China Crash 2011 - Part I: The repetition compulsion of central bankers
It’s China’s turn to pop a world-class asset bubble and smash the global economy
• China tried to pop its property bubble once before but the global economic catastrophe caused the US financial crisis aborted the effort in 2008
• This week China re-launched the crash phase of its Greenspan Credit Bubble with Chinese Characteristics
• Watch out for flying bricks
Why don’t central banks, and the governments they front for, ever learn? The only way to prevent macro-economic damage from a collapsed asset bubble is to not allow a bubble to develop in the first place. Once a government takes the path of winning popular favor with the temporary prosperity that’s produced by asset price inflation, there is no easy way out, as Japan re-discovered in the 1990s, the US found out again in the 2000s, and China will experience soon enough. As part of our project to map out the coming decade, this week we investigate the prospect of the collapse of the Greenspan Credit Bubble with Chinese Characteristics.
Monday China embarked anew on a treacherous program of rate hikes to end a property bubble that took root there in 2005.
Here is a game readers can play at home to simulate the genius of a central bank managing an asset bubble down via interest rate hikes.
Find a cinder block and a bungee chord. Place the cinder block on the far end of your kitchen table. Attach one end of the bungee chord to the cinder block and put the other end between your teeth. Kneel down so that your face is level with the tabletop and pull the chord until it is taught.
Now it’s time to begin “tightening” the way central banks try to, bit by bit, to bring an asset bubble to a benign end, or so they believe.
Pull ¼ of an inch. If nothing happens then pull another ¼ inch. If nothing happens then do it again, and again.
Silly game, you’re thinking. A child can see how this will turn out. Sooner or later that concrete brick will sing across the table and smash your face.
As obvious as the outcome might be to a 10-year-old, the brick-in-the-face lesson remains lost on central banks. They must be slow learners because repeat it over and over. Or perhaps there is a common institutional neurosis shared among central banker’s that compels them to repeat the same mistake, to recreate the experience of concrete on teeth.
For years I’ve referred to China’s asset bubble economy as a Greenspan Credit Bubble with Chinese characteristics. This week we find that not only the policies that created China’s bubbles but even the policy responses to attempt to tame them mirror Greenspan’s.
Democracy or dictatorship, credit bubbles buy political favor... while they last
The beauty of a credit bubble is that while they expand both the creditor and the debtor believes they are getting rich. But unless the asset purchased with debt is appreciating, as might a piece of farmland, in fact only one of the two of them is getting richer, the one who holds the loan has an asset on his or her balance sheet. The debtor may increase his or her purchasing power temporarily, but once the cash is spent -- on a car or tuition at a culinary school or a home in the US since 2006 -- all they have left is a depreciating asset and a liability.
After a bubble gets big and fearsome enough, and all of the political benefits have accrued – capital gains tax revenues, high paying appointments to influential political posts such as running Fannie Mae or Freddie Mac, large scale wealth redistribution from debtors to creditors, and so on – and a catastrophic crash looms, first governments attempt to slow a bubble gingerly, such as restricting bank credit and raising taxes on particular classes of capital gains.
But speculators are not discouraged by such half-measures. The specter of marginally higher costs pale beside the dreams of quick riches created by the central bank during years of bubble growth. The speculator believes that the wealth and success they have achieved during the bubble resulted from their own genius, and this misguided view undoes all but the most self-aware of investors in such periods. The idea that excess liquidity and cheap credit were the main sources of their good fortune only occurs only to a small number of those who understand how asset bubbles operate, both economically and politically, as iTulip.com readers have since 1998 when we played the technology bubble until April 2000.
Asset versus wage and commodity price inflation: the central banker’s game
If commodity and wage inflation containment policy is all about managing consumer inflation expectations downwards, then the central bank’s policies that produce asset price inflation, to bribe the middle class into accepting insane levels of income and wealth inequality, is aimed at managing speculators' asset price inflation expectations upwards. Later, affecting an asset bubble policy about-face from encouragement to discouragement is like trying to convince Paris Hilton fans to stop reading her tweets.
The “solution” that the Greenspan Fed devised to quell the technology stock bubble was a program of 25 basis point rate hikes. The theory was that these clearly communicate the central bank’s determination to end the bubble, and cause the speculators to exit the market in an orderly fashion.
The central bankers’ dream is that these tender rate hikes will first slow the bubble, then allow it to deflate gradually to give the macro-economy a soft landing. But that never happens. They believe this despite the evidence that these measures cause the asset bubble to collapse. Every. Single. Time. It’s as predictable as the laws of physics that propel a brick airborne.
The NASDAQ Cinder Block
After six interest rate hike tugs the NASDAQ cinder block flew off the table and smashed the Fed in the face in 2000.
The first five hikes (percent, right hand axis) were quarter point each, just like the Bank of China’s on Monday. The final sixth hike that finally produced the NASDAQ crash starting in Q2 2000 (price, left hand axis) was a full half point just for good measure, nine months after the tightening program began.
Six months later the Fed began unprecedented panic rate cuts from 6% in Feb. 2001 to 1.5% by the end of the year. Many analysts at the time thought it was U.S. 1929 all over again, or maybe 1990 Japan, and a deflation spiral was sure to follow. Within a year, as the FIRE Economy crisis indeed began to spill over into the Productive Economy, median duration of unemployment (weeks, right hand axis) doubled from under six weeks to over 10.
The Housing Bubble Cinder Block
But as it turned out the year 2000 wasn’t 1929. The tech bubble was Greenspan’s warm-up for an even bigger and more macro-economically devastating bubble, the housing bubble. Incredibly, after allowing the housing bubble to grow by ten trillion dollars in fictitious value via asset price inflation, the Fed followed the exact same procedure as before except this time to pull a ten trillion ton brick off the table.
The Fed tugged on interest rates for two years before the housing bubble finally burst and the cinder block went flying. But as we explained in 2004 (See Housing Bubbles Are Not Like Stock Market Bubbles, January 2004), when housing bubbles collapse they don’t pop like stock market bubbles. The process is slow and corrosive, like rust, rather than an sudden like a stock market crash. Bank analyst Chris Whalen can be heard repeating our forecast after the fact six years later.
A stock market crash informs the unfortunate investor of their condition in quarterly stock portfolio statements, but homeowners don't experience their asset price deflation pain until they try to either refinance or sell their home, and that happens over years not quarters. As the realization of losses is gradual, so is the political, legal, and economic fallout. If a stock market crash is a ball of sodium burning up in a bucket of water, and housing bubble crash is pickup truck rusting on the bottom of a lake.
The main reason that the macro-economic damage of a property bubble is far more severe and long lasting than an equity bubble is that property bubbles are debt not equity financed, and a debt is an asset on the balance sheets of the politically protected commercial banking class whereas stocks are owned by a politically diverse group. The losses of banks are pawned off on the taxpayer, and if the taxpayer can't cover it then the nation's balance sheet takes the bad debts on.
This is why, ultimately, private credit risk (See Credit Risk Pollution, April 2006) expresses itself as currency risk, and why we bought gold in 2001.Fourth Currency (Gold) Price Rise Eight Step Thread of Causation:
- Asset bubbles end in
- Financial crises that cause
- Debt deflation that forces
- Governments to deficit-spend to reduce unemployment that results in
- Fiscal crisis that leads to
- Sovereign debt crisis that ends in
- Currency crisis that causes
- Decline in the exchange rate value of the asset bubble host country's currency
In the US case, the reduced equation is:
US asset bubbles + n years = rising gold prices
If we were in Argentina in 2001 instead of in the US we’d have bought US dollars instead of gold, but as the world’s reserve currency is the source of currency risk in the current case, the only place to go to hedge dollar currency risk was into gold. But that still leaves open the question, how will the global currency imbalances work out?
China Crash 2011 – Part II: Do the currency wars end with a bang or a whimper?
For the perspective of an expert who consults to governments worldwide on trade, monetary, and currency policy, I caught up with Michael Hudson in Germany for an interview on Wednesday. His Financial Times editorial on the currency wars appeared the day before. Here’s his take. more... $ubscription
Tulip Select: The Investment Thesis for the Next Cycle™
For a concise, readable summary of iTulip concepts read Eric Janszen's 2010 book The Postcatastrophe Economy: Rebuilding America and Avoiding the Next Bubble.
To receive the iTulip Newsletter/Alerts, Join our FREE Email Mailing List
To join iTulip forum community FREE, click here for how to register.
Copyright © iTulip, Inc. 1998 - 2010 All Rights Reserved
All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Nothing appearing on this website should be considered a recommendation to buy or to sell any security or related financial instrument. iTulip, Inc. is not liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. Full Disclaimer