Eric Basmajian, macroeconomic expert, and the founder of EPB Macro Research, returned to the ETF Think Tank recently to offer up his current take on the global economic landscape. With inflation rates elevated, the Fed looking to begin acting on its tapering plans and the latest unrest in the Chinese real estate market, his opinions come at a very opportune time.
The conversation started with a review of the events that have occurred over the past couple weeks. Basmajian sets the table by explaining that we were in a global industrial upturn earlier this year, but growth began to dip as inflation rates rose. As real income growth falls, there are a lot of knock-off effects. Since April, growth has been decreasing and, while many assume it hits a floor where it bottoms out, in reality we don’t know where it’s going to stop. The markets started to adjust to this and we saw a rotation into safety and quality. This week, the Fed came in slightly hawkish and interest rates adjusted upward accordingly.
Not surprisingly, the events in China came up early and often. Basmajian notes that the real estate sector has been the primary driver of cyclical changes, but changes need to happen in order make the sector more sustainable. We need to see slower growth because the country has gotten ahead of itself in terms of construction. China may be experiencing 6% GDP growth, but if they’re building hundreds of empty buildings, you run the risk of severely negative GDP and inflationary impacts. If one looks 3-5 years out in the future and those apartments aren’t sold, you’ve got a disinflationary pulse in the economy. China is in a difficult spot today trying to sustain high economic growth with the background of low population growth. It may take 6-8 years for this entire story to play out.
Basmajian also sees structural problems on the labor front. He mentions the positive wage growth data we’ve seen recently but emphasizes that these are nominal figures. If nominal wages rise by 4%, but inflation is 5%, there’s no wage growth there and people are actually losing purchasing power. Nominal wages won’t be able to deviate much from nominal GDP growth and, given the amount of labor sitting on the sidelines today, we need to increase productivity to make up that gap. Higher productivity requires capital investment and we’re not seeing a lot of that today. The economy is attempting to grow GDP with fewer people, and we haven’t yet figured out what to do with that pool of unused labor. Currently, they’re being supported by government transfer payments, but over time that weighs on productivity.
The idea of high rent inflation impacting overall inflation rates has been a popular topic lately. Basmajian says that people assume if rent inflation is high then overall inflation will likely get out of control. That may or may not be true and he emphasizes that it’s important to understand all components of those CPI numbers. In the current environment, it turns out that it’s actually durable goods driving higher inflation for a few reasons. Supply chain issues are the obvious one, but it’s also because consumers were directing their discretionary spending towards physical purchases since the services-related opportunities were closed during the pandemic. An inflation analysis is not useful by looking at just one component.
How does the arrival of institutional buyers, such as BlackRock, entering the single-family housing market impact the sector as a whole? Basmajian thinks that it will compress the rate of return potential for that asset class. Institutional buyers have specific advantages, such as access to capital and lending rates, that many retail buyers don’t. If real estate, as a hypothetical example, offered an 8-9% return potential before, residential real estate may only return 3-4%. It’s just another asset class that’s been financialized and it’s going to drive the rates of return down.
As a final note, Basmajian reiterated his stance that stimulus payments usually provide a short-term boost but tend to be a long-term drag on the economy. If the government were able to find a way to curb spending, it’s the opposite that could actually be true. The government tends to layer on debt in order to cover up past unproductive debt and that eventually turns into a vicious cycle that hampers growth and puts disinflationary pressure on the economy. China may need to do that in the short-term if the real estate sector goes south, but any economy that overspends is at risk.
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