THE BEAR'S LAIR Pockets of rot
By Martin Hutchinson
The collapse of Dubai World is pretty unsurprising; when examined closely, the
Dubai real estate market was always likely to prove a gigantic bubble. It does,
however, raise the question: how many other pockets of rot are around globally,
left over from the cheap money boom of 2003-07 and likely to plunge the world's
markets into gloom by their collapse?
Even at the peak of its fashion allure in 2007-8, Dubai was clearly a market
that had got ahead of itself. Residential mortgages were available at a cost of
7% below the local inflation rate, and were
eagerly snapped up by ignorant expatriates in a sure sign that the local
construction industry was running way ahead of genuine demand.
Bizarre relocation decisions were being taken worldwide. It may have made sense
for Halliburton, the giant oilfield services company, to relocate its chief
executive and headquarters staff to Dubai in March 2007 (though Texas, its
original home, produces a lot more oil). However, it made no sense whatever for
the International Cricket Council (ICC) to move in 2005 to Dubai - a country in
which cricket is played very little, and which, however much it spends on fancy
cricket grounds, lacks the essential of a successful cricket match - spectators
cheering on the local team. The move was undertaken for unsavory tax reasons;
the result, however, has been that the ICC is now completely removed from the
bedrock support of the game, either in Britain, Australia, India or anywhere
else, and so is prone to making increasingly eccentric and damaging decisions
that it imposes on the world's cricketers.
Thus the collapse of the Dubai real estate market is little if any loss to the
global economy, although it causes one to raise further eyebrows at the amounts
of money the world's banks committed to the bubble. HSBC shareholders, in
particular, should ask some tough questions of the bank's management, while
British taxpayers can groan once more in the knowledge that Royal Bank of
Scotland (RBS) management was as capable of running into gigantic losses in
real estate lending abroad as it was at home.
Dubai's problem, and that of several other hidden pockets of rot in the world
economy, was the 14 years and counting of excessively loose monetary policy,
initially in the United States and, from 2000, worldwide. This stimulated
investment in fixed assets far beyond the level required by the world economy.
It also prolonged the life of many uneconomic operations that could be propped
up with easily available money from compliant banks.
It allowed the less-productive areas of the investment banking/brokerage
business to grow to immense size, to the enormous profit of their senior
employees, largely at the expense of everybody else.
Finally, it allowed the establishment of innumerable entrepreneurial ventures,
initially in dot-coms but more recently in clean-tech, that lacked a solid
economic basis and attracted capital purely because of their fashionable sector
and the infinite availability of capital.
These artificial constructs won't last forever. An unneeded building
constructed with cheap money never attracts sufficient tenants and so is
permanently a drain on its owners. An uneconomic business kept open with cheap
money does not generally recover, but becomes more uneconomic, multiplying the
losses when it eventually fails. A trading operation built with cheap money
flourishes fine while money remains cheap, but is forced into enormous losses
and rapid disappearance (like the subprime mortgage securitization business in
2007) once the cheap money dries up. An entrepreneurial business that is
founded primarily with cheap money does not grow into a self-sustaining,
employment-providing venture, but instead limps along sucking in more
resources, always one deal away from viability.
Beyond Dubai, therefore, there are a number of other areas that on closer
inspection appear to be patches of rot that will eventually collapse, causing
immense losses to those involved in them.
One such pocket of rot is undoubtedly China. People have been writing this for
at least a decade and have lost credibility because collapse never happens.
Nevertheless, China, while big enough and opaque enough to hide problems, is
NOT immune to the normal laws of economics. It now bears every sign of a
gigantic jerry-built economic edifice waiting to crumble.
China has had money supply growth in the past year at 28.7%, with the
government now doing 50-year bond issues at 4.4%, far less than the rate of
inflation - both signs of a market in extreme bubble mode. It also has a mass
of uneconomic state industries that have been propped up by the banking system;
a gigantic portfolio of real-estate investment, financed by cheap loans, that
has been built far ahead of demand; casinos in its stock exchanges that are
supporting immensely lucrative but fragile trading operations; and innumerable
entrepreneurial ventures in all sectors of the economy, at least a substantial
percentage of which have to be non-viable.
Having all four types of bubble-created rot (albeit in different degrees),
China must eventually undergo the collapse that is necessary to remove the rot
and restore its long-term growth prospects. That's not to say China isn't the
great growth economy of the 21st century - it probably is - but it has to go
through a truly gigantic financial crash first, before resuming its growth on a
healthier basis, probably at least five to 10 years later.
A second "pocket of rot," quite localized but nevertheless involving a lot of
capital, is the London housing market. US house prices have declined from their
overvalued state in 2006 by about 25% to somewhere near their long-term average
in terms of national earnings (but still have further to go before finally
bottoming, as interest rates rise to a more normal level and subsidies are
removed).
However, the British housing market, which was far more overvalued, with the
average dwelling price being about six times average earnings at the peak
compared with about 4.5 times in the United States, has declined by only about
10% from the peak and has recently rebounded. There is thus no question that
London housing in particular is still far into bubble mode. At some point, the
rot will make itself evident, prices will collapse by close to 50% and huge
losses will result for foolish lenders and speculators, as well as for many
unfortunate over-extended homeowners.
A third "pocket of rot" is Wall Street and the other global trading operations.
These were created partly by misguided financial theories, but more especially
by the ready availability of cheap money for over a decade. Had they been
allowed to collapse in 2008, the world would have been the better for it. As it
was, they were bailed out by unfortunate taxpayers and have proceeded to make
even more money in 2009, as finance has become even cheaper and more available
- at least for rent-seeking trading. Their collapse will probably have to await
the rise in interest rates and withdrawal of liquidity that is the inevitable
denouement of the current commodities bubble.
At that point, the Wall Street houses will demand yet another bailout, claiming
that their tangle of mutual obligations makes them systemically essential and
that they play a vital role in the US and global economies. The answer this
time should be NO; their role has for the past decade been a negative one, and
the parts of it that are genuinely essential can quickly be replicated by
boutique operations staffed by those of their ex-employees that aren't under
indictment.
Finally, there is undoubtedly rot in the green-tech bubble of the past few
years. Quite apart from the question of whether the entire global warming
extravaganza was a gigantic hoax, as now seems possible (probably not entirely,
but its over-inflation certainly was), the companies set up using readily
available pools of over-excited venture capital don't look like ordinary
youthful tech ventures.
Instead of their "footprint" expanding inexorably like Google's until it seems
about to take over the world, it has remained stubbornly modest, with their
margins remaining slender and their revenues heavily dependent on new research
grants from various government "stimuli" and other non-market sources.
That suggests that the oxygen of genuine and explosively expanding demand for
their products and services simply is not there; they will limp along at
marginal profitability as long as the money lasts, but will then collapse
altogether leaving no permanent results other than investor losses and the
wrecked career prospects of their unfortunate ex-employees.
As was the case in 2001-02, the recession of 2008-09, painful though it was,
has been prevented by artificial means from cleansing the rot in the global
economic system. New healthy growth will be very limited indeed until the
cleansing happens, because the rot, being powerful and well-connected, will
tend to suck up the great majority of available capital and other resources.
Its eventual decay and collapse will thus be immensely painful, but is wholly
necessary before healthy economic growth can resume.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)
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