In the Belgian news today: new apartments in Belgium drop 15% in price by the end of 2008.
Only 2 weeks ago De Morgen was still wirting that Belgian real estate prices were growing fastest in Europe, or how deceivingly inaccurate the Belgian mainstream press is.
I’ve been writing for the last months about the deflationary hurricane that is coming towards Europe, the United States and even South Africa.
Surprised to read deflation, while all the newspapers and politicians are screaming inflation?
Let’s define inflation; dictionary.com defines inflation as:
“A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services.”
Mind the "caused by". The problem with these “because of” definitions is that you don’t know why prices are rising or falling. Example: is there any way to decide what % of the increase in the price of oil (or any other product) was "caused by an increase in available currency and credit beyond the proportion of available goods and services"? The answer is no, of course.
The proper economical definition of inflation is:
“a net expansion of money supply and credit”, while deflation is the opposite.
In this perspective, the Brazilian inflation of 6,2% (projected yearend inflation) is a real inflation; the credit expansion is there and the Brazilian central bank is cooling it off by crunching the credit supply with higher interest rates.
Still, over the last years of growth, credit has remained much crunched in Brazil, the country still has the highest real interest rate in the world, after Turkey. And this is a good thing. This in sharp contrast the South African credit glut of the last decade. And this is where Brazil and South Africa diverge, a lot. The real interest rate (Money market interest rate – inflation) remains relatively stable in Brazil. In South Africa the real interest rate is increasing, rapidly. Which means that the deflation hurricanes are hitting the South African borders. In South Africa, as in the US, the weak South African Rand and US dollar have been masking deflation, this in sharp contract with Brazil, where the Real has been one (if not the) best performing currency of the last years, even at the moment of writing this article.
Everyone has been screaming ‘peak oil’ and ‘bond bubbles’ in South Africa, Europe and the US, while missing the more important point of the deflationary forces of foreclosures, bankruptcies and massive write downs in credits.
Exaggerating? You wish, quoting Standard Bank in South Africa -dated end June-:
"Lower house prices are expected as the credit crunch starts to have an effect, according to South Africa's Standard Bank. In 2005 South Africa was one of the fastest growing property markets in the world. But now analysts believe recent overvaluation means it cannot go unaffected by global economic conditions. We anticipate a large decline in demand for residential property as we enter a period of national house price deflation which we see as a correction in house prices to more plausible levels", a spokesman said.
I have been writing since September 2007 on this upcoming financial change, Q4 2007 was the first quarter decline of asset backed securities in the US. Since then more than 225 billion US$ went from the asset sheets into the loan tables of US banks.
And guess what, this massive contraction hasn’t stopped yet, we now have a year-on-year decline curve and I don’t expect to see this change any soon. This means that the credit crunch is not coming to an end either.
Today in South Africa, lenders are paying well above market rates to lend money. Most South African banks are offering 250 basis points or more above treasury rates. On a percentage basis, this is an enormous spread. And expect this spread to widen further. In a credit crunch, junk yields should rise, and they are (in SA, the US and starting in EU); in a credit crunch lending standards will tighten, and they are. In a credit crunch lenders will say not to almost everyone and they are (certainly in SA). Expect the South African bank to do another rate hike this august, which will bring the SA prime interest rate above 16%. When you read this excellent article on the 3,5 Income versus property price (hat tip, Vincent), you understand that this next rate hike will kick start a true deflationary spiral effect on SA real estate prices. The deflationary spiral in SA (and Europe) is only starting, Q3 2009 is the moment to go in and buy. Until then: hold in to your Money Market accounts or rent out your apartments/houses. In Europe the renting road can be bumpy though. Look to Belgium: the politicians are well aware of the flood of people who will be turning to the rental market and the lobby machine to make sure rental prices remain contained is already white hot.
Why would Brazil be any different, you ask? I’ve written extensively on the macro economical differences of Brazil. Never forget the country in itself is a huge internal market, in contrast to South Africa. Just read this excellent Reuters article of last weekend on Brazilian millionaires. True, a commodity crash would impact Brazil. Yet, today only 16% of the GDP of the country depends of exports.
But all this of a lesser importance compared to the fact that Brazil only has a real estate financing of 2% of its GDP. 
In Belgium and the US, this figure is today more than 70% of the GDP and in South Africa the figure must be also well above 50%.
This is where Brazil differs from South Africa, Europe and the US: the country knows what ‘peak credit’ is, whereas in Europe, the US and South Africa we have lived in an insane ‘leveraged world’ during the last decades and this world is now coming to an end. Don’t think this is just another cyclical crisis we are having; this is ‘peak credit’, worse than ‘peak oil’. This is why a real estate crisis is far less plausible in Brazil, only a tiny amount of the GDP of the country has been based on ‘leveraged real estate’ which means that a contraction of the money supply would not result in a deflation.
The uncertainty factor of Brazil is of a different kind: all the above leads to the Brazilian Real becoming so strong that the Brazilian government might decide to devaluate the currency and for example peg it to a basket of Asian currencies. Anyway, the effect would never be of such a magnitude of the 40% devaluation of the South African Rand against the Euro since February 2006. If you foresee, you can act.
