houses in the bitterly cold winter weather.

Now, time to get even more skeptical. Did you notice I used the words ‘priced at’, rather than ‘worth’ as the original article did? That’s because the worth of something, contrary to the Taipei Times belief, is not actually defined by its asking price. If I offered you a house for free, would the house be worthless? If I offered you a tasty 12″ pizza for 1 million NTD, is it worth 1 million NTD? Of course not!

There’s a stronger argument that ‘achieved prices’ measure a sense of worth, where worth means ‘what people are prepared to actually pay’. But if some dumb guy pays 1 billion NTD for a Big Mac, does that make all Big Macs worth 1 billion NTD? I say, hell no – of course it doesn’t. And that is as true of houses as it is of Big Macs. There is nothing magical about a collection of bricks and mud, that makes it different to every other type of item in the world.

Instead, I personally prefer (and recommend) a more ‘financially real’ sense of worth which derives from the financial value of a thing. If I buy a house with cash, and it returns me a rent of 10,000 per month, and after costs I am left with 7,000 per month, then I can compare that with putting my cash in the bank; or shares; or I can compare that with the damage done by inflation. This sense of worth is often imprecise and subject to your own beliefs about the risks and alternative returns involved. But, I personally believe it’s probably the most valuable sense of worth that there is. I encourage you to develop your own meaning of worth by thinking about these issues, rather than believing the absolute junk you are normally fed by the mass media about financial assets.

But, we can be more skeptical still. There are other questions we need to ask about housing data. Is it averaged out over several months, or raw data? Are we considering regions or national figures? Are they seasonally adjusted (taking account of the ‘nice weather effect’) or unadjusted? Are the annual figures a 12 month average, since start of year average, or an extrapolation of the current month’s data? Are the figures measuring asked, agreed, or achieved prices? Net of costs, or without costs? Money borrowed or money spent? Who is measuring (estate agents? the government? banks? surveyors?)? Why are they measuring? What are they measuring (sentiment, prices?) How are they measuring?

In fact, it’s fairly trivial to ‘flip’ between 100 different types of housing data, so that house prices can appear to go onwards and upwards continually each month; or to present housing in a negative way continually. It’s worthwhile to watch journalists do this as they are spoonfed ready-made ‘press releases’ by banks and estate agents. Many such press releases are seemingly published without a moment’s critical analysis.

My all time favourite is the simple, ‘declare victory, and retreat!’. We saw this above in the Taipei times article, where they talk as though this news is actually encouraging! They start by saying the news was ‘mixed’, but then we were soon told ‘the market is continuing to boom’, and then we are told about a collection of statistics going up (value of houses on sale, number of houses on sale, number of estate agencies, …). Take a look at the full article online (or in print). Notice how much time was spent talking about the number of real estate salesmen’s offices in Taipei and where they all opened? Notice how little time was spent calculating the average price of a house, or the consequences of a rise in price per ping in a falling market?

No, most houseowners will worry when they see news of a mixed market, but then they will see ‘market continues to boom’, look at numbers going up, and they will feel reassured. The newspaper has succeeded! The scary headline sold the paper, yet the lovely story of the main article made the reader feel warm and happy.

To end this article, let’s look at the claim that the house price measured by ping went up. Intuitively, many people will think – oh ho – houses are becoming more expensive! But in fact, we’ve seen that collectively the ‘asking price per house’ went down by 10%; so if the price ‘per ping’ went up by around 5%, we can conclude that people have given up on selling big houses (generally) and are now selling pishy little apartments that are 15% smaller on average. Since the ‘achieved price’ should be considerably lower than the asking price in a low turnover market, this ‘house shrinkage’ effect may even be much worse.

As housebuyers in Taipei spend the next 30 years of their lives paying off around $10,000,000 NTD of debt – a sum which bought only a smaller-than-ever-before apartment – I wonder if they will question their sanity back in 2007.

Point 1: Old people are screwed. Can’t get a good return from the bank on their lifelong savings, because of low interest rates. Can’t effectively invest in assets like housing and stocks (prices are sky high, since people have borrowed money practically for free, driving up prices). Legal restrictions on their investment overseas. Ergo, old people are screwed.

Point 2: Young people are screwed. House prices are absurdly high (10-20 million in Taipei) relative to wages. Take long term (historical) mean interest rates of around 6%, plus bank mortage premium, and you come to the conclusion that either every single guy in Taipei is earning 2-3 million a year to pay for his living costs, or you have a lot of couples working super-hard in normal jobs, just to keep up. How will they save for their middle age and old age? How will they take time off work for kids? How will they pay for kids? What happens if one of them falls ill? What happens if they both fall ill, even for a month or two? How will they cope when interest rates rise beyond the mean, but wages don’t go anywhere at all?

Worse, there is a strong tendency for people to do what their parents tell them. And parents are telling kids to buy houses – many having never seen a really shocking economic crash in action firsthand, unless they were working in Japan 10 years ago. Oops. Practically every 20-something and 30-something in Taiwan has been set up for financial disaster.

Here’s a graph of Taiwan’s historical interest rates. Are we in a ‘normal’ or ‘abnormally cheap’ situation, do you think? How screwed will homeowners be if interest rates go back to 15%?

Point 3: Creative businesspeople are screwed. Yeah, for big companies with huge anti-competitive moats (i.e. the ultra-big fabs, TSMC etc.), life is pretty sweet, you can expand and expand and it costs you no money at all. But for small companies? No sooner do you think of a way to make a profit than 20 other guys are crowding in and destroying the profitability of your business niche! Damn!

Oh look, a street where no-one is running a hotpot store. 4 weeks later, after one guy has taken the risk and tried opening his pet store, everyone else sees the trade he’s getting, and muscles in with cheap loans (or cash from the oldies, who are desperately seeking any kind of return), and BAM!Every businessman in the fight is screwed.

Whether it’s pet monkeys, hotpot dishes, or mass-production of plastic widgets, as a businessman you are still going to get painfully screwed – time after time – in a ‘cheap and easy’ borrowing environment. Of course, everyone dreams of running their own business here… so they sleepwalk into small business failure.

Point 4: Consumers are screwed. Consumers have used up the next 10 years of consumption already. I look at the guys where I live, who struggle to earn a consistent $80-150TWD / hour. They are all driving super-cool cars; cars far, far cooler than those in the UK, supposedly one of the world’s richest economies. How the hell can they possibly afford them?

Of course, they can’t really afford them. It’s the magic of 10-20 year finance and low interest rates allowing a low monthly repayment – for the rest of your life. However, this repayment sucks up all their income each month – and as rates increase, it gets more and more painful. I’d say that most of the shiny, awesome, beautiful, expensive Japanese cars I see round here have bashes and dents somewhere. People can’t afford to have the car *and* get it repaired every time some scooter blasts into it from a blind corner.

But if you spend all your future earnings today – what do you spend next year, or the year after …?

Point 5: Importers are screwed. With the Taiwanese dollar as weak as it’s ever been, you wouldn’t want to be an importer. Hell no.

Point 6: Exporters will be screwed. Whenever the interest rates do go up, and the carry trade in TWD reverses, it will be UGLY for those exporters who have borrowed to their eyeballs to expand. Gearing up heavily is a nice way to set your business up for disaster. The only reason exports are rising in Taiwan so quickly is because Taiwanese Dollars are being handed out like candy to the rest of the world. What’s the good of selling 30% more stuff beyond the growth you’d have normally had, if the money you sell it for is worth 30% less?

Taiwan does more work, but gets the same money, in terms of international buying power. Great for employment numbers. Crap for increasing the wealth of Taiwanese people – which they find out as soon as they try to buy anything from other parts of the world, or go travelling, or pay their electricity bills…

Point 7: Houseowners are screwed. Besides the ongoing agony of mortgage repayments in a low inflation environment with rising interest rates, there’s the simple matter of negative equity. Low inflation means any ‘real’ drop in house prices will be a ‘nominal’ drop in house prices. I.e. prices actually DROP rather than stand still while everything else goes up in price. That means you can’t sell without taking a huge multi-million dollar loss. Which means, you effectively can’t sell. So you had better like the house you buy, people, because you will be living there a very long time.

Oh – and did you know that Taipei is famous for holding world records when it comes to house-price-to-earnings multiples? We’re talking about a earnings multiple of 10-15 in many regions of the city. That makes even America, Ireland, Northern Ireland, Australia, New Zealand and London look cheap. Heck it makes Hong Kong and Shanghai look cheap. Last time this happened in Taiwan was around the mid 90’s, and Taiwan’s housing market went nowhere for the following 8 years.

Point 8: Everyone servicing ‘young industries’ is screwed. Demographic decline. Basically, there was already a trend towards having fewer kids, (and later in life), but my belief is that it’s being accelerated by the ridiculous housing situation. Suffice to say I wouldn’t want to be Toys’R'Us in 5 years time. No money, no kids. Great for business…

Taiwan is also faced with a tough political choice. Either take in immigrants, boost your replacement ratio (number of kids per couple) or go into population decline like Japan. The last of those three options would not be good for house prices or businesses in this country.

Point 9: Energy screwage. Taiwan doesn’t have energy resources. You may have noticed the oil price recently. And last year. It looks like it may be with us to stay. Oh dear.

Und so weiter…

… I could go on. Now of course, there’s always something wrong in the economy. And there’s always something right. I mean, you could point to the superbly low unemployment in Taiwan and say, “hey, that’s pretty awesome”! But my view is that the good vibes of the ‘booming economy’ and ’superb unemployment’ are an accident, caused by people spending 10 years of future earnings, right now.

Analogy.

Imagine a car. What happens when you put your foot down hard on the accelerator all the time? You travel fast, everyone in the car feels pretty good…whee!… but you burn up your ‘future fuel’ early, and not as efficiently as if you’d just driven a little bit more carefully.

That’s what low interest rates do. And the effect is much the same. Then suddenly, and with little warning… you hear a funny noise from the engine and the car starts slowing down. And no matter what you do to the accelerator pedal at that stage… there’s nothing to stop your car grinding to a halt. It’s too late.

Don’t believe me? Look at Japan. They used up their fuel; their economy has stood still for more than a decade. Yet still they stupidly hold their foot down on the economic accelerator of cheap money, when there is clearly no gas in the tank. They need to raise their interest rates, get the old people spending for a while. Put a change of fuel in the engine.

You cannot have your cake, and eat it too. The people in your country either spend their future wages now (by borrowing money), or they spend them in the future (by earning them). But if they spend it now – it’s gone, and the future must go without.

Conclusion.

Will Taiwan take it’s foot off the economic accelerator pedal, and raise interest rates? Or will they hold the accelerator pedal to the floor, even as the car grinds to a halt, and find themselves stuck in the mud with Japan? It will be interesting to watch, either way.

Picture taken from globalpropertyguide.com.

18220444 (prizes for matching 3 or more digits starting at the right hand side).

26888640 (prizes for matching 3 or more digits starting at the right hand side).

37661297 (prizes for matching 3 or more digits starting at the right hand side).

1) Recently, a consortium of banks (Fortis, Santander, and RBS) offered £48 billion to buy ABN Amro.

2) According to the words of RBS’s CEO, Fred Goodwin: RBS has a 38% share of that transaction. In other words, £18.24bn.

3) However, that 38% included a bank within ABN Amro, called La Salle. La Salle has just been sold seperately for £11.5bn.

4) That leaves RBS paying for £6.74bn (18.24bn-11.5bn) for its share of the remaining parts of ABN AMRO, assuming that the business splitup is the same.

5) When RBS first expressed an interest in bidding for ABN Amro, its share price was £6.66.

6) However, RBS’s share price became £5.71 today (and was £5.76 at close of market).

7) RBS has 9,456,444,000 shares outstanding.

8) (6.66-5.71)*9,456,444,000 = almost exactly £9bn.

9) In other words, the market has ‘written off’ £9bn from the equity of RBS as a result of an offer made of £6.76bn, net.

10) Therefore, assuming the remainder of RBS not involved in this transaction is still worth what it was before, new buyers of RBS shares are effectively paying their fraction of -£2.26bn for ABN Amro. So, as a new buyer of RBS you are obtaining your ABN Amro shares for “Cheaper-Than-Free!”.

11) But wait. It gets better.

12) The consortium (Fortis, Santander, RBS) recently altered the offer being made, so that a greater proportion would be paid in cash. I’m going to change to Euros here, for simplicity’s sake.

13) The offer as it currently stands consists of 35.6 Euros (cash) and 0.296 RBS shares, being paid per ABN AMRO share.

14) At the close of market today, ABN’s share price was 35.29 Euros.

15) That means, RBS’s shares are being valued at ‘Cheaper-Than-Free!” too. By buying an ABN AMRO share, you get your money back, plus 0.31 Euros, plus 0.296 RBS shares.

16) The horrifying conclusion.

a. ABN Amro’s shares are being valued at ‘less than nothing’.
b. RBS’s shares are being valued at ‘less than nothing’.
c. If an acquirer whose equity is valued at less than nothing, buys a company whose equity is also valued at less than nothing – is the acquirer’s equity diluted? Or does a black hole open up in the space time continuum and swallow us all?

Further notes

(point 4/9) It turns out, in the revised bid, RBS actually altered the net portion of ABN it wishes to have (in its revised bid) to around £10bn. But still, the market is apparently assuming that the entirety of this investment by RBS will just disappear into thin air… though it’s not quite as bad as I made out in the above argument – yet.

(point 15) Demully (a writer on various UK financial forums) suggests that because there are two bids in the running for ABN, the market price for ABN implies shareholders will pick a lower bid rather than the one from RBS; and also it reflects a risk premium, in that the bid might not go ahead at all. That’s a fair point. However, to my mind, the size of the premium seems… collossal… given that the RBS bid is actually formalised.

(generally) It’s actually unfair to say that all of the fall in RBS’s price can be attributed to the bid they have made for ABN Amro. There has been a mild fall in the market lately; however, comparing against one of RBS’s peers – say, HSBC – we can see that RBS’s share price has changed in a unique and significant way since the bid was announced.

Thanks to demully for some of the above.

Together, we can refer to these charges as friction. Just like air friction slowing an aeroplane, or road friction slowing your car, ‘financial friction’ slows your ability to make money by stealing little tiny chunks of it all the time.

Many people incur other costs on their interactions with the stockmarket beyond these three basic types of friction. You may incur capital gains tax if you make a big profit on the assets you’re buying. If you invest through a mutual fund, then you are paying some salaries for the people who run the fund, and you are also paying for their behaviour on your behalf. If they trade a million times a day, then the frictional costs they’re incurring on your behalf become rather high. If they trade once per year…. well, then they lose their job for ‘not looking busy’ while being paid a huge salary, which is one of the most unpardonable sins in Big Finance. There may even be another frictional cost involved for you, as you buy into the mutual fund or sell back out! Friction, friction, friction! It’s no wonder that the people who run stockmarkets are able to spend half their time driving around in Porsches.

Anyhow. I bought the Taipei Times today and was having a browse when I noticed that the ‘turnover‘ of the Taiwanese stockmarket was 211 billion Taiwanese dollars. Now just 7 years ago, turnover was considerably lower – about 20 times lower – following the Asian financial crisis of the late 90s. So this got me thinking, how much ‘friction’ does that imply in the marketplace these days? How much are people effectively paying each year, simply to rename the ‘owner’ part of the stock certificates, over and over again? What percentage of the Taiwanese economy’s earnings is being pissed away on simply renaming share certificates from Mr Yi to Mr Yang to Mrs Ting every few minutes?

Let’s look at turnover. Turnover represents the ‘dollar value’ of buys and sells on the stockmarket today, so it describes how quickly a particular value of shares is changing hands. Turnover in TAIEX stocks was 211 billion Taiwanese dollars on Friday. That means that in total, if you added up the value of all the shares that were bought and sold, it would come to 211 billion NT dollars.

Now, there are 365*5/7 = around 260 trading days in the year. So if Friday was a typical day, that means that there is 211*260 = 55 trillion NT dollars of turnover in the Taiwanese stockmarket per year.

What’s the size of the Taiwanese stockmarket? I.e. the ‘total price’ if one person was to try and buy every single company at once? The TAIEX has a total market capitalisation of around 21 trillion NT dollars. So from this we see that every single share in the Taiwanese stockmarket is having the name changed on the ownership certificate, every 5 months or so on average (55 trillion of turnover, divided by 21 trillion of actual shares available to be turned over!). Clearly investors here are overwhelmed by the terrifying prospect of long term company ownership!

Next, let’s assume conservatively that the costs of friction come in at around 1% of each trade (combining the costs of buyer and seller). For comparison, in the UK, these charges are usually in a range from 0.75->10% depending on the type of shares being traded. The costs happen on each end of the trade (the buyer and seller both have to pay their brokers and their taxes!). That gives a total cost for ‘friction’ of 0.01 * 55 trillion Taiwanese dollars = 550 billion Taiwanese dollars.

Example: So if you spend 100,000NTD on buying some shares, your frictional charges would add up to about 500NTD for you and 500NTD for the seller. That doesn’t seem unreasonable. Pretty cheap, in fact – you’d hardly notice 500NTD on the top of a 100,000NTD purchase, would you!

Last of all, how much profit are these companies actually making on their owner’s behalf? Correcting these figures for the current index value suggests an average company PER ratio of 14.6 for 2007. Turning that ratio upside down, 1/14.6, tells us that each company is earning $68 of profits per year, for every $1000 that gets invested into its shares, on average.

So we take the market capitalisation (21 trillion Taiwanese dollars), multiply it by 0.068 (earnings ratio), and we get $1428 billion Taiwanese dollars of profit this year, shared between all the major companies in Taiwan. That’s how much all the major companies made, added together.

Holy Friction, Batman! Can you believe it? We just worked out that Taiwanese stockmarket investors are (in aggregate) paying $550 billion NTD each year, out of their companies’ profits of $1428 billion NTD, just to alter the ownership details on the share certificates every few months, from Mr Yi to Mr Yang to Mrs Ting! This ‘changing ownership’ problem is wasting than a third of the company profits!

Example: Imagine you are living in a street with 8 hotpot shops. Every 5 months, the owners decide to sell up their shop and buy their neighbour’s hotpot shop since they think it’s probably doing better than their own. Over time, they all gradually move their ownership of a hotpot business up one side of the street, and back down the other, in a big circle. After a few years, they sit down together to work out how much this silly ‘buying your neighbours business, selling your own’ behaviour is costing them.

Imagine their shock when they find that moving their business up or down the street is costing them more than a third of their annual profits! Instead of making 60k a month on their hotpot stall, because they keep buying their neighbour’s business, and selling their own, they are all making just 40k a month after the costs of transferring ownership around. Do you think these people would keep moving around? Or do you think they would gasp in shock, and then decide that maybe the grass isn’t greener on the other side of the fence and decide to stay in a single business for the next 10-20 years?

The Taipei Times labelled the Taiwanese stockmarket as being red hot in an article they wrote last week. Clearly they are right – the money that is thrown into it is being burnt up – by stupid amounts of frictional costs, caused by swapping ownership around.

If anyone has the turnover, marketcap and PER figures for other regional stockmarkets, please do the calculations and email me – I’d love to know the extent to which friction is burning up the company profits of the markets of Asia just now.

As I did so, a woman in a very smart black suit (who had been standing near the door) walked over and asked to see my ID. “Blimey”, I thought, “They must have a bunch of laowei crooks bringing in their fake giant bags of NT$1’s and trying to nick all the $500’s”. Assuming it was the manager – and with these words, I’m sure Taiwan veterans are already beginning to grimace – I proceeded to try to dig out my bank card and ID card.

“Ello ello ello, wot’s all this then?” remarked the approaching security guard – in Mandarin, admittedly, and perhaps using a somewhat more local idiom. He then turned to me, and exclaimed “ka de!”.

“Ka de?”, I inquisitively inquired.

“Ka de!!!”, he strained, gesturing towards the woman.

Crikey – 3 exclamation marks! He must really want me to show ID to this manager!

But then, the more I tried to find my card, the more upset he became. At which point it occured to me that this woman was in fact not a manager at all, but rather an unscrupulous debt salesperson who was attempting to pinch my name, date of birth and address from my ARC card. The security guy was trying to say “credit card” in English to warn me of the reality of the situation. The woman, of course, was not amused. So this bud’s for you, Mr Credit-Card-Fraud-Preventing-Bank-Security-Dude.

Anyhoo, “ello ello ello, wot’s all this blogpost about then?”. Well, it turns out Taiwan has just passed a new law that lets you borrow 12 million Taiwanese dollars of unsecured debt (credit cards) and then only pay 20% of it back. All you need to do is: get the card, blow the money on beer and betelnuts and … err… more beer, lose your job, and then providing you can cry like a girl in front of a judge for an hour, you’re sorted!

You may have your debt cancelled; more likely, your debt payments will be delayed 8 years. However, if you’ve just burnt through 12 million dollars of booze and betel nuts then frankly, being alive in 8 years time is probably not on the cards anyway – excuse the pun.

Get your free debt while you can, I suppose. And if somehow you can’t find a cardmonkey who’ll set you up with your new plastic, then wander into the nearest branch of any major bank in Taiwan with your ARC card and pretend to be a saver. A credit ghoul is already patiently waiting there, ready to sign your soul away.

Mussst… havvve…. ARC!!!

p.s. Don’t actually do this. It would be completely illegal, and what’s more, it would be lame. Your actions are your own responsibility. Picture is copyright of “Wizards of the coast”. Yada Yada Yada.

“The yield or interest rate on 10-year U.S. bonds closed at 5.126 per cent, up 0.16 of a percentage point on the day and half a point over a month.” – that is one heck of a move! (thestar.com)

What is happening? Here is one guess.

1. The US owes lots of money to Japan and China. They hold this debt mostly in the form of ‘long term fixed rate treasury bonds’ – in other words, a piece of paper saying the US government will pay out a regular stream of interest on what they owe.
   
2. However, the US appears to be experiencing higher than expected levels of inflation – mainly because there is stacks of new money being added into circulation by the banks. So it looks like the US will probably have to pay better interest rates in future to balance the ‘devaluing’ caused by inflation and an excess of dollars; and to try and limit the willingness of consumers to borrow cash.
   
3. This makes people think, ‘aha – maybe my fixed rate of interest on these treasury bonds isn’t so good then. Maybe I’ll just sell some.”
   
4. Therefore, the price of treasury bonds goes down, as the supply of them (the number of people selling them) goes up.
   
5. But, if you were China or Japan, and you had billions of these things, what would you want to do if you believed the price of them was going to go down? You’d want to get rid of the blasted things, sharpish, and swap them for something else that might keep its value better.
   
6. It *may* be that what we are seeing right now is the ‘US treasury debt’ system beginning to unwind. That is, China/Japan trying to get out of their positions. Further evidence for this can be found in the colossal investment into foreign equities that the PRC government is currently undertaking.
   
7. There’s something of a feedback loop – the more governments sell US treasuries, the more other countries will want to get out of them too!
   
8. This is all well known, of course. The interesting thing is that it hasn’t happened yet. Like a group of poker players trying to bluff each other, everyone has kept playing the game. But perhaps we are now reaching the end of the game.
   

http://www.swaprates.co.uk

If it says ‘UK 1 year 6.2%‘ (as it currently does) then that means, the billions of pounds slushing around in the futures market has been (on average) bet upon the outcome of ‘we think interest rates will be 6.2% in June 2008′. The site provides US, EU and UK rates over a number of different timespans.

It’s not completely accurate – for 2 reasons. Firstly it’s just the average of what bankers are estimating and staking their money on, and they are ultimately only human. Secondly, there is a little bit of ‘margin’ built into the system. You are rewarded, in other words, for being prepared to lend based on your guess of a future rate. So 6.2% probably really means about 6.1% to 6.15%.

You can see how the market’s views are changing too, using the visualisations on this site. Just now, people are getting pessimistic about international rates – fast! They are beginning to think that rates will rise much further than has been talked about in the newspapers.

Changing subject: I always wonder why people depend on the newspapers for expectations of future interest rates/mortgage rates. Remember that the majority of newspapers are in the business of telling people whatever they want to hear. If their finance writers were actually any good with money, why would they still be working for a newspaper, rather than sunbathing on a nice tropical island?

Picture liberated from inmannews.com.

In summary: Futures markets are in the business of accurately estimating future economic data; they have billions of pounds on the line. I would therefore encourage you to pay rather more attention to this swap rates site, and rather less to the front pages of tabloids, if you are curious about what may happen to mortgage costs or cash savings in the future.

I hope you find this useful.

The anecdotes related in the FT article are quite remarkable; I wish I could have seen it in person.

“Having taken 25 years to reach 1,000 in late 1986, the Taiwan Stock Exchange rocketed to 12,495 by February 1990. At the peak, some 10 per cent of its population were trading daily. People stayed away from work so they could spend time investing. On some days, market volume exceeded activity on the New York and Tokyo bourses combined.”

Amazing stuff.

LOL.

“Hmm. That’s not right. I’m pretty sure the wiggly line thing isn’t meant to do that. I’m sure it will be OK though. Yeah, it’ll be OK. I’ll just keep watching it for a while though. Just in case.”

1. PRC government triples the tax rate on trading shares (0.3% stamp duty from 0.1%).


2. Shanghai market index drops 6%.


3. Shanghai stockbrokers at a loss trying to explain the concept of a market fall to recent joiners who have only ever seen the market go up.


4. Don’t worry lads – plenty more to come. The market is easily 200% overvalued, maybe more. Expect another 60-70% or so.


5. Sad truth: Most of the newbies will see this as a second chance to buy shares ‘cheap’ and will continue to pile in.

Obtaiwan: Taiwanese and HK markets are down too, slightly.

UPDATE:

As you can see, that went well, didn’t it? Tripling trading tax resulted in … a mere 3 day setback for the insane bubbling of the Shanghai market. The numpties just piled right back in.

I’ve already talked about how completely fracked up these folk are, and I think the numbers in this article are a particularly excellent quantitive demonstration of this fact.

ChinaHR.com, a Web-based job placing firm, said that of the 2,500 responses this month to a survey… just 10 percent said they had a firm grasp of the market, while 56 percent said they were learning as they went, according to the poll. It did not account for the remaining 34 percent.

Dear lord! It’s either noob hell or noob heaven depending on your viewpoint. If you’re living in Shanghai, here’s a clue about the real way to make money. During a gold rush, sell shovels. Or better still, make shovels. Start up an ‘investment advice’ centre. Perhaps even a training center for ‘investment advisors’. Promise people the path to infinite wealth if they attend your course and give you money.

After all, this strategy has worked in the western markets for hundreds of years. So I bet there’s far more easy money and potential for getting rich to be found in selling dreams to suckers, than in spinning the gunbarrel of stocktrading on the SSE.

Meanwhile, here are some more quotes (taken from the Taipei times) on the current boom.

“China’s securities regulator issued a second public warning within two weeks on risks involved in the country’s soaring stock market, state media reported yesterday, while former US Federal Reserve chairman Alan Greenspan warned China’s red-hot stock market was heading for a steep correction.”

Meanwhile, speculators in Shanghai reacted by putting their fingers in their ears and singing “la, la, we’re not listening…” for several hours.

Further, given the wobblyness of the average Taiwanese small bank, adding some biggies to the banking scene might be seen as a very good way of bringing a bit more stability to the Taiwanese banking system.

However, for the ordinary person, this whole kerfuffle might not seem like a terribly big deal. Woohoo, banks merging. So what? In fact though, there could be some interesting consequences, depending on how things play out.

1. Share prices up? Assume the government is actively trying to create a favourable environment for companies to be bought (in their entirety) from the stockmarket, by other larger companies. This means that companies should want to buy the shares from existing shareholders. Increased demand, same supply: therefore share prices of small Taiwanese banks should go up. This is a short-term consequence. It is probably already priced into the market to some degree, but retail punters do seem to love piling into this kind of fun and mayhem.
2. Less price competition. Fewer banks = less competition = less favourable terms on loans/savings for people like you and me. This is a longer term consequence.
3. Debt kept cheap? A favourable environment for acquisitions might imply the government intends to ‘keep debt cheap’ to allow companies to easily borrow, for the purpose of buying other companies. In my view, this would suck for Taiwan. It could prolong and worsen the already-far-beyond-stupid housing bubble, as well as increase the tendency for people to drop borrowed money into expensive Japanese cars and crappy copycat hotpot businesses. This has both long and short-term consequences for Taiwan – if it happens.

   Yet for the typical man in the street, all of this pales into comparison when considering point 4 – the potential for chaos.

4. Chaos, disaster and loss of money. The government is targetting a situation of at least 3 banks having a market share of greater than 10%. Now, that could happen by consolidation. Or it could also happen via the government allowing the bigger banks to run promotions/saving schemes/lending schemes designed to push smaller banks completely out of business.

   Consider what would happen if your town mayor decided there should be 3 big restaurants in town. He might encourage McDonalds to buy out your little restaurant – or he might just turn a blind eye to McDonalds doing a 1-month ‘free burger’ promotion designed purely to drive your own small restaurant completely out of business.

   Either way, it doesn’t bode well for the customers of smaller banks in Taiwan. If a small bank is bought out, there can be confusion and disarray as it is merged into the larger corporate structure of the acquiring bank. If a small bank goes out of business through tough competition, you have even more chaos and the possibility of huge personal financial loss.
   

Conclusion and what it means for you.

Given the alarming number of smaller banks that went out of business in Taiwan already this year, I personally would not consider leaving my savings with a smaller Taiwanese bank. I know this might seem very unfair on the smaller banks, many of whom have a tough time competing as it is, but to put it simply, life is a bitch sometimes.

Equally, I would be unkeen to save with one of the medium-sized contenders that are likely to go on a debt-fueled acquisition binge. Over-borrowing is a very effective way for any medium-to-large company to commit suicide.

Instead, consider saving with a bank that is ‘big enough’ not to need acquisitions, and that has shown a history of being a survivor and going it alone. Particularly, one that has mechanisms to protect your assets in the event of lots of banks going under. Frankly, I would not be caring about 0.05% of a savings rate difference at this stage.

I suspect we will see small banks hurry to improve their capital ratios (the amount of cash they have lying around for a rainy day) so that they look ‘nice and safe’ to discourage customers from leaving; to increase the chance of surviving a rush for the doors by savings customers if a few smaller banks fold; and finally to make themselves more appealing as the target for an acquisition.

I wonder if they will try to find a way to sidestep price wars with larger banks, perhaps by offering ‘unusual’ services – 24 hour banking service? Unusual saving/lending facilities? Who knows. Regardless of the details of what eventually happens, I find myself left with the feeling that many of the smaller banks of Taiwan are about to get their bollocks soundly kicked – and that perhaps the TW government may achieve its goal of a big-bank-dominated finance sector through the simple tactic of making a self-fulfilling prophecy.

11489122 (prizes for matching 3 or more digits starting at the right hand side).

13311551 (prizes for matching 3 or more digits starting at the right hand side).

35345410 (prizes for matching 3 or more digits starting at the right hand side).

Check out the symmetry in the 3rd number…

(picture liberated from the Xinhua ‘news’ service)

I’d like to draw your attention to this article. In it, the Times exposes a few more of the completely bonkers things that are happening right now in the PRC.

Some of my favourite quotes from the article:

“Trading hours coincided with my shift so I gave up my cab,” Lin Huaqiang, a driver, told a local reporter who discovered that more than 100 cabbies had followed his example.

Even schoolchildren given cash by relatives at this year’s spring festival have clubbed together to pile into investment funds.

Among them are eight members of a class in a Nanjing primary school. One of them is Xiao Yue, 9, who boasted that he had already made £66 profit on an investment of £1,300, concluding: “What fun”.

Another investor, Chen Ping, told how he, too, had raised a loan on his house for 300,000 yuan and put all the money into the market. “I believe there’s no risk,” he said.

The richest man in Asia, the Hong Kong tycoon Li Ka-shing, declared last week: “It must be a bubble.”

Shanghai-ers, I’ll be blunt. What you’re doing is batshit crazy. By this, I don’t mean the kind of crazy where you pull your T-shirt over your head, and run around in the middle of town all day, shouting “Wheee! I’m an aeroplane!!!”. Nor do I mean the kind of crazy where you grab a damp towel, and spend the whole day at the zoo, trying to sneak into the cages so that you can painfully towel-flick the lovespuds of the fiercest animals you can find. Nor even the kind of crazy that would make you enjoy playing Second Life all day….nope, not even that.

I’m talking here about the kind of crazy where you wake up one morning to find dolphins crawling out of the wall, and all the dolphins have flowers growing out of their eyes. The kind of flatout insanity where you genuinely believe people you meet are giant invisible fish that are trying to eat your soul.

That’s the kind of crazy you have to be, to put your money in the Shanghai Stock Exchange (SSE) right now. To know that around 400,000 people per day are signing Faustian Deals with the SSE – so that for a few days they can feel what it’s like to make money from thin air – is absolutely horrifying. This is going to end with decades of poverty for millions of families.

Consider this: nearly 10% of the entire Chinese population (i.e. nearly 2.5% of the entire world population) has been sucked into this one particular pyramid scheme in Shanghai already. The rate of growth in the number of investors is accelerating at breakneck speed – 15 times as fast as last year. Last month, more new Chinese stockbroking accounts were opened than in all of 2005+2006 put together. And the entirety of them seem to be people expecting that they will get rich from doing… nothing at all, besides quitting their jobs and sitting on their butts all day, watching numbers going up and down on a computer screen.

And 4 final thoughts…

• Turnover in the PRC on Wednesday exceeded that in every other market in Asia, put together. Who wins with turnover? Certainly not the little people. Turnover means ’shares being bought and sold’. In other words, it’s great for stockbroking companies, who make commission from each buy/sell. It’s great for the government’s tax coffers too, since usually a cut is taken for them too. Therefore, what has been set up here is a system which efficiently moves money from poor people to rich people and the government. Good old communism in action!
• The ‘real’ interest rate on savings that is driving the bubble: -3%. (i.e. real=gross rate – inflation)
• Current PER ratios in Shanghai: 50x-60x. Look at the graph below of PER ratios for the US market over the last 100 years or so. Notice the two spikes around the years 1930 and 2000? Notice that neither of them even got close to 50-60x, yet they marked the onset of a ‘generational’ crash in the markets and general economy, with an average of 70%-90% losses in equities, as well as massive unemployment, business failures…

  

  Graph by John Xenakis. Notice the peaks. Shanghai is so nuts, that it is already ‘off the scale’.

• If you are invested in Asian equities: BEWARE.

More news here, here, here and here.

Take a look!

At the end, are you left with the feeling that house prices have a long way up still to go… or a terrifyingly steep plunge right ahead?

10439011 (prizes for matching 3 or more digits at the right hand side).

67032883 (prizes for matching 3 or more digits at the right hand side).

84391882 (prizes for matching 3 or more digits at the right hand side).

What happens is this:

Day 1: Person A has a genius idea – selling ice cream for people’s pet dogs to eat.
Day 5: Persons B,C,D… notice that A has been making a tidy sum of money, selling ice cream for dogs.
Day 6: 20 new dog-ice-cream stores open up a few metres away, using cheap borrowed money.
Day 10: Persons A,B,C,D go out of business…. [tumbleweed].

It really does happen this quickly. You wouldn’t believe it. I’ve seen businesses last less than 5 horrifically unprofitable days. They open up, try to grab some of the hot money by copying someone else’s idea on the same street, then close down again right away if they can’t. Usually, a stream of people trying their luck at this game results in the painful destruction of the original, innovative business.

Remember also: This happens after the expensive kitting-out of shopfronts and after running several days of lossleaders. This isn’t a zero-cost exercise for the copycats either.

Currently, each day I walk along a short street (150 metres) that has 10 hotpot restaurants fighting to make their $10 NTD profit per meal (that’s just 15p UK or 30 cents US – and remember, each person takes about 1.5 hours to eat a meal in the restaurant). They are competing against another 30-40 food shops and stalls on the same 150 metre street. This isn’t sustainable in semi-rural Taiwan, even with super cheap labour. It’s just stupid.

My friend opened a Do Hwa shop (Do Hwa is a tasty and healthy Taiwanese dessert). After a few weeks they began to grab some of the local ’sweets’ market… and the very second they did, an old lady sat down a few metres away in a portable stall and started selling exactly the same products for a few dollars less (no business tax, no fixed store costs)! Promptly, another Do Hwa shop opened further up the road.

And of course, it started being very unprofitable very quickly, and after a period of running at a loss, my friend gave up. Of course, so did the old lady.

There’s a wonderful fruit stall nearby. They get a regular stream of business by selling fresh fruit, well presented, very cheaply. A second stall just opened up about 20 metres away the other day. I’m already dreading the 3rd, 4th and 5th ones.

We don’t need 5 identical fruit stalls in one street. We don’t need 10 identical hotpot restaurants in this street either. We need a few great businesses that can compete a little, grow, and offer new products.

In Kaohsiung County, 2 hours out into the countryside, my friend’s parents make a living selling wax apples by the road. Or rather, they did. Now there are 10 stalls within a few metres of them selling wax apples too. And no one is making any money any more. They are all going to go bust.

Until Taiwan raises interest rates, to stop people investing in completely pointless copycat ventures, this problem is simply going to continue. Look elsewhere in the world. In Indonesia, where rates are nearly 10%, the economy is growing twice as fast as Taiwan’s. In Japan, where rates are even lower than Taiwan’s, the economy is growing half as fast.

There has to be some risk – some higher cost for borrowed money – to deter stupid amounts of profitless copycat competition. Otherwise, a good business idea has no chance of surviving, and entrepreneurship is punished rather than rewarded.

Indonesia clearly knows this and is doing rather well from it’s high interest rates. Taiwan has not yet realised this, and is instead obsessed with keeping consumer spending high, and housing/stockmarket bubbles afloat. Until interest rates rise – and sharply – Taiwan is going to succeed only in crushing the entrepreneurship of an entire generation, and wasting a lot of capital pointlessly in the process.

I’ve received some feedback about this post from Michael Turton. He suggests:

Taoyuan nights points out the problems of yi wo feng — everyone rushing into the same business at the same time in the same place. I don’t think low interest rates are the problem there — those vendors aren’t borrowing from banks, but from family.

My view is that all lending must be based on prevailing interest rates in one way or another; whether it’s bank or private individual.

Think of it this way. Imagine you are a family member in a Taiwanese family. And imagine that interest rates are 10%, as they are in Indonesia currently. If you could get 10% return from the bank completely risk-free, would you lend your life savings to some crazy young relative who is hoping to turn a risky 3% profit on your money over the year?

Hell no! Guanxi be damned, they can go get their own loan. You might give them a couple of thousand kuai for the sake of saving face, but you will not be gambling your life savings on that proposition!

Now, re-examine the same situation but assuming you can only get 0.2% risk free from the bank, as is currently the case for many people here. For them, a risky 3% gambling opportunity might look like it could pay off better than the bank, if they misestimate the size of the risk involved in a copycat business.

Copycat businesses can look low-risk (hey, look how much money HE’S making, it must be easy!), which is where family lenders make their mistake. But copycats invariably cause direct competition, price wars, halving of customers, and are invariably followed by further copycats that compound the problem further.

In any event: I hope you can see the logic that it doesn’t really matter where the money is coming from – family or banks. When rates are low, money is more freely lent by everyone; people pay less attention to risk; and consequently hordes of unimaginative, unviable, copycat startups drive the viable companies out of business. This damages the Taiwanese entrepreneurial spirit in the longer term, by ‘punishing’ creative businessmen for any initial success they might have.

More feedback, this time from Battlepanda. He writes:

Taoyuan Night have an interesting theory for how the “swarm of bees” (meaning a crowd mindlessly moving in the same direction) phenomenon came to be — Taiwan’s low low interest rates: “There has to be some risk – some higher cost for borrowed money – to deter stupid amounts of profitless copycat competition. Otherwise, a good business idea has no chance of surviving, and entrepreneurship is punished rather than rewarded.” Of course there has got to be more to it than that since Japan has even lower interest rates and you don’t see the same kind of crazed, unstructured entrepreneurship there. Besides, a rise in the interest rate will punish all entrepreneurship, not just copycat ones. In fact, it could concievably have the perverse effect of suppressing original ventures more than copycat ventures because it is risky to innovate, which is why there are so many copycat ventures in the first place.

There are several responses to this.

• Japan has lower rates, but it has also been battling a deflationary environment vs. the crazy asset bubbles currently seen in Taiwan. Consider the following scenario;

  Country A: 3% deflation (house prices dropping, for example, or strong currency), 0% rates. Doing nothing makes your money worth 3% more!

  Country B: 5% inflation (house prices rocketing, weak currency), 2% rates. Doing nothing makes your money worth 3% less!

  So you need to talk about real rates rather than nominal rates. Unfortunately, that relies on governments providing realistic measures of inflation, and there’s not a country in the world where that happens, except perhaps Zimbabwe :)

• Entrepreneurial spirit. Japan has an ‘inventive’ culture, but entrepreneurial? Not in the way Chinese cultures are.

• Maybe Japan did go through this phase, early in the deflationary period / low interest rate period? But after a while, perhaps it exhausted the ability of banks to lend to businesses that were going bankrupt. I don’t know, and I don’t know how to get data on this. Does anyone else know?

In any event; I think the ‘real’ vs. ‘nominal’ rates issue is the main distinction here, followed by the length of time the cheap money has been available (Japan: very long term; Taiwan: only a couple of years) and the tendency for banks to burn out after excessive lending over a very long period. Thanks, BattlePanda!

Previously the notional tax credit (that prevents you needing to pay basic rate tax on dividends, and saves hassle on your tax return) was only available for companies based in the UK. This new change means it is also available on non-UK companies too. It’s particularly useful if you hold ETFs such as the iShares index tracking shares, which are based in Ireland for tax purposes. Now there will be less admin/hassle, and less tax too.

There are a few exclusions: only up to 5000 pounds/year; only a basic rate tax credit; only if you own less than 10% of the company. Still, for many small shareholders, esp. expats, this is great news!

The film “Hot Fuzz” is debuting currently in the UK. By the same people that produced “Shawn of the Dead”, and ‘Spaced’, this film could perhaps be described as a comedy about a top London cop being transferred to a rural village police force, but it’s probably more accurate just to say “Simon Pegg and chums d*cking around in police uniforms, being funny”. Trailers here. Already showing in the UK, but it doesn’t reach the rest of the world till April. Curses!

Finance: There’s gossip going round various respectable mailing lists about the price movement in Shanghai this week. The word on the street is that China’s government deliberately engineered the drop in Shanghai’s market, to try and prick the speculative bubble that is pointlessly sucking in all the free capital in the country. If so (and unlike 99% of what I read about markets, this actually seems like a sensible thing to do), there will probably be more hilarity to follow as Shanghai investors adjust to the idea of being regularly ninja-nutkicked by their own government as a form of therapy. Oh, and if you’re as much of a finance geek as I am, you’ll be delighted to know Warren Buffett’s annual shareholder newsletter is out and quite deservedly slagging off the efficient market hypothesis.

Fighters: The Taipei Times (& Michael Turton) report that America has decided to sell shiny new explody things to Taiwan to counter the large number of shiny new explody things lined up along the Fujian coastline of the PRC. Who knows – perhaps Taiwan’s invasion of the PRC is now merely weeks away from happening. China is responding by implanting electrodes into the brains of pigeons to control them remotely. Missiles, pigeons – where will this military escalation end?

Flat transistors: You’ll be reading a lot just now about some crazy new carbon based transistors that – just like every other idea you’ve ever heard – will revolutionise computing as we know it, for ever. Graphene is actually rather groovy and the story behind the research that went on over the last few years is kind of funny. Basically, Graphene shouldn’t exist. Nano-meter-thick sheets of material (such as the toilet paper found in British public toilets) tend to tear rather easily. Graphene is kind of wibbly shaped though, and not entirely flat, which provides it with structural integrity that makes it fantastically interesting and useful. It has some unusual properties that also allow it to be made into a fast, reliable and low-power transistor at sizes that would be completely unsuitable for Silicon chips. It is so thin, and uses so little power, that it can be easily stacked up into sheets. Electrons don’t seem to scatter in Graphene, so it makes electronic circuits run super fast. And when I say super-fast, I mean, electrons travel at speeds normally only found in the center of collapsed stars or at the beginning of the universe. Great stuff. The future is Graphene, I’m fairly sure.

Anyway, the amusing story. Graphene is just like a single layer of ‘Graphite’, the carbon molecule that your pencils are made from. Some researchers realised that to draw little tiny bits of graphite, you should make a really tiny pencil. They spent tens of millions of dollars developing this ‘nano-pencil’ that could be used – at great time and expense – to draw little areas of Graphene. Then, just as this huge research effort was finally starting to produce some results, some guys at Manchester Uni and Columbia Uni had an idea. They got some bog standard pencil graphite. Then, they stuck some sellotape on it and a thin layer of graphite came off. Then, they stuck other sellotape to the first bit, and an even thinner layer came off. Repeat as necessary till you have single layer Graphite on your sticky tape. Total cost: $0.30. LOL.

However this cheap production method is actually very important in other ways. Current computer processors are made from silicon crystals that are carefully grown at great time and expense, and represent the biggest part of the cost of a computer besides research and development. Sellotape and pencils on the other hand, are plentiful. Anyway, that’s all I’m going to say about Graphene for the moment.

Finally, Frikkin nutcases: “Canada’s ex-defense minister continues to call on governments worldwide to release their extra-terrestrial, UFO-derived technologies for the benefit of mankind. Film at 11.”

“China’s stock market, one of the world’s best-performing bourses, plunged nearly 9 percent on Tuesday as profit-taking by local funds snowballed before a parliament session beginning next week.

“This kind of terrifying fall means the market has become abnormal,” said analyst Chen Huiqin at Huatai Securities, adding that shares could take a while to stabilise even if negative rumours proved false.”

Lessons:

1. Market “professionals” have as much idea of what is about to happen as you or I do, in the short term.

2. “Shit just happens.” This is probably the thing about the stockmarket that most people find hardest to accept. Nassim Taleb’s book, “Fooled by Randomness” (US,UK), does a good job in explaining why people try to ‘explain’ random events.

3. People are batshit crazy. Case in point: A 130% rise in the Chinese stockmarket was so ‘normal’ that it was hardly worth commenting on last year. On the other hand, a mere 8% fall gets widespread media coverage spouting this kind of language:

“This kind of terrifying fall means the market has become abnormal” (Chen Huiqin, Huatai Securities)

Get a grip, Mr Huiqin. 8% is small beans. Your market was abnormal months ago, perhaps even years ago, and you apparently didn’t notice then, so you’re hardly likely to be any better at abnormality-spotting now. And besides, look at famous US crashes – 30-50% drops. That’s more like what I’d call a terrifying fall for anyone relying on the market value of their assets. 8% is merely an exhilerating ride on a harmless rollercoaster.

Mu.

So let’s have a quick dose of reality. Shanghai is a crazy market in a country with at best ‘interesting’ financial regulation. If you’re investing there, then bluntly you’re a gambler who is taking a big risk to begin with – and an 8% smack on the bottom is a very small punishment for a gambler.

The PRC is still a developing economy, and the present asset bubbles there are very obvious. These bubbles, incidentally, are due to several different factors: an extended period of artificially low interest rates… yawn… lax lending policy… zzz…. combined with a trade surplus, high savings rate, and the widespread belief that for some reason, the PRC deserves success because, it, well…. err…. well, it just does, right! And chances of financial mishap be damned.

Anyhoo, here are some pictures that put yesterday into perspective, based on Hong Kong’s Hang Seng index (which is the world-class index most likely to be affected by price changes in Shanghai). These graphs were provided by Yahoo Finance.

The last 5 days in Hong Kong. It looks like the stockmarket is just grinding lower, and lower, and lower, every day! And yesterday is the nail in the coffin! Oh noez! How terriblez!

On this graph, showing the three month view, you can see, the market is in fact much higher than it was in December, or in January when everyone felt optimistic. You can also see there have been lots of 1 day drops like this in the last couple of months, and hardly anybody cared about it then….

And here’s the 5 year view. See how unimportant yesterday was?

A big perk of all this is that you get to see all the witchdoctors and horoscopists crawling out of the woodwork. Here’s one of them. Guess what: if you have 10,000 snake oil salesmen, each predicting different ‘horrible days’ in the market for each year based on their own feverish interpretations of the Da Vinci Code – and if you combine that with a search engine that allows you to pick out the ‘winners’ when something interesting does happen – guess what! You are likely to find some ‘winners’.

Coming up next: I predict it will be a terrible turning point for a major world market, on… emmm… July 19th, 2011, because on that day, there will be a conflict between overlapping MooCow Market Cycles!

Now all I need to do is cross my fingers and wait for people to start Googling for me if something actually happens on that day. And then I’ll be a famous financial pundit, and everyone will want me to explain exactly how MooCow Market Cycles work. Oh, and I’d better remember to use FTSE, NYSE, NASDAQ, NIKKEI and HANG SENG somewhere in this article so that they can find me more easily.

Oh well… even though I have most of my money in the market, I would be delighted to see some further falls – I’m young, so I expect to be buying far more shares than I sell over the next 10 years. And with bubbles in every asset class all around the world, further falls seem very likely indeed…

I’ve received some feedback since I wrote the original article, so I thought I’d follow the article up with a few more thoughts on cheap money & how it affects an economy…

Cheap money

First of all, a question: What do I mean by ‘cheap money’? Historically, interest rates around the world have averaged a little higher than inflation. In other words, if I know that prices of beans, cars, monkeys and so on will be higher in 3 years time, then if I lend you money for 3 years, I will want to get enough money back so that I can still buy at least the same amount of beans, cars, and monkeys in 3 years time. Further, I will want a bit of extra money as a thankyou for accepting the risk you might not pay me back, and for the fact that I have allowed you to make use of my money for 3 years, and for the risk that inflation might have been higher than I expected. So if I say ‘cheap money’, I mean money that is being lent rather freely without too much consideration for:

• Likely or possible levels of inflation over the period of lending.
• Achieving good returns over and above the rate of inflation.
• Risk of default, i.e., when the money doesn’t get paid back.

Does Taiwan have ‘cheap money’?

The long term average for inflation (over most of this century) in most developed economies is around 5%, with short-term interest rates averaging around 7% and long-term mortgage rates around 8-9%*. So typically, people throughout history in stable countries are looking for 2% ‘real’ return over inflation, in exchange for lending their money, and another 1-2% of real return for a riskier longer term loan that is backed up by a house (which can be sold if the borrower stops repaying the loan).

It depends, of course on what you mean by inflation: increases in wages? increases in the average shopping basket cost? increases in the average cost of living?

These measurements bring immediate headaches. Whose wage rises do you consider? Do you take the median or the mean? What is the ‘average shopping basket’ spend each week by someone in Taiwan – how do you measure the average, when the items people buy change so much every year (TVs, computers…)?

So, the first thing we can see is that there is a lot of difficulty in measuring the true rate of inflation. In fact, the situation is even worse because most governments play cunning tricks to confuse consumers, so they don’t ask for such big wage rises.

Take Britain, America and Europe. They don’t include the cost of housing in their inflation figures, because it is ‘too volatile’. That’s right – it makes the inflation graph look all wobbly and difficult to read, so they just leave it out – after all, who owns a house? Instead, nice ‘non-volatile’ items are used, such as hamsters, TVs and so on. Because if there’s one thing the human body needs to survive, it’s hamsters, not a roof over your head. This example is not made up. Around the time the UK dropped housing costs from it’s standard measurement of inflation (when it adopted CPI), it added hamsters. Nice.

Taiwan’s official inflation figure, should we choose to believe it, is currently 2.3% (2005), or 1% (2006)**. With the exchange rate at record lows relative to other currencies (making imports super-expensive), energy prices having gone through the roof, and with house prices having soared relative to a few years ago, frankly this seems not just hard to believe, but literally impossible.

Fortunately, we can choose to be ignorant of such statistics here without damaging the argument. Taiwan’s interest rates are somewhere around 1.5% (best consumer savings rate) and 2.3% (base rate for adjustable rate loans)***. We can immediately ask, is this savings return figure going to be much higher than inflation?

Frankly, there is not much room below 2.5%. Therefore, without knowing anything else besides the savings rate, it is immediately obvious that ‘real’ gains from lending money, that is, the return after inflation, are not likely to be very high.

In fact, unless prices on most goods and assets (property, company shares) are quite obviously either standing still or dropping like a stone from the viewpoint of the average person in the street, real returns on lending are likely to be very close to zero. Money is therefore effectively ‘free to borrow’ from the point of view of the consumer.

Worse, if my beliefs (above) about the current level of inflation in Taiwan are correct, then money is not just free to borrow, the borrower is effectively being ‘paid’ in real terms to take it off the bank’s hands!

We can see that the first checkbox, a very low short-term cost of borrowing is ticked. It is cheap to get your hands on cash here in absolute terms (2.3% is a low number, compared with the historical average rates even in the US or Europe!) and real terms (money is effectively ‘free’ to borrow in real terms, because by the time you repay your loan, the money you repay will buy ‘the same amount of stuff’ as the original loan would have bought).

Is money ‘easy to borrow’ in Taiwan?

From the number of adverts encouraging people to borrow money to finance cars/houses/whatever that can be seen on the TV, on posters, and on the Internet – and from the number of banks that have gone bust in the last few months due to ‘lending to people who don’t bother to pay it back’, I think the answer to this one has to be YES. Borrowing money is not difficult. In fact, I get the impression from my Taiwanese friends, that some savers are so desperate to beat the appauling returns from the bank that they will lend to anyone in their family or circle of friends who says they can turn any kind of profit with it.

I’ll leave this one to the reader to decide for themselves.

So what?

Knowing from our everyday experiences and from the interest rate figure that we have cheap and easy money available, what kind of things can we predict seeing in the economy around us?

• When the ’savings return’ is so low, and the ‘cost of borrowing’ is also low, people will be more inclined to take big risks to try and get better return, by borrowing money and putting it into adventurous financial endeavours. Buying up rental housing is just one example of this behaviour, and it is probably the most obvious form in most countries. But you will see the same effect on the stockmarket (it will be pushed artificially high, as people borrow cheap money to buy shares).

  I haven’t checked this before, so let’s take a look at the Taiwanese stock market.

  Surprise surprise! It has doubled in ‘real terms’, if you believe there has been no inflation, in just 3 years. World stockmarkets usually double in real terms every 14 years. This suggests the stockmarket is rather likely to crash back to where it should be, and perhaps even overshoot, when the ‘cheap money’ is removed from the market and people must repay their loans at higher rates, often by selling back their shares.
  

• Taiwan’s exchange rate should become terrible, as people borrow TWD to buy other currencies with better ‘real interest rate returns’ (and sell their borrowed TWD in the process). This ‘borrow and sell’ process makes TWD ‘worth less’ internationally – since supply for TWD then exceeds demand. It’s known as the ‘carry trade’. This has also happened, though most people involved in the carry trade would pick Japan before Taiwan as a source of borrowings. Only the other day on CNN Asia, I saw one of the heads of HSBC’s subsidiaries saying they were trying to get out of the carry trade, because it is becoming so dominated by crazy retail (i.e. you and me) investors who had no idea what risks they are really taking.
  

• Risk becomes ‘mispriced’ in every sense. People stop worrying about risk as the chase for higher returns on savings becomes their overriding aim. For example: People should try to start up small businesses more often with low interest rates, and they will take less care to make sure the business is a good idea, because the loan seems ‘cheap’ to them at the time.

  I see this all the time here! Businesses start up and go out of business within 1-6 months here constantly. I know Taiwan is an ‘entrepreneurial country’, but what I see is just crazy! Shops with no customers at all, from day 3 onwards.

  When money is at ‘a sensible price’ in terms of the cost and ease of borrowing, you will see a slower rate of new businesses, but they should be more successful because people only take the risk when the idea is very good! Now, all the good ideas are driven out of business by millions of ‘copycats’ who just want to try and beat their savings account… but there aren’t enough customers to go around…
  

• People buy big expensive items because the payments seem cheap. Houses are one example, cars are another. Everyone in Taiwan seems to be driving a luxury car, even in the poorest areas I visit, where there are no jobs. It’s incredible and completely unsustainable. No one has the ‘right’ to a luxury car, including me – it is something you should work hard for a long time to earn. Here, the japanese cars most people drive would cost them around 5-10 years of their savings (or 2-3 years of their full salary before tax)!

  Interestingly, no one seems to be able to pay for the expensive repair the first time a scooter crashes into their car (probably, because that is not available on cheap credit).

However, if the cost of borrowing rises, or it becomes more difficult to borrow money due to bank or government restrictions on lending, then the foundation of these asset bubbles and crazy behaviours erodes quickly.

Are rates likely to rise in Taiwan?

“Governor Perng Fai-nan (彭淮南) said last month that the benchmark rate had yet to reach the “neutral level” where it neither fuels nor curbs inflation and growth, suggesting more rate rises.” ****

And keeping up with the neighbours? 2007: Japanese rates rise, British rates rise, Australian rates rise,New Zealand rates rise, European rates rise, Indian rates rise, PRC to raise rates, and they’re also restricting lending.

In fairness:
Amid a collapsing house market, (22 lenders have gone bust in the last 2 months!) the US is holding rates steady but big banks are restricting lending. After a year of raising rates, Korea is holding rates still, as recession looms over their economy. Indonesia is in a similar situation, with rates up around 10% already. Canada stands still.

However, very few parts of the world are cutting rates, and those that are, have rates around 10% currently; every single country that is holding rates steady has far higher interest rates than Taiwan currently (usually around 5-10%); and most of the ‘biggies’ (Europe, Japan, UK, PRC) are pushing rates upwards.

So what happens?

What I expect to happen is the following, over the next 3 years – not just in Taiwan, but in most countries that have had their rates too low, for too long.

1. Credit cards and car loans can’t be paid back by consumers. Cars and items being taken back by the lender.
   

2. Car dealerships going out of business.
   

3. 10000’s-100000’s small businesses abandoned, as the costs of running them rise quickly and profits fall at the same time (because of reduced spending by consumers struggling to repay loans).
   

4. People really struggling to pay their mortgage. People starting to lose their homes, move back to their parent’s houses, share with friends, or rent instead. Household density increases (slightly more people start living in each house on average) leaving lots of property empty.
   

5. Banks stop lending mortgages to most people, since it has become too high risk.
   

6. The ’surviving’ small businesses starting to do much better from reduced competition after the initial difficulties.
   

7. Collapse of the housing market: house prices halve, or more, relative to the price of other goods.
   

8. Possible collapse of the stockmarket? (maybe – Taiwan’s stock market is export driven and so is being sustained by the weak exchange rate. It really depends on whether the same scenario plays out in the US and Europe).

Item 7 is the most interesting, because a drop in house prices in ‘real’ terms can happen two ways. Either:

(7a) house prices stay the same, and everything else becomes expensive (with very high interest rates), making houses relatively cheap.

(7b) house prices drop, and the price of everything else stays the same (with low interest rates), making houses relatively cheap.

Historically, it is usually (7a) that happens, because governments panic whenever people stop spending money, and governments start spending extra money like crazy or lending it out cheaply via the central bank, to try to get people to spend, spend, spend. Consequently, too many dollars floating around in the economy makes the price of things (measured in dollars) go up, i.e. inflation goes up.

The high interest rates that then appear (as rates rise to keep ahead of inflation) leads to many people struggling to survive.

(7b) would however be extremely interesting to watch. Japan and Germany have both experienced (7b), and it pushed their economies into disaster for 10 years. So, I’m very curious to see how this all turns out in the end…

Mu

Some sources….

* i.e. here, here…

** i.e. CIA factbook,Taipei Times/Bloomberg 2 weeks ago…

*** Bank of Taiwan, 25th Feb 2007.

**** Comments from the governer of Taiwan’s central bank.

I hope he’s paid well.

What on earth could possess a man to undertake such employment? The money behind the housing boom in Taiwan. Personally, I hope this guy is getting a decent hourly wage, because he is doing his job really well. You’d think he’d take a break every now and then, but no, he’s tireless – as long as he stands there, the arrow shall wobble – come hell or high water.

This leads me into my main topic for this post, housing and bubbles. Presently, like most of the world, Taiwan is suffering from a unsustainable housing boom. I know this despite the fact I know almost nothing about Taiwan’s house prices. Like almost every country in the world, Taiwan dropped its interest rates to very low levels a few years back and hasn’t been quick to put them back up. Tada, unsustainable housing boom, the same as in every other country that did it.

Low interest rates mean money is cheap to borrow. If money is ‘cheap’, then people will want more money in exchange for their stuff, i.e., you’ll get inflation and prices will go up. Some of the inflationary side effects of cheap lending have been held back temporarily by a group of factors in many countries; importing low-cost foreign workers (keep wages low); exporting manufacturing to cheap countries to keep costs low (mainland China and India being the main beneficiaries); and continually improving technology and production processes (Taiwan being famous in this regard!).

The simple fact, though, is that houses cannot be made in the PRC or India and shipped to Taiwan. And when money is cheap, demand goes through the roof and supply can’t keep up. Consequently, prices go up, up, up. In the short term, at least. Further, low interest rates over a long period of time eventually force people to look elsewhere besides floating/fixed interest bearing deposits or bonds, as a place for their long-term savings. In other words, low interest rates screw up your long-term retirement saving plans. This in turn fuels further excess demand for housing, as housing mutates rapidly into a mainstream investment option for the masses.

However, house purchases are almost always funded by borrowed money – and whenever interest rates eventually go up again, the cost of that borrowing can rapidly become unsustainable on a large debt. This leads to people defaulting on loans (and forced sales) and also people running for the doors before they are forced to sell (discretionary sales). Further, as the cost of borrowing (interest rates) goes up, housing becomes much less attractive as an investment option as its return (i.e. the rent you get paid as the landlord) remains roughly stagnant compared with the rate of growth in interest rates. Consequently, few new investors in housing will come along. And the economic instability surrounding this period spooks businesses, and puts a freeze on hiring – and that drops the employment rate and means no big payrises. That in turn discourages people from making any big new speculative investments.

So when interest rates go up, a number of pressures on house prices emerge and they all push the cost of housing back down again. You can see this in the US just now, and parts of the UK. You can see this in Japan as well. In fact, the shock of the initial housing collapse in Japan last decade was so severe, that even when money was being literally given away for free (0% interest rates), no one would ever touch housing again, and so house prices continued to decline for 10-15 years.

Given the danger of housing bubbles when they collapse, why on earth would any government allow this to happen – much less every government (UK, USA, Australia, Europe, Japan, Taiwan….)?

It turns out, housing bubbles are more or less a dream come true for most governments.

• Boosts taxes. If your government taxes the estate of a dead person (Inheritance Tax), then boosting the value of the estate boosts the inheritance tax. If you tax property transactions (the buying and selling of houses), tax income goes up during housing booms. If you tax houses each year based on their value, again, tax income rises. If you tax ’short-term capital gains’, then the speed of a housing boom usually ensures higher taxes too. A huge surge in building can lead to higher tax returns from that sector too.
• Boosts employment. “Let’s build some houses, lads!”. Employment makes voters happy; employment brings in more taxes.
• Makes voters happy. There are few things people love more, than to be told that their personal ‘pile of bricks on a piece of dirt’ is worth twice as much as it was last year, and that they are now a millionaire (on paper). Oddly, they will feel ‘rich’ as a result of this, even if they can’t actually move to another house without spending the same amount of money, and even if they are in fact still living in the same crappy pile of bricks they were living in 5 years ago.
  Don’t believe me? Look at the number of leading world politicans who were easily re-elected for a second term in the last 5 years, despite unpopularity on issues such as domestic security, international affairs and spending. UK, USA, Australia, I’m looking at you!
• Solves your pension problems / demographic timebomb. Generally, old people own houses. Young people do not. In order to get a house from someone else, you must pay. Housing bubbles ensure that the flow of money from young people to old people is very high. This can be used to solve the problem of a pension crisis, where the government cannot afford to look after all the old people in the country. Ever noticed how it’s always your grandparents that ask when you’ll be buying a house and settling down? It’s an old-person conspiracy, I assure you =). Unfortunately, this kind of intergenerational wealth transfer rains shit upon the lives of young people, and leaves them trapped in debt with no chance of a better life, and little ability to afford a family. But who (in government) cares? It saves the government from being seen to directly raise tax in order to hand out money to old people, if they can indirectly cause the same flow of funds from young to old.
• Renews dead housing areas. “Wow, it’s a swamp, but apparently it’s magically worth $20,000,000 dollars, simply because the area next to it is ‘worth’ $40,000,000 and isn’t a swamp. Let’s drop some bricks on it and sell some houses, quick!”.
• Easy to make it happen. Simply drop your base rate of interest at your central bank, and magically, you get a housing bubble with very little need to interfere politically or craft cunning laws to make it happen. Best of all, you can feign ignorance of the whole thing! Simply declare your central bank independent then in reality stack it with cronies to do your bidding. Why is it that all the world’s central banks seem to have their key decision makers chosen and frequently swapped around by politicans, I wonder. Independence? Hah.

It brings some problems however.

• Ruins the lives of naive young people If your first action as a young adult is to take on a mortgage that will take 50 years to repay, then you are unlikely to be living a particularly enjoyable life between the age of 25 and 75. There will be no ‘housing ladder’ to move up. With interest rates only likely to go up (or inflation staying low and therefore, limited wage increases), you will be living in the first house you buy for the rest of your life. Consider yourself warned.
• Drops your population. “Honey, do we get a 3 bedroom flat instead of 2 bedroom, or do we have a family?”. You think I’m joking? Ask any young couple you know if they’ve had to push back their plans for a family, or work hours that don’t allow time for a family, as a result of the miraculous ‘housing boom’.
• Causes economic catastrophe when people realise they’ve been tricked. Bubbles seldom burst slowly. Look at the UK housing crash of the last 80s, the initial phases of the Japanese crash of the early 90s, the stockmarket crash of 2001.

Summary: Housing bubbles are a great way for governments to create ‘good feelings’ amongst the public that can ensure re-election effectively. They make economies look great, by sacrificing the hopes and chances of young people on the alter of failed pension provision. The inter-generational transfer of wealth that occurs at the peak of a housing bubble destroys lives on a very long term basis.

Here’s a nice quote to end this post:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” – Ludwig von Mises, Human Action, A Treatise of Economics, Yale University Press, 1949

Like Britain, most of the high street banks in Taiwan pay out effectively nothing on their current accounts, and a pittance on the savings accounts. Current accounts run at 0.1%, and savings accounts often only offer 0.5%.

When I got here, one of the first things I did was try to find some way I could get a better savings rate. It turns out, the best short-term savings account rate (currently around 1.735% in most banks) is based on leaving your money in a ‘time-deposit’ setup, which works as follows…

1. Go to your bank.
2. Wait 15 minutes to get served.
3. Try to explain what an automatically recurring one month floating rate time deposit with reinvested interest is (trust me: it’s best to prepare your mimes and diagrams in advance for this one).
4. Fill in about 10 billion forms transferring the money between yourself and yourself and yourself.
5. Wave goodbye to your money – you won’t be seeing it for a while.
6. Wait 30 days.
7. Profit!!!!

By automatically recurring, I mean that after 30 days, your money (and perhaps also the interest) automatically gets fed back into another 30 day time deposit for the next month, without you having to visit the bank again. This is very important, if you value your will to live.

Bear in mind that withholding tax will still be charged on the interest at 20%, as it is on all bank interest in Taiwan, but that any excess you get charged (over your normal income tax band in Taiwan) can be refunded at the end of the tax year. [Unless you haven't spent over 181 days in Taiwan during the year, in which case, sorry mate, you're paying 20% tax, like it or lump it.]

This time deposit malarky can probably be made to work quite well, if you know the Chinese characters for ‘time deposit’ or have a fluency in Mandarin that I blatantly lack. Particularly so, if you know of a time when the bank won’t have queues to get in your way. However the approach has a few little stings in its tail.

1. If you really need that money, you can get it back – but you lose all the interest you would have gained during the month. And it’s hassle, too, trust me. Basically, they will find it hard to believe that any sane person would choose to give up e.g. $23 of interest they have accrued on paper.
2. If you want to cancel the time deposit, you have to go in on the exact day it ‘loops’ and goes into another 30-day cycle. You can’t say to them “Please make it stop on the 16th”, if it’s only the 15th when you ask. Why, that would be absurd! It would go against everything Taiwan stands for!
3. If you want to get your hands on the money, you will need to visit the bank in person. You can’t control it via the ATM.

Fortunately, Nature abhors the savings vacuum of a banking cartel, and so HSBC (one of the world’s largest banks by assets, operating in 80 or so countries) has stepped in to fill the void with a decent account: HSBC Direct. You may have seen this advertised on TV, in the MRT stations, or elsewhere in Taipei. I must admit I haven’t seen any ads in Taoyuan.

It works as follows:

1. Set up an account. Slightly annoying since they will want to verify your ID a lot of times. However, the staff in branch, on the phone, and on the Internet, uniformly speak EXCELLENT English and are unfailingly polite.
2. Transfer over some money from your normal account using an ATM or in branch. ATM will cost about $15 to send the money, in branch will cost $30. But fear not! HSBC will refund this evil charge up to 3 times! Hurray!
3. Log into the internet and admire your bank balance.
4. For security, you can’t move the money to any other bank accounts. It’s designed to be like a ‘moneybox’ for your main banking accounts rather than a current account. Given the levels of financial fraud here, it’s a smart move by HSBC to be super-paranoid.
5. You get an ATM card in case you need to get your hands on the cash quick and don’t want to transfer out of HSBC and back to your current account.
6. Transfers out of HSBC are free.
7. Interest accrues daily (so you could leave your money in for 3 days, and get a little interest), and is paid at the end of the month.
8. Best of all: they pay a whopping 1.5% interest!

Now, you might think 1.5% is rather crap, but I think it beats 0.1% or 0.5% hands down, particularly when it is effectively just an easy-to-use savings account with ATM card. On 300k of savings it’s a 3-4k bonus per year for doing nowt. I toyed with the idea of a mix of time deposits and HSBC for my needs, but after spending an hour waiting in the queue trying to set up just one time deposit, I just gave up in disgust and figured it wasn’t worth the hassle for 0.2% extra on my money. Besides, I don’t have enough money to make it worth any kind of hassle anyway :)

According to the reps I spoke with, HSBC will be raising the interest rate as other banks raise their rates to keep it very competitive compared with high street banks, so that makes the floating rate aspect of the time deposit less critical too.

HSBC direct also have an excellent English language website and phone service for managing your account. By ‘excellent’, I mean excellent. This aspect alone is worth the 0.2% difference.

A final note on bank transfers. If you transfer over 30k TWD at one time between any bank accounts in Taiwan, you’ll need to take in your ARC or ID card and possibly also your passport. That’s the law. Worth knowing in advance.

Oh, and the free money? Well if you sell your friend’s souls to HSBC by filling out their details on a form to be contacted about HSBC Direct, apparently they’ll give you a bonus $25-30 or something like that per person. I don’t recommend it, though, since your friends may reasonably question your neutrality in recommending HSBC Direct to them, if you’re prepared to sell them out for a poxy 25 kuai.

Anyway: I love the service, and HSBC Direct have in-branch staff specifically to deal with any HSBC Direct issues you may have. I strongly recommend HSBC Direct for your short-medium term savings. Further, unlike the local Taiwanese banks that went out of business last month (really!), HSBC have been around for hundreds of years, comply with international banking standards, have sensible lending criteria and a solid loan book, plenty of assets, and operate globally. All of which suggests that any systematic regional financial problems won’t have much effect on them as it might on other banks – making them a relatively safe haven.

Link: HSBC Direct

Amusing sidenote: It’s almost worth asking about getting a normal HSBC account in the branch, just to see their face go into a weird embarrassed smile. They will politely explain how much money you’re going to need to get that account: $3 million TWD in loose change, never mind your actual investments. Seriously, chaps. Wowsers.