Wednesday Briefs – 7 July 2021

THIS WEEK: Two Scenarios for the Twenties; China – Taiwan; Second Homes.

TWO SCENARIOS FOR THE TWENTIES

The economy is recovering strongly. Productivity is rising again. Corporate profit margins are near all time highs, as are the major stock indices. Technology and health care innovations are accelerating. Space exploration is in a new era. We are at the start of the new “Roaring 20s” that will come after the Covid pandemic as surely as the Roaring 20s followed the Great War and the Great Influenza a hundred years ago. The budget deficit is rising rapidly but per Modern Monetary Theory, it should not matter as long as we are able to issue debt in dollars and at low interest rates. Inflation is tame; its recent spike is transitory or will be offset by rising productivity. The Fed’s balance sheet has expanded but will start to shrink again. After years of polarization, America’s politics seem to be calming down and are full of a better promise. Bright days are ahead.

This at least is the scenario built into many people’s expectations: prosperity, peace, low inflation, benign and effective government. It is prudent however to consider another scenario.

This other less positive scenario is that we have already enjoyed since 2009 a long economic boom and that we have sown during the pandemic the seeds of many problems. On this view, the huge government stimuli will result in inflation that is more than just transitory. When this realization takes hold, Treasury yields will jump and will impact equity prices adversely. A recession in 2022 or 2023 will only make deficits larger and the need for stimuli greater. Innovation will continue at a reasonable pace but many setbacks will delay commercial applications. Politically and culturally, tensions and divisions remain high and will surface again.

Yet a citizen’s (and investor’s) ethos is that America runs on optimism, the kind of optimism that does not dwell on negative scenarios. Something to ponder on the 4th of July.

READ MORE >>> Running of the Bulls… OR >>> This is as good as it gets for the US economy.

CHINA – TAIWAN

After the Chinese government moved to increase its control of Hong Kong, will Taiwan be next? China has made no secret of its intention to reunite Taiwan with the mainland. Demographically, Taiwan’s 23.6 million population is small compared to China’s 1.4 billion. Its $668 billion GDP is similarly dwarfed by the mainland’s $14.3 trillion. These are important disparities but not necessarily determining ones in a conflict that may involve other powers.

An attempt to seize the island by force would lead to complications on every level. The most obvious is that the US could defend Taiwan and that Japan may do the same. The US does not have a security pact with Taiwan but a 2016 Brookings Institution paper noted:

“Reliance on the United States has been the constant element of Taiwan’s security strategy. The Taiwan Relations Act provided Taipei confidence in the United States even after the termination of the U.S.-ROC mutual defense treaty. On the American side of the coin, concern for Taiwan’s security has lasted through several administrations due to the political support Taiwan enjoys in the United States and the knowledge that Asian allies and partners treat Taiwan as a larger litmus test of U.S. resolve. Finally, Beijing was long discouraged from attacking Taiwan because of the risk that capable U.S. armed forces would intervene to protect Taiwan.”

One consequence of an armed conflict would be that China’s trade with the United States, a key factor in China’s economic growth, would come under severe pressure. US firms would relocate their foreign sourcing to other countries, as is indeed already happening. The global economy and its trade relations would be overhauled and redrawn.

READ MORE >>> Will China Invade Taiwan?

SECOND HOMES

The market for vacation homes has experienced a boom since the pandemic. The National Association of Realtors’ 2021 Vacation Home Counties report states that:

“Vacation home sales rose by 16.4% to 310,600 in 2020, outpacing the pace of total existing home sale of 5.6%… Vacation home buyers are more likely to pay all-cash. During January-April 2021, all-cash sales rose to 53% of all vacation home purchases, a higher share compared to less than 50% in past years. In comparison, 22% of all existing-home sales in January-April 2021 were cash sales.”

This has been largely driven by the pandemic (and work from home) and, for the 47% who did not pay all-cash, by very low interest rates. The market now is showing signs of cooling but only in relative terms, meaning that its growth is still healthy but not as strong as in the past year.

Vacation homes and any second homes do not have the same tax advantages when an owner keeps them for personal use (vs. renting them out). The $250,000 deduction ($500,000 for couples) from taxable capital gains only applies to primary residences. Further, when a second home becomes a primary residence, the ability to later use the deduction is limited by some factors such as length of occupancy etc.

New work protocols may turn many second homes into primary residences. And some locations formerly seen as mainly vacation or summer spots will now acquire a year-round work from home population. However, the market for second homes will remain relatively small. NAR estimates vacation home sales at only 6.7% of total existing home sales vs. 5.5% before the pandemic.

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