China's Real Estate Bubble

I'd say China's growth is unsustainable. There are indications.

The popping of China's current housing bubble -- considered inevitable by regional experts such as Andy Xie -- could have widespread consequences. If housing turns down in China, China's growth could slow or even decline. And since the entire world is looking to China to lead global growth, then that could spell major trouble for the "global economy is recovering" story.

The reflation of China's real estate bubble has a number of causes, and the most obvious one is that nation's stupendous $586 billion stimulus, which was packaged with efforts to promote real estate lending and development to boost growth. According to China's central bank, new home mortgages in the first nine months were quadruple the amount borrowed a year earlier.

In terms of GDP -- China's GDP is $3.3 trillion compared to $13.8 trillion for the U.S .-- China's $586 billion stimulus is three times as large as America's $787 billion stimulus. China's stimulus spending is a heart-pounding 17.8% of their GDP, as opposed to America's comparatively modest 5.7% of GDP.

I can't see this turning out well. Of course China has large reserves of other country's currencies. And if they spend it all? Then what?

The China Bubble

When it comes to China everyone who is even slighly familiar with their financial problems is waiting for the first shoe to drop.

Imagine that your local city and county controlled all land rights, and the only ownership a private builder or developer could secure was a long-term lease. Now imagine that 40% of the city and county's revenues come from the lease fees paid by developers. Next, imagine a giant real estate bubble has priced most residents out of the market, and that the local governments are reaping huge gains as the development rights and leases they sell are skyrocketing.

Can you say conflict of interest?

That's the Chinese real estate dynamic in a nutshell. Local governments have every incentive to push lease prices higher, further fueling China's real estate bubble, and zero incentive to build low-cost housing for the average citizen

Our problems in America stem from the opposite impulse. Getting low income people into houses. But the fundamental impulse is the same: government can distort markets in ways that will benefit the country. No it can't.

Here is another parallel to the current economic problems in the US.

"With access to almost unlimited no-cost credit from the state-controlled banking system," he wrote, "these behemoths have abused their financial clout and plunged headlong into the real estate market, snapping up high-priced land and investing in high-end residential housing units that now sit empty across the country."

Once you understand this dynamic, it's not difficult to see why China's housing bubble will end badly. Local governments are so heavily dependent on development fees and taxes for their revenues that any fallback in new development will spell catastrophe for city and regional government budgets.

Who will lose when the bubble inevitably deflates?

Residents will suffer because government services will have to be slashed as revenues from development fees collapse.

The Chinese investors who overpaid for grossly inflated luxury condos will suffer massive losses, developers dependent on a fast-rising bubble market will go bust, and somebody will end up covering the losses as bankrupt developers renege on their loans.

Since most of the loans came from government-owned banks, then that "somebody" will be the Chinese taxpayer. Sound familiar?

Yes it does. Here in the US we can name names. Fannie Mae. Freddie Mac. Barney Frank. Chris Dodd. And don't forget Senator ∅bama.

And then there is this effort by China to meet energy saving targets.

BEIJING (AP) - Chinese steel mills and mobile phone factories are being idled and thousands of homes in one area are doing without electricity as local governments order power cuts to meet energy-saving targets set by Beijing.

Rolling blackouts and enforced power cuts are affecting key industrial areas. The prosperous eastern city of Taizhou turned off street lights and ordered hotels and shopping malls to cut power use. In Anping County southwest of Beijing, an area known as China's wire-manufacturing capital, thousands of factories and homes have endured daylong blackouts over the past two weeks.

"We can't meet deadlines for some orders and will have to pay penalties," said Han Hongmai, general manager of Anping's Jintai Metal Wire Co. "At home we can't use the toilet" on blackout days due to lack of power for water pumps, he said.

While the U.S. and Europe struggle with flagging economies, the power outages are symptomatic of China's torrid growth and officials' capricious use of their powers to meet the authoritarian government's goals.

China's economic expansion, which hit 10.3 percent in the latest quarter, blew holes in government efforts to curb surging energy demand, pollution and emissions of climate-changing greenhouse gases. Beijing told local leaders to clamp down and stepped up pressure by sending inspectors to see the order was carried out.

Curbing the production of plant food (AKA greenhouse gases) is an economy killer. Fortunately we live in a free country where Present ∅bama has promised to make the price of electrical energy skyrocket. Different method. Same result.

When the US has problems similar to the problems of a country run by Communist Dictators you know we are in a world of hurt. For the same reason. Central planning is an economy killer. We do have an advantage though. We can vote the bums out.

See you in November.

Cross Posted at Classical Values

China Is Bubbling

It looks like real estate in China is going through a massive bubble. It is still on the upswing side.

We don’t really have a view on when it will end; [but] we do have a view that this is a bubble. Real estate is very much driven by government policy. This year we have RMB 4 trillion through the stimulus package, another RMB 6 trillion from municipal bonds, another RMB 10 trillion from bank loans. We have RMB 20 trillion in the system and it all finds its way to real estate. If the government next year decides to continue the relaxed monetary policy the market will continue like this, regardless of whether this is wasteful investment or not — people will still buy and we will still be building and selling.

These buildings are not fully occupied and people should be worried about it. I am sure the government is worried about it, but what do you do, they want the stimulus and if you want to create jobs then this is a by-product.

And how much is that worth In $US?

Not to detract from her point, but I should note that I tally the total influx of funds somewhat differently. I think she is double-counting the RMB 4 trillion government stimulus, which was funded half by bank lending and half by municipal bonds. The combined figure, as I calculate it, is more like RMB 16 trillion, or US$2.4 trillion.

So how much is that in US dollars?

BEIJING -- China's economy expanded by 6.1 percent year-on-year in the first quarter of 2009, official data showed Thursday.

The quarterly growth was the slowest in the past 10 years as the global financial crisis continued to affect the world's fastest-growing economy. It was 4.5 percentage points lower than the first quarter of 2008 and down 0.7 percentage points from the previous quarter.

Gross domestic product (GDP) reached 6.5745 trillion yuan ($939 billion) in the first quarter, Ma Jiantang, director of the National Bureau of Statistics (NBS), told a press conference.

Since the numbers are never as precise as the figures show, let us say that it is $3.8 trillion. And a $2.4 trillion stimulus represents 63% of the GDP. That is a lot. The Chinese can pay for most of it in cash. But that leaves them vulnerable to the next shock in the market place.

So how about an anecdote? Here is one from March 2009.

Today I visited Beijing’s most stunningly dysfunctional, catastrophic mall, called The Place, and all I could think about was what I wrote back in 2006. Made to look kind of like Versailles on the outside, The Place is an irrational maze of stores and eateries that seems to have been designed to turn off and turn away customers. It has stairways that lead nowhere, unmarked elevators that take you to surprising places, not to mention a generally chintzy feeling created by all the faux marble and Grecian columns; it always looked pompous, but now it’s looking seedy and run-down as well.

The Place is around the corner from my office, and this was my first trip back in about two months, I was shocked at what I saw. Fifty percent of the eateries in the basement were boarded up. The cheap food court, too, was gone, covered up with ugly blue boarding, making the basement especially grim and dreary. The two good restaurants there, Ganges and Master Kong Chef’s, were still thriving. The few others that remained seemed to be just hanging on.

That same night I went by The Village, which seemed so cool when it first arrived and now seems so unnecessary aside from the Apple store and a couple of restaurants. Same thing as The Place: lonely clerks looking plaintively out the store windows, eyes begging you to come in and buy something. But no one does. There is simply too much stuff, too many stores, and no buyers. Do you have to be a rocket scientist to conclude this is unsustainable? And to top it off, they are now finishing the second Village mall down the street, across from the Poppa Bear of all disaster malls, 3.3. All I can say is, WTF??

I’m predicting The Place and many of its sister ghost malls, shunned by customers overwhelmed by so many malls to choose from, each selling the same crap that no one can afford nowadays, are going to experience a catastrophe, if they haven’t already, and will ultimately become burnt-out, boarded-up shells. In turn, this is going to throw a lot of fuel on China’s current financial crisis. Real estate will be further cheapened, and the general misery unique to times of deflation will set in. Brother, can you spare a dime?

The author has some ideas on why it got so bad.

I told them this was coming 2.5 years ago and no one listened. The day of reckoning, the moment of truth is here. Even if things pick up, these malls are hopeless. Like the Mandarin Oriental, they will need to be razed and replaced with something useful, like affordable middle class housing (wishful thinking on my part). If not, Beijing could become a city pockmarked with looming dinosaurs, huge husks of once breathtaking buildings, now vacant and decaying, like so many of the Olympic structures.

I kind of understand why this overbuilding happened, as the economy became a vicious inflationary circle. Now we are experiencing the down wave, and it’s just starting. As we crash, The Place and many other useless mega-malls like it will serve only as reminders of the excesses of good times that we fooled ourselves into believing would last forever. Their time has now come. In fact, their demise is long overdue.

The government in China is doing the same thing the government of the US is doing. Trying to reflate the bubble instead of marking down assets to their real value. It will end badly. In the US and China.

Given that the real volatility of the Chinese political system is far in excess of the volatility in the US and we in the US have the safety valve of local, State, and National elections with a range of policies to choose from (Texas or California?), I think there will be a LOT of political upheaval in China in the years to come. They will be so caught up with domestic problems that their opportunities for international mischief such as the current uproar over arms sales by the US to Taiwan will be limited. OTOH they could do what governments the world over do when domestic trouble is serious. Start foreign adventures. Will China go down (for a while) quietly? Or will they make a fuss? Stay tuned.

And another thing. When China crashes it will put a LOT of downward pressure on the price of oil. Unless they go in for oil adventurism.

Cross Posted at Classical Values

The Trouble With China

The AEI Outlook Series takes a look at China and sees a few bumps in the road. Here are the main points:

China is facing destabilizing inflation; capital has flowed into China must faster than it has flowed out, in part because Chinese residents are prohibited from investing abroad.

China's reported inflation rate on consumer goods rose to 5.4 percent in March, but its implied inflation rate is 8.4 percent--a large discrepancy suggesting that China is underreporting its inflation rate.

Chinese authorities have taken some steps to lower inflation, but they may be delaying more drastic measures to avoid instability before the 2012 transfer of leadership.

China has the second-largest economy in the world--accounting for one-third of global growth in 2010--so a Chinese hard landing would be very damaging to the global economy.

Yes. Trouble in China would be very damaging to the world economy. But it would also damage China.

The problems for China are similar to those of Japan. An economic model that works in an economy that needs rapid development no longer works in an economy that needs a broad development of internal services.

On a more fundamental level, China is tracking what one might call the Asian "work, save, and invest" model that proved so unsuccessful for Japan after its economic boom period in the 1970s and 1980s. During those decades, its financial sector failed to develop, and Japanese citizens were discouraged from investing abroad. Inside Japan, investment-allocation decisions were made largely by government agencies that recycled household savings deposited in Japan's Postal Saving System and its sheltered banks. As a result, Japan's financial sector developed far more slowly than its production sector. Saving was very high, as in China today, so there was a huge supply of funds for the government to allocate inside Japan. The government agencies favored investment in Japanese manufacturing facilities, especially those in the export sector.

As Japanese citizens grew wealthier, by the 1980s they looked for ways to store and enhance the wealth they were accumulating as a result of their hard work. They invested in the Japanese stock market and even more vigorously in Japanese real estate. In the late 1980s, the Japanese real estate bubble grew so large that the emperor's palace in central Tokyo was said to be worth more than the state of California. Of course, the bubble burst a year later, and Japan entered a lost decade that included wealth losses equal to nearly three years of national income followed by persistent deflation and generally stagnant growth. These are problems that persist to this day in Japan, which sadly has a whole new set of problems from its recent tragic earthquake and related nuclear disaster.

And Japan's current problems are huge.

Japan Posts Second Biggest Trade Deficit In History

For those who may not have noticed it, the headline says "deficit" and pertains to Japan: once upon a time a booming export economy. The reason: the ongoing collapse in export trade, after May exports dropped by 10.3% from a year ago, and just better than April severe economic contraction of 12.4%. Consensus was for an 8.4% decline. The net result was a monthly deficit of 853.7 billion yen, or $10.7 billion, the second biggest inverse surplus ever. And just like in Europe, where things are going to go from insolvent to perfectly solvent any minute now... just not yet... so in Japan the economic renaissance which will cause the economy to surge (unclear how: no new monetary stimulus, and the recently announced fiscal stimulus of Y500 billion in new loans will do precisely nothing to boost anything except for some corrupt bureaucrats Swiss bank accounts) is coming any minute.... just not yet. Bloomberg says: "Shortages of power and parts have disrupted production and slowed overseas sales, prompting Japanese companies including Honda Motor Co. to forecast weaker earnings. Higher unemployment in the U.S. and weakening demand in Asia indicate Japan won’t be able to rely on global demand to pull itself out of a slump caused by the quake." And the understatement of the weekend comes from BNP economist Azusa Kato: "The state of the global economy is a little worrying. Both the U.S. and Europe aren’t doing that great and emerging economies are also tightening at an incredible pace, increasing uncertainty."

"Increasing uncertainty", is econo speak for: "Things are going from bad to worse."

There is the little problem of radiation safety in agricultural exports.

#Radioactive Tea in France: Shizuoka Governor Tells France Tea Is Safe, "No Problem"

Besides, the tea leaves may not be from Shizuoka anyway, says his government.

The Oxford PhD (in comparative economic history) governor of Shizuoka strikes again, responding to the news that the French authorities confiscated the radioactive tea from Shizuoka Prefecture at the Charles De Gaulle Airport in Paris for the high radioactive cesium count (1038 becquerels per kilogram), more than twice the safety limit for the EU. (I'm rather surprised that it's that high in the EU.)

The follies going on in the treatment of the nuclear disaster in Japan are so numerous, depressing, and foreseeable that I have done nothing for over a month in cataloging them.

Here are two blogs that will help a LOT if you want to keep up:

ex-SKF

Radiation Safety Philippines

Cross Posted at Classical Values

Central Banker - China's Economy Is Too Hot

I did a post yesterday about China's bubble risk. Nothing official mind you. Just some observations and an anecdote. Today we are getting the word from an official source.

A senior policy adviser to China's central bank said Monday that asset bubbles were a concern for the nations' policy makers, reflecting official unease about the rapid gains in real estate prices, according to reports.

Fan Gang who sits on the monetary policy committee of the People's Bank of China told reporters that surging asset prices were the "the real worry" for the economy, according to a report by Dow Jones Newswires.

Fan also praised recent efforts to rein in excessive liquidity as "good, timely and necessary," even while he downplayed inflation risks, saying gains in consumer prices were unlikely to be a major problem this year because of spare capacity and stable food prices.

In a separate development during the weekend, the mayor of Shanghai said the city plans to raise the minimum wage by 15% and accelerated plans to build subsidized housing.

And enforced higher wages (as opposed to market wages) will help Chinese competitiveness how?

In any case China has yet to undergo the first round of bubble collapse. And the US has not gotten in its second round. I can see a double dip coming this summer. Just in time for election season.

That which is unsustainable will not be sustained. That goes for politics as much as it does for economics. Tea anyone?

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Chinese Threats

I have been wondering about China. Especially the threats to America over arms sales to Taiwan. And I wonder if the threats aren't mostly for internal consumption. What made me think of this was the popping of China's real estate bubble.

Why internal consumption? To justify a large army. And why a large army? To handle unrest caused by possibilities such as:

Wow, China fighting inflation with predictions of 50% commercial vacancy rates in Beijing, Japan is Japan, Vietnam is worried about their Dong, and Europe and South America are a mess - it looks like it’s up to America to save us because, as I said earlier in the week - do you really have anywhere better to put your money?

China's government depends on growth to keep the population pacified.

What about the big picture? The world has been generating more capital than it can profitably employ. Which means we are under invested in research. Which is the cause of our secular decline.

A Double Dipper?

Chairman Bernanke says no double dip recession. Sort of.

Federal Reserve Chairman Ben Bernanke said Monday he is hopeful the economy will gain traction and not fall back into a "double dip" recession.

"My best guess is we will have a continued recovery, but it won't feel terrific," Bernanke said.

That's because economic growth won't be robust enough to quickly drive down the unemployment rate, now at 9.7 percent, he said in remarks to the Woodrow Wilson International Center for Scholars, a nonpartisan research group.

The economy grew at a 3 percent pace in the first quarter of this year. That's good growth during normal times. But coming out of such a deep recession, the economy must grow much more strongly to make a dent in the jobless rate.

Fears have grown that the recovery could be derailed if Europe's debt crisis turns into a broader financial contagion, crimping lending in the United States and around the globe.

Broader financial contagion? IF? There is no IF about it. It is just a matter of when. And did the Chairman mention the China Real Estate Bubble? No he did not.

And something else he didn't mention while we are at it. Housing may go into a double dip.

mortgage purchase applications are down nearly 40 percent from a month ago to their lowest level since April of 1997. Yes, you can argue that a larger-than normal share of buyers today are all cash, but those are largely investors.

That means real organic buyers are exiting in droves.

"With another week of historically low mortgage rates, the trend from the prior three weeks continued, as refinance applications increased while purchase applications dropped. Purchase applications are now almost 40 percent below their level four weeks ago, while the refinance share, at 74 percent, is at its highest level since December," said Michael Fratantoni, MBA's Vice President of Research and Economics.

And then the Realtors' chief economist, Lawrence Yun, after touting the numbers and telling all of us how much home equity was "preserved" by the tax credit stabilizing prices ($900 billion), throws water on his own numbers:

“A big concern surfacing recently is insufficient time to close the deal at the settlement table. Under normal circumstances, two months would be enough time from contract signing to settlement date,” Yun said.

“However, the recent housing cycle has brought long delays related to the short sales approval process by banks, and from ongoing appraisal issues. There could be a sizable number of homebuyers who responded to tax credit incentives, but may encounter problems meeting the settlement deadline by June 30.”

The mentality seems to be "If we just hold on there are better days around the corner." But what if that is not true?

What if they are cooking the books?

The Bureau of Labor Statistics reported on Friday that employment in the United States grew by 433,000 jobs in May, but that those jobs included 411,000 temporary workers hired by the Census Bureau.

So let me answer the question: what if better days are not around the corner? And the answer is: a second crash. A Double Dip Recession.

This book on the Great Depression was pretty popular for a while:

The Forgotten Man: A New History of the Great Depression

The reason I bring it up is that there were lots of dips (rises and falls) in that depression. Could we be repeating some of the same mistakes? Why not?

Cross Posted at Classical Values

China Opens The Gold Window

Well Gold ATMs actually.

China is one of the world's largest producers and purchasers of precious metals, especially gold and silver. Beijing has now unveiled its first gold ATM machine in a shopping district. More than 2,000 will be installed in the next two years.

I wonder if this is meant to sop up the money that no longer has confidence in Chinese real estate?

Cross Posted at Classical Values

Added Risk

The US Treasury Department says that bailouts add risk to the financial system.

WASHINGTON – The government's response to the financial meltdown has made it more likely the United States will face a deeper crisis in the future, an independent watchdog at the Treasury Department warned.

The problems that led to the last crisis have not yet been addressed, and in some cases have grown worse, says Neil Barofsky, the special inspector general for the trouble asset relief program, or TARP. The quarterly report to Congress was released Sunday.

"Even if TARP saved our financial system from driving off a cliff back in 2008, absent meaningful reform, we are still driving on the same winding mountain road, but this time in a faster car," Barofsky wrote.

And guess what? He is not the only one saying that.

From a November 2009 report we get the word that more stimulus creates more unemployment.

"Stimulus" is in the process of turning a nasty recession into a genuine depression. The evidence is in the "Employment Situation" report released by the Bureau of Labor Statistics (BLS) on November 6th. The "headline" unemployment rate shot up to 10.2%, the highest in more than 26 years. But the report was much worse than most people realize.

The "household survey data" showed that 589,000 jobs vanished during October. This is bad enough, but the three-month moving average of changes in total employment (current month and prior two months) shows that job losses are actually accelerating.

The three-month moving average (TMMA) of changes in total employment began a serious decline in February 2007. It went into negative territory two months later. This indicator has now been negative for the past 21 months. During this time, total employment has declined by more than 8 million jobs.

I have to admit that recently the rate of job loss appears to have slowed. But that may only be a temporary respite. And why is our recovery from problems so off track?

The massive sales of U.S. Treasury bonds to finance "stimulus", bailouts, and other government spending is sucking capital out of the private sector and destroying jobs.

And there are still problems with other sectors of the economy.

The smaller banks are carrying the burden of the commercial real estate problems and consumer debt and mortgages still present these banks with problems because these loans represented “Main Street” and were not all packaged and sold to investors in Finland. Remember there are 552 banks, all small- and medium-sized banks that are on the FDICs list of problem banks and this is expected to grow this year before declining, generally do to actual failures.

There are more dislocations throughout the economy that point to persisting problems. For example, in manufacturing, since the 1960s the unused capacity of United States industry has continually declined from peak usage to peak usage of that capacity The latest peak utilization of capacity still saw that about 20% of the industrial capacity of the United States remained unused. Unused capacity for the past thirty years seems to average around 23% to 24%.

We see unused capacity in the labor force as well. Since the 1970s under-employment of labor has grown quite consistently. Attention is focused upon the unemployment rate, but this measure does not include those individuals that have left the labor force because they are discouraged and those that are only working part time but would like to work more. We have seen estimates that 17% to 20% of the employable people in the United States are under-employed. Another dislocation that is not comforting.

Then we hear about the problems in state and local governments. Reports indicate that there are more than 30 states that are currently experiencing fiscal difficulties. We hear most about California and New York, but there are many other states particularly in the west and southwest that are having real problems. One estimate is that the states will have a combined budget shortfall of at least $350 billion in the fiscal years of 2010 and 2011. And, this doesn’t even get to the difficulties that are being faced by local governmental bodies.

Illinois where I live is in bad shape. Very bad shape.

And, there are the dislocations being created by the federal government. Budget deficits for the next ten years have been placed in the range of $15 trillion. The United States is fighting three wars throughout the world. The government is passing health care legislation that has been justified fiscally by postponing start dates of programs from three to five years. There is climate control efforts being considered along with regulations, like anti-pollution controls, that will just exacerbate the economic and fiscal problems of the country. Then there are other changes in the rules and regulations that apply to industry that will further change the playing field and create greater uncertainty about what management’s should do.

There is the problem of unemployment, the number one issue among the American voter. (And you thought the number one issue was health care or pollution or terrorism or the war in Afghanistan.) But, there is a dislocation problem relating to federal government stimulus programs.

For fifty years or so the federal government has attempted to stimulate the economy to put people back to work in the same jobs from which they were released from. The government has sought to put unemployed people back to work in the steel industry, in the auto industry and in other jobs that are the backbone of American industry (according to the labor unions and others). As a consequence, the steel industry lost competitiveness, the auto industry lost competitiveness and so did many other industries.

This effort to stimulate the economy and put people back into the jobs that they lost has contributed greatly to the increase in the unused industrial capacity and to the increase in the under-employed in this country. The effort to constantly maintain a low unemployment rate by putting people back into the jobs they have lost has resulted in a massive slide in the competitive position of the United States.

And the funny thing is that we did not lose those jobs to foreign competition. We lost them to computers and robots.

...the news about the manufacturing sector gets a little better. According to the Federal Reserve, the dollar value of U.S. manufacturing output in November was $2.72 trillion (in 2000 dollars), which translates to $234,220 of manufacturing output for each of that sector’s 11.6 million workers, setting an all-time record high for U.S. manufacturing output per worker (see chart below). Workers today produce twice as much manufacturing output as their counterparts did in the early 1990s, and three times as much as in the early 1980s, thanks to innovation and advances in technology that have made today’s workers the most productive in history. So at the same time that manufacturing employment has been declining to record low levels, manufacturing output keeps increasing over time, and the amount of output that each manufacturing worker produces keeps rising almost every month to new record high levels.

So despite Stupid Government Policies the economy is getting rationalized. The reason it is so painful this time is that we have 50 years of accumulated dead weight to shed.

Which brings me to a book. This Time is Different: Eight Centuries of Financial Folly and a book review.

Unemployment rose by several hundred thousand jobs in the fourth quarter, and if you look at some surveys, it approached 500,000. That is hardly consistent with a 5.7% growth rate. Further, sales taxes and income-tax receipts are still falling. As I said last year that it would be, this is a Statistical Recovery. When unemployment is rising, it is hard to talk of real recovery. Without the stimulus in the latter half of the year, growth would be much slower.

So should we, as Paul Krugman suggests, spend another trillion in stimulus if it helps growth? No, because, as I have written for a very long time, and will focus on in future weeks, increased deficits and rising debt-to-GDP is a long-term losing proposition. It simply puts off what will be a reckoning that will be even worse, with yet higher debt levels. You cannot borrow your way out of a debt crisis.

While I was in Europe, and flying back, I had the great pleasure of reading This Time is Different, by Carmen M. Reinhart and Kenneth Rogoff,...

The thesis of the book is that this time it is the same as it ever was.

Let's lead off with a few quotes from This Time is Different, and then I'll add some comments. Today I'll focus on the theme of confidence, which runs throughout the entire book.

"But highly leveraged economies, particularly those in which continual rollover of short-term debt is sustained only by confidence in relatively illiquid underlying assets, seldom survive forever, particularly if leverage continues to grow unchecked."

"If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government's policies, a financial institution's ability to make outsized profits, or a country's standard of living. Most of these booms end badly. Of course, debt instruments are crucial to all economies, ancient and modern, but balancing the risk and opportunities of debt is always a challenge, a challenge policy makers, investors, and ordinary citizens must never forget."

And it not just the US. It is a problem world wide.

One point I found fascinating, and we'll explore it in later weeks. First, when it comes to the various types of crises with the authors identify, there is very little difference between developed and emerging-market countries, especially as to the fallout. It seems that the developed world has no corner on special wisdom that would allow crises to be avoided, or allow them to be recovered from more quickly. In fact, because of their overconfidence - because they actually feel they have superior systems - developed countries can dig deeper holes for themselves than emerging markets.

Oh, and the Fed should have seen this crisis coming. The authors point to some very clear precursors to debt crises.

We hear of trouble in in Greece taking Europe down. Maybe down so hard that it will collapse the Euro market. And then there is China which I have been writing about for the last few days. They have yet to undergo the first stage of the world wide fall. And every one knows China will fall. No one knows just when. It could start this week. Or it could start two years from now. If I was a betting man I'd bet on sooner than later.

So what should the US Government do? Other than keep people off the streets - nothing. And by off the streets I don't mean in homes that are unaffordable. A roof - we have plenty of them - and a minimal diet. Then let the wisdom of 300 million people take over.

At the core of our problem is a secular decline. The easy gains from microprocessors (I have the equivalent of four or ten Cray 1s on my desk - not so micro any more. Except for size.) have been realized. So what is the next big thing? It could be a real breakthrough in fusion not one of those mega projects with big promises and small results. It might be in carbon nanotubes. Or it might be a breakthrough in materials that allows us to substitute cheap materials for much more expensive ones. Or it could be something in biotech. Or a new way to do business. Or probably something hardly any one knows about. Some unrealized potential.

The deal is, that what ever it is, Washington with its macro policies is more likely to hurt than help. So what could Washington do? Pour money (it need not be a lot) into micro policies. More fundamental research. And a big push into research is not expensive. A few tens of billions a year could reap us big dividends. If we are truly in a knowledge economy (we are) then what we need is more knowledge not more bail outs of dying sectors of the economy. What is unseen is more important than what is seen.

H/T Instapundit

Cross Posted at Classical Values

The Chinese Economy

Daniel Drezner is discussing China's power in the world. Soft and economic. I liked this quote from one of his commenters re: the success of state capitalism (i.e. sovereign wealth funds).

18 Jun 2008 at 7:45 am, DWPittelli:

Yes, and Japan’s MITI and other government control of the economy has given it some of the world’s strongest growth rates. Japan will continue to dominate global markets, to increase its share of manufactured goods, and to buy up premium US real estate.

– My dad, ~1989

Trends do not always go in straight lines. What looked smart in the 1930s in Germany didn't look so smart in 1945. The all devouring Japan has hit a wall. It is very nice next to the wall. It is still a wall.

Here is another comment that illustrates the problem:

If I understand the concept of sovereign wealth funds, they are under the control of the government. In that case, they are necessarily under political control.

I have worked at two different levels of government and have concluded that politics permeates EVERYTHING in government. If the funds are under political control, decisions will be made on political rather than economic grounds. The system may achieve economic success for a while, but it won’t over the long term.

Inevitably, political considerations will trump economic ones. That is because in government people are hired, fired, promoted, and demoted on political grounds. If you institute a civil service, you may insulate workers from the broader politics only to create a politics internal to the civil service system. Witness SEIU.

Issues can be decided on an economic basis or a (broadly defined) political basis. There are no other bases, and only an economic basis offers hope for long-term success.

Now if we could just get some bits of the US economy back from the clutches of government (No Blood For Oil or No Drilling For Oil?) then we might have better long term performance than we have seen for the last decade. And it hasn't been a bad decade.

H/T Instapundit

The Old Order Is Breaking Down

Commenter Frank asked me to elaborate on my point about the start of the next world war at Palin: Libyans Should Be Protected By Nato. I replied in a comment. I think that comment deserves more eyeballs.

====

Frank,

The world system is breaking down. In America:

1. The lower education/union bubble
2. The higher education bubble
3. The real estate bubble
4. Not enough oil production
5. Drug Prohibition is being recognized as a failure
6. Insufficient food production to support the world system.
7. The Green bubble
8. Unsustainable Social Security, Medicare, Medicaid, etc.
9. The Democrat party is near a collapse point. Wisconsin is the leading indicator
10. etc

Europe - similar to the above without oil resources plus a Muslim problem.

In the Middle East:

1. Islam is breaking down due to the Internet/cell phones
2. It will not go quietly
3. Muslim Brotherhood etc.
4. Not enough food production
5. Dictators R us
6. etc.

China

1. Food
2. The Jasmine Revolution
3. Internet/cell phones - see Jasmine Revolution
4. One Party rule - like the Democrats in America only worse

India - I'm going to have to study more. Probably much of the above plus an Islam problem going back at least 500 years only partially resolved with the India/Pakistan partition.

No doubt much more.

The world system is breaking down. Much of the old system that we have been carrying is unsupportable. It will be a better system once the old order is gone. The old order will not go without a fight.

Texas is designing a degree system that will cost the student $10,000. I don't see why the cost shouldn't be more on the order of $2,000. We have the Internet.

The US is well positioned with its TEA Parties to come out on top of this upheaval. But it will not be pretty here either.

Some good places to start for further reading are:

The Origins of The Second World War

and:

The Proud Tower: A Portrait of the World Before the War, 1890-1914

From a review:

The fateful quarter-century leading up to the World War I was a time when the world of Privilege still existed in Olympian luxury and the world of Protest was heaving in its pain, its power, and its hate. The age was the climax of a century of the most accelerated rate of change in history, a cataclysmic shaping of destiny.

Sound familiar?

and:

The Guns of August

May I also suggest Sara Hoyt's blog post Marx Is Dead

Batten the hatches, General Quarters, Incoming! This is not going to be pretty. At all.

Cross Posted at Classical Values