AS YOU’VE PROBABLY NOTICED, we are in an asset bubble and have been for some time. With interest rates on the floor and investors desperate for yield, folk have been able to make risk-free profits using banks’ almost free money to buy bonds and shares and houses and flats…and sit back and marvel at their brilliance as their prices go up.
So, oddly enough, as the free money has continued to pour out, the prices of bonds and shares and houses and flats have continued to go up, allowing more and more waves of risk-free profits to be taken, politicians and central bankers to claim they’ve found the path to risk-free economic growth, and a generation to think they’ve gotten rich—and to party hard on the rich profits they’ve made.
But there is a problem.
What grows economic wealth -- what drives real economic production, what pays real wages, what makes innovation possible – is capital. When capital grows, real economic wealth grows. When it diminishes, so too does real wealth, and real wages. Like a farmer conserving his seed corn and using it to plant a bigger harvest next years, capital is produced production that makes the production of each subsequent economic period possible. So like a farmer’s seed corn, capital needs to be reproduced in greater quantities each period to make each subsequent production period even greater.
So here’s the problem: we haven’t been growing capital, we’ve been consuming it.
We’ve been eating our seed corn. And we think it’s been making us rich.
MAYBE YOU’VE BEEN AWARE of this fairly major problem, but possibly not: Asset bubbles, as a rule, tend to consume capital.
It turns out all that free money wasn’t free after all.
A bull market whose rising asset prices are driven by cheap credit – by the counterfeit capital emitted by the banking system --overseen by central banks driving a low-interest-rate policy—tends to create illusory wealth, and to consume real resources.
Here’s one way, explains Keith Weiner:
Common sense tells us that it should be impossible to consume without first producing something… The falling-rate-driven bull market is a process of converting [real resources] into your income.
Nice, huh. Here’s how it works:
Suppose Jennifer buys a house for a million bucks. If she pays cash, this is a large chunk of her life savings or inheritance. If she borrows to buy it, then she’s disbursing someone else’s savings… Jen forks over this cash to the seller, David. Dave recovers his original cost to buy the asset, say six hundred grand. The rest, say four hundred, is profit. He goes out and uses much of the profit to buy a Ferrari, drink a 1983 Bordeaux, and dine on beluga caviar.
NOTICE THAT NOTHING IN SUM is produced here. Instead, real resources are transformed into a Ferrari, a 1983 Bordeaux, and large helpings of beluga caviar, which are rapidly and enthusiastically consumed. Dave is then free to repeat the process immediately, as is Jen in a few short years (or, the way Auckland prices have ben going, just months.)
Charles Ponzi is now infamous for having promoted a scheme, where people who buy in later are enabling the earlier participants to cash out with profits. Such schemes can’t go on forever, because they are cannibalising the participants. They do not generate real profits by increasing production. There are mere transfers, converting the wealth of some into the income of others. Ponzi had nothing on the [central banks], with [their] endless bond bull market, speculation, and capital destruction. Don’t blame Jennifer or David. Blame the [central banks and their] perverse game, wherein people destroy capital.
Here’s Patti Smith:
- “We all like to talk about grand business ideas after a few drinks. But too many great business ideas are never even tried. They remain just a dimly remembered conversation or — at best — a business plan saved in a .doc file that hasn’t been opened in years… Why invest in a risky business when you can get huge returns by just owning a flat?”
How falling house prices could end up making us rich – Jason Murphy, NEWS.COM.AU [hat tip Francis McRae]
- “With artificial stimulus like ZIRP, we only end up with a situation in which governments, financial institutions, entrepreneurs, and consumers who should actually be declared insolvent all remain on artificial life support.
”In line with Bastiat’s thoughts, numerous fatal long-term consequences of zero-interest-rate policies can be identified, but are generally ignored…”
The Unseen Consequences of Zero-Interest-Rate Policy – NOT PC
- “Fundamentally, demand is desire backed by wherewithal. And where do you think most of the wherewithal comes to buy a house? I’ll give you a clue: we have a system in which debt is organised into currency. A system run by the Reserve Bank. So while the Reserve Bank looks around all wide-eyed blaming others for “the demand problem,” currency is being borrowed into existence at breakneck pace, a very, very large proportion of which is going into New Zealand housing …”
Housing: It’s basically unintended consequences all the way down – NOT PC
- “Artificially low interest makes it necessary to seek other ways to make money. Deprived of a decent yield, people are encouraged (pushed, really) to go speculating. And so the juice in bonds spills over into other markets.
How Do People Destroy Capital? – Keith Weiner, SNBCHF.COM
- “In a healthy economy, markets should go up on good news and down on bad news. But markets aren’t healthy today. They’re addicted to easy money. In this “Alice in Wonderland” economy, good news is bad news…”
Why Higher Rates Could Kill the Bull Market in Stocks – CASEY DAILY DISPATCH