A Melman Minute — June 10, 2011

Those of us who have been observing and writing about the worlds economic structure for more three decades or more will not likely ever forget the Japanese Miracle. Left for dead following their humiliating defeat in WWII, Japan appeared to be headed for decades or even centuries of troubled times, both socially as well as economically. However, the exact opposite took place. Thanks to technological innovation as well as a highly motivated labor force, the Japanese economy took off with a whoosh and by the mid-1950s, they began to move from triumph to triumph as Japanese goods found wide acceptance in the worlds commercial marketplace.

There were two simultaneous events which took place along with that economic growth. In the first event, their stock market exploded upward in a sustained and breathtaking move from under 1,000 on the Nikkei 225 Index in the 1950s to an astonishing high of 38,957 by year-end 1989. (see chart)

While Japans stock market was moving relentlessly higher, an even more spectacular rally took place inside their real estate market. Real estate pricing moved into a kind of imaginary never-never land which knew only one direction and that was ever-upward. Eventually, real estate in downtown Tokyo was priced in square inches and a growing number of multi-millionaires measured in US Dollars allowed Japanese individuals and companies to buy up real estate, factories, movie corporations and other assets around the world, driving up their prices in turn.

Many observers believed that steadily rising prosperity generated by the combination of Japanese entrepreneurship combined with an enormously productive labour force would never end, but that was not to be the case. With a suddenness and finality which caught virtually everyone by surprise, the Japanese real estate market reversed direction and fell like a stone, evaporating the net worth of multitudes of Japanese real estate holders along the way and finally spilling over into the economy at large.

As can be observed from the chart, action in the Nikkei 225 Index from 1989 through 1992 bore an eerie resemblance to action in the Dow Jones Industrials from 1929 through 1932 and now, more than two decades later, the Nikkei 225 has never its former glory. After tracing out a clear series of declining tops, the Nikkei now stands this morning below 10,000.

We are taking the time to review this bit of monetary history because stories coming out of China are starting to at least take on a tone similar to rumours which ultimately became truths about the true state of the Japanese economy and real estate markets in the late 1980s, that is that they were ready for a fall. The important thing to note, however, is that todays rumours now involve the giant economic nation of CHINA.

There are similarities which should not be over-looked. Like what happened in Japan, the Chinese Miracle has been built on exporting huge quantities of low-priced goods into the Western World, to be followed by steady advances in both quality and quantity. Then, using the income from such manufacturing combined with rising value of their own domestic real estate holdings, Chinese investors have gone around the world buying up assets and industries in foreign lands, and no small part of their ability to make such purchases has originated in the rapidly increasing value of their own domestic real estate holdings.

Therefore, it is a matter of no small importance that word is now leaking out of China that their own real estate bubble may be ready to burst. As the Wall Street Journal put things in an article on Chinese real estate, ...After years of housing prices gone wild, Chinas real estate bubble is starting to deflate. Residential prices are heading downward in some major cities...raising the prospect that the Chinese economy may slow more rapidly than anticipated with profound consequences for global growth. (Our emphasis)

It is not difficult to imagine some of those consequences should the Chinese real estate market truly deflate. Just as we witnessed in America and, to a lesser extent, in Canada, when residential real estate construction shrinks, so goes the economy as the impact of a construction industry contraction spreads across the realms of residential real estate finance, construction employment and appliance manufacturing just to name a few.

Relating to Chinese real estate, if their residential real estate industry goes into free-fall, it would likely have a major impact, for example, on the world of base metals mining as the demand for construction steel, copper tubing and wiring in addition to various metals for appliance manufacturing and infrastructure projects went into sharp decline.

One could also envision that if Chinese real estate holders who have become ultra-wealthy in recent years were suddenly faced with declining net worth, their ability to purchase real estate in favoured foreign markets, such as hot Canadian cities like Vancouver and Toronto would also diminish accordingly.

The article also points out that, ...Local municipalities and provinces depend on rising prices for land sales as well to fund infrastructure projects. In a slightly different sense, we have also seen where declining real estate values have led to a host of problems for American cities and municipalities in the form of revenue shortfalls.

Interestingly enough, we may already be seeing some effects of this developing story as copper prices appear to have hit a technical stone wall above the $4.20 level and we now learn that, Major steelmakers have been consistently cutting their product prices since February.

This is a development which justifies the closest attention and we pledge at The Melman Report to report developments relating to Chinese residential real estate as significant information becomes available.

Clearly, something serious is now beginning to trouble the worlds financial markets as they continue their decline of recent weeks, with the Dow Industrials breaking below the 12,000 level this morning for the first time in many weeks. (see chart)

As of 10:00 AM PDT, financial markets in Canada and the USA continue to trade sharply to the downside with precious and base metals following suit with gold down about $7 to near $1,535, silver off by just under one dollar to near $36.60 per ounce and copper off by six cents to about $4.05 per pound. Mining share indexes are reflecting the declines in metals prices by dropping about 1.5 to 2 percent.

In other markets, the US Dollar is up slightly, crude oil is off by more than $2.00 per barrel and long term interest rates are a little lower on the session.

All quotes US$ unless otherwise indicated.

Next Melman Minute scheduled for Monday, June 13, 2011

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