Replacing China’s Lost Demand is Everything to the Global Economy Now

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Since 2008, China’s boom was fueled by $20 trillion in borrowing and in turn fueled the world’s recovery. Today, China’s bust means a dramatic decline in demand for exports to China. If  China doesn’t come back on line, where is that demand going to come from?

At the port of Long Beach, a near record percentage of containers go back to China empty these days. Commodity exporters, most notably Brazil, have seen a decline in excess of 35% exports to Asia, both Europe’s export engine, Germany, and the US’s export of finished goods and consulting fee income to China in 2015 are down significantly, weighing on industrial companies.

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This is what is ailing Brazil’s Economy

It is now apparent China’s building boom was financed with $trillions of debt that created an unprecedented demand for iron ore, coal, oil, lumber and grains. Commodity producing countries like Brazil, Canada, Australia and Russia boomed as a result. Since 2014 however, things have cooled in China and has resulted in a bust in commodity producing countries.

Only now has it become widely appreciated how dependent on leverage China’s rapid growth was. In only six years, the Chinese increased their total outstanding debt by about 400%.  That is how China’s ghost cities were paid for. But how will the ghost cities repay their debt? That is something the Chinese never discuss and is at the root of the uncertainty about China’s return to growth.

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China’s Debt Grew Faster Than Its Economy

One example of how problematic the bad investment in ghost cities was in the way they were financed. Emerging middle aged, middle class investors valued apartments as rock solid investments that they believed would provide above average returns. Developers sold these projects with income return projections that were very nice. Chinese demand for speculative real estate investments lead to over building and $trillions in suspect debt. It has been estimated that nearly 65 million Chinese apartments are currently empty. Today, small investors are stuck holding grimly on to their money losing empty apartments. They have to continue to simply pay the mortgages hoping for a turn around or that their son will use the apartment as proof of means to woo a wife. The consumption and investment capacity of these middle class investors is now heavily constrained by the burden of supporting their mistake.

For countries like Brazil, Venezuela and South Africa where debt, horrid politics and the crash in the profitability of their exports are all converging, the deepening recessions are increasingly leading them towards default on perhaps $trillions in debt and much of it is priced in ever more expensive dollars. The loss of a Chinese scale demand is the fulcrum of the growing crises in many emerging and developed exporting economies.

China’s boom was also a primary fuel for the US recovery that started over six years ago. The economy’s leading growth industries were meeting rising Chinese demand. As a result investment in manufacturing and energy, created 30% of the good jobs during the recovery. Both industries were the biggest beneficiaries of China’s burgeoning demand and now are seeing the most damage from the Chinese bust.

2016 is the year that global economic activity and demand must restart or a credit bust will begin to spread across commodity dependent emerging market economies. Where and how growth returns is not at all certain at this time, but given China’s huge debts and malinvestments in properties, it doesn’t seem likely they will lead the next upturn.

There are candidates to help lead a growth cycle and they are also in Asia. Let’s see if Indonesia, Malaysia and India can help turn this around.

 

Related Article:

China’s “Ghost Capitol Building” Has Been Overrun By Vagrant Food Vendors: by Tyler Durden

 

China Surprises with a Devaluation of Its Currency

What it means. How It Affects Your Money.

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China’s Devaluation Signals Important Trend

On August 17th, China announced a downward revaluation of the Yuan. The world seems very  concerned. While the US economy is doing about the same as it has been the last few years, the reality is the global economy is under a lot of pressure. Currencies are falling, recessions are breaking out and US export industries are already suffering.

Now China, which is number two in the world,  has taken the surprise measure of devaluation which can only mean they are under pressure too.

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Currency War Fears Over Yuan Devaluation: Reuters. How other countries are effected.

Surprisingly, China isn’t the cheapest place to make things anymore. In fact, right now labor in Mexico and a host of other countries  is cheaper than in China. Slowing economies and rising competition have caused China’s exports to decline 8% since last year. One remedy is to devalue their currency like so many other have.

How does a devaluation help their economy grow? If a Chinese worker is paid 10 yuan/hour that is $6.20. If the yuan should fall 10% against the dollar, that 10 yuan/hour worker now costs $5.58/hour lowering the cost of their products. By devaluing, the Chinese hope to sell for lower prices and beat out Vietnam and Mexico for export business.

China’s devaluation was a surprise,  but devaluations are common these days. Why in just the last year, both the Japanese yen and the Euro have devalued at least 15% vs. the dollar. But that’s not all. Many emerging countries’ currencies are at or near record lows and falling.

The world is worried that China will buy less and try to sell more. China is the second largest economy in the world now and its impact is very large. It is said that in the last 15 years China used more concrete than the United States did in the 20th century. It has been China’s huge demand for commodities and goods since the financial crisis that has had the most positive affect on the world economy. That is reversing.

Recent competition from  emerging countries with lower wages than China and the resultant drop in exports has forced it to devalue the Yuan. In turn others will be forced to devalue even more. Within hours of China’s announcement, Vietnam allowed their currency to devalue for the third time this year. If currencies are in competition to chase each other down, you may ask down to where? Well that is a good question.

The Good and Bad for the US

For Americans, in the near term at least, devaluations mean prices for imported goods and commodities will fall and a dollar will go further.  Now that China has joined the currency devaluation club, we may even see negative inflation for a time. Remember, exporting countries are competing for the same business. They may continue to devalue further and further to win business.

The stuff we buy at Target may get a little cheaper. This sounds great but there are two downsides. China and most everyone else isn’t going to be buying as much equipment, food or Harleys from us going forward. Our products are getting more expensive for them. Some people here will lose their jobs because of fewer exports.

International trade is going to pressure wages in the US as most of the world’s currencies are devaluing against the dollar and as a result their wages are falling in terms of dollars. In fact, increasingly this process is pressuring wages and business everywhere from Europe to Asia to Latin America, from Spain to Singapore.

Falling Currencies Have Triggered Defaults and Financial Crises Before

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The devaluations are increasing the risk of a debt crisis . Many commodity producing emerging economies, such as Brazil, Venezuela and South Africa, are falling into recessions and deficits and are particularly vulnerable. Commodities are at 15 year lows.  Brazil, a very large country, is particularly concerning. It has borrowed $billions to host the World Cup last year and the coming Summer Olympics. It isn’t being discussed in the media but this huge country’s reliance on commodity exports is killing them now.  They have both huge debts to pay in a back drop of huge economic and political problems.

Global Borrowings in Dollars is a Risk Now

Which brings up an important issue.  Emerging countries have accumulated record debts over the past 10 years and much of this has been borrowed in dollars, not their own currency. Devaluations mean  paying these debts is becoming more difficult.

Emerging economy recessions often do create crises. In 1997, Thailand’s currency crashed and subsequently a debt crisis broke out across Asia. Twelve months later, the crisis found its way to the US and the Federal Reserve had to intervene as a huge fund defaulted in New York threatening the entire financial system.

This time emerging market countries have about three times more debt than in 1997 and the majority of it is due in dollars. Having to repay debt in dollars isn’t a good thing right now. Remember many countries’ currencies are at or are nearing record lows. That means it takes more and more Thai Baht, Brazilian Reals or South African Rand to buy a dollar. The value of those countries debts is increasing as the dollar increases. Unfortunately, this is happening as their economies fall into recessions.

The Global Economy Seems More and More Important

The pressure globally on currencies, prices, wages and foreign economies does and will affect us in some good ways but potentially very bad ways as well. China is the world’s second largest economy and their announcement that they too want to devalue their currency shows they are worried about their own economy more than was expected. Most importantly, it accelerates the competition to devalue which in turn makes debts borrowed in dollars harder to repay.

We are one global super interconnected financial system now and how low is low enough for many currencies is yet to be seen and the consequences considered.

Wealth Building Secrets of Middle Class Millionaires: A Financial Analysis

Can This Family Really Afford This Lifestyle?

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In comfortable middle class neighborhoods across America there are families that are just getting by and those that are more than financially secure. The view of their lives from the street probably can’t tell you much. The attractiveness of their homes and the cachet of the autos in their driveway may not be an accurate representation of their wealth. In fact, middle class neighborhoods very often consist of families that are multi-millionaires, while others are carrying a lot of debt and have little equity. Surprisingly, you may not be able to tell which is which from the outside.

Unexpectedly, middle class millionaires are often not super high earners. They can be public employees, Main Street business owners and technicians. Outward appearances are misleading. Financial decisions often determine financial success more than huge earnings. Saving and investment are critical to middle class wealth accumulation.

John and Joan Anderson are in their mid 50’s and have a modest income of $125,000 a year. She is a teacher and he is a contractor. They are careful with their money and despite appearances, they are self-made millionaires.

The Andersons drive late model but paid for vehicles. Their home is nicely kept and typical for their neighborhood. John is a contractor so the upkeep and upgrades on their home were done without loans or great expense. They don’t hire lawn services or pet sitters. They avoid extra expenses like storage units, security services and house cleaners. They live well but without frills.

The couple saves money in many ways large and small. Her health benefits from the school help their budget a lot because John is self-employed and health care costs are very high for small businesses. John and Joan are masters at do-it-yourself and save a lot on home maintenance. Monthly bills add up so they have cut out the extras in their monthly outlays for cable and cell phones down to what they need. Their utility bills are reasonable; they have insulated their house well and use a programmable thermostat.

Consistent and sensible investors, the Andersons have three apartments from which they plow the rent back in to pay off the properties. With the kids done with school, they now invest about $25,000 a year in their retirement plans. The value of his SEP and her 401k is already over $430,000 and the equity in their investment properties is $300,000. The equity in their home is $250,000. They have almost $1 million of equity in just these three categories. They are modest people but they are already worth a $million.

10 years from now they will be able to retire with multiple sources of income. Her pension and their social security benefits should payout about $85,000 a year. Income from their properties will net them about $25,000 a year. Finally, income from their IRA’s should comfortably provide them with $40,000 a year. Yes, that is more income than they have now. But they are happy living on much less than all that.

Conspicuous consumption has the appearance of success. Ironically, in the middle class it very often undermines success. The luxury SUV in one driveway may announce success, but if it is leased, this status symbol is an expensive monthly liability. Buying new cars and holding on to them for 10 years or more, easily saves a family with two cars $6,000 a year over leasing. The choice is starker still when you take into account how they need to earn about $10,000 before taxes to carry that extra leasing expense. Most of that could have been deposited into a retirement plan.

The question is; does the family with high status cars really have the huge income required to spend many thousands a year leasing luxury vehicles and still build equity in their investments and home? It’s too bad but the irony is so often the people, who live most like millionaires, are less likely to become one than others in the same neighborhood who spend carefully and invest steadily.

Can you think who might be the middle class millionaires in your neighborhood?

Social Security: Waiting Until Later is Like Getting a Second Pension

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Susan Kasik is an office manager and will be 62 soon. She is considering retiring. Susan is healthy and ok with her job, but she just wonders if she can move on now to a life of days doing whatever she likes and nice vacations.

But Susan will probably live a really long time. Her statistical life expectancy is 85 years. Half of women her age will live longer. Being healthy and relatively affluent, Susan is particularly likely to exceed the average. Does she have the financial resources to live 30 more years in retirement?

At 62 Susan can begin to take Social Security but should she wait? She has an IRA that is over $500,000 and no mortgage, but Social Security will be an important part of her income and financial security. Lets look at how much more Susan gets if she waits to retire at age 70 when she can get the maximum benefit.

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Waiting to 70 Pays an Additional Benefit: It is like Having an Extra Pension

The extra $1,132 a month Susan will get amounts to $13,584 a year. She would need another IRA account with $250,000 in it to get that kind of income if she doesn’t wait. The Best part; this is a real diversification from stocks and bonds that she doesn’t have to manage or do anything sbout.

*Illistration is Hypothetical. After age 80, Susan will have received more in total benefits by waiting until 70. By the age of 95, she will have received $196,222 more than if she had begun to draw at age 62.

Ultra Low Interest Rates Have Hurt Retired Investors

Investors are increasingly focused on the task of finding retirement income. Sadly since 2009, one and two year CD’s have earned much less than 1% a year. On the other hand, inflation has been over 2% a year. The result has been a significant loss of principle as many retirees have had to cash in their CD’s to make up for the income shortfall. Since 2009, most CD’s have lost 6-10% of their purchasing value to inflation.

In this graphic, CD rates have been under the black line (inflation) most of the time since 2002.

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Many income investors have responded to the failure of CD’s in this ultra low interest rate world by investing in diversified income portfolios. Diversification smooths price fluctuations and puts money to work in places that provide income and sometimes appreciation as well. These portfolios are generating income above the rate of inflation and preserving purchasing power but they don’t have the fixed price guarantee of a CD. That is the tradeoff. Fluctuating account value with sufficient income or fixed account value with insufficient income.
It is believed by many respected analysts that in the next few years inflation is very likely to make a return. Income investors should be positioned for that. Diversified income investing can offer solutions should interest rates and inflation begin rising and can even look to profit from it. On the other hand, CD investors will have to keep investing short term in ultra-low interest rates until rates get higher. That means more of the same slow loss of purchasing power and draws on principle.