Asset Bubbles

In a capitalist system, the market forces of demand and supply is driven by people. Thus if the market represents the aggregate view of its participants then it is prone to bouts of fear and greed just like its participants. When greed takes over, it will drive the price upwards with many bears asking themselves, "What are the reasons for these higher prices?" The irrationality of greed is the answer to this question.

So how do we spot a bubble? We look at price inflation and see if incomes can sustain those prices. At the top of markets the general populace are the most bullish. Prices appear to be vertical when viewed on a larger timeframe. They are "self-reinforcing" on the way up and brutally fast on the way down as people realise the boom is over.

As with the US housing bubble, many pundits will claim that the price rises are justified for any number of reasons including strong economic growth, population growth/migration, low supply and high demand. What is not talked about is the amount of leverage (debt) in the market. Like any market that uses debt as the primary source of funding, the prices of the market will be affected by monetary policy of the central bank and the lending policy of the banks. Once these two factors put enough pressure on demand, asset prices will collapse. Higher interest rates and tougher lending policies not only put pressure on the housing market but also on jobs and hence average income per person declines.

The Sydney property market has risen remarkably over the past decade. But are the price rises justified by population growth, income or anything the pundits claim? No. You only have to compare median income with median house prices and you will find Sydney to be one of the most unaffordable cities in the world. See here: http://www.demographia.com/dhi.pdf

When this bubble eventually pops not only will banks fail but the economy will grind to a halt as it deleverages in a similar style to the US.
It's not just economic but social and political change that comes about through economic shocks. The rise of the Nazi party from hyperinflationary Germany, collapse of the soviet union and rise of the US, the south American debt crisis giving rise to socialist governments. The world as we know it will change.

Another bubble that is generating a lot of debate is China. This bubble is a mix of inflation and the belief that Chinese growth will continue forever. Who's to say that this isn't another 1980s Japan style bubble inflating in China.

Fixed currency rates have been another problem that has inflated many bubbles as history has shown. Several South American countries during the 1980s and early 1990s had fixed exchange rates that caused their economies to implode as the bubble popped and were forced to float their currencies causing further instability. The Chinese government thinks it can micro-manage a capitalist economy. But only when they wake up to an economic bust will they realise how fraudulent their growth has really been.

Even the Chinese stock market is treated like a casino as the index has been rising at an unsustainable pace. It was not surprising when I read a news headline that the Chinext exchange went up 300% on the first day. It is clear that the Chinese will have a lot to deal with when the house of cards tumble and it will be interesting to see how the single political party state deals with the crisis.

I will end the article with a quote: "There is no means of avoiding the final collapse of a boom brought about by credit expansion.

The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

Downfall of the US Empire

The fall of an empire is usually caused by war. Just like the wars of ancient history, the wars of modern history have caused empires to go bankrupt and lose their superpower status. One only has to look back to World War 2 to see how war bankrupted the British empire. Britain was once the superpower of the free world but the war placed an enormous economic toll on Britain from which it never recovered and led to the isolationist US usurping Britain as the world superpower.

Once again we witness the fall of one empire (the US) and the rise of another (China). There is no doubt that the US stock market bubble of 2001 and the 911 terrorist attacks were massive shocks to the economy and confidence. The US Federal Reserve (Fed) then lowered rates to 1% and kept them there, for some time, to guarantee a recovery. What central banks fail to realise is that economic activity caused by lowering interest rates is an artificial boost to the economy. Money becomes cheap and the market reacts by borrowing more and accumulating more debt. Is this really economic growth? Was the NASDAQ bubble valuing companies accurately? In 2005, were US houses valued correctly? No and No. Central bank fuelled debt and the old cliché of "irrational exuberance" are to blame for the bubbles.

The great idea to invade Afghanistan and Iraq added more debt onto the US empire. Funding unwinnable wars with debt is how empires go into decline. The US government is now forced to use "quantitative easing" or printing money to fund their government expenditure. Imagine how much money would have been saved if Iraq had not been invaded or more importantly the thousands of lives that would have been saved on both sides of the conflict. These costs are now placing a huge strain on the US economy and will severely delay its recovery.

The government funded its wars with paper dollars. You can see that debt levels increased rapidly after Nixon closed the gold window. This is what happens when governments fund wars with debt. Eventually an economic crisis will hit government tax revenues hard and if the government had already been running a deficit then the deficit will become larger and eventually governments will print money to fund the war and to stimulate the economy.

Clearly after 2001, the price of gold accelerated upwards from $200/oz and has been growing exponentially since then.

The only way wars of aggression can be beneficial is if the resources that are captured are greater than the resources expended in fighting the war. Since Afghanistan had little economic importance and more strategic importance, we can say that this war had a purpose with no expected economic gain. On the other hand Iraq has major economic significance as an major oil supplier and posed little threat to global security (WMDs did not exist and the intelligence community knew this). We can therefore say that Iraq was war based on economics which secured future oil supply for the US.

Despite this gain, the war has no end in sight and every day the US military operated in Iraq is another US$ 150 million gone. Perhaps the strategists have worked out the future cost of oil being so expensive that the cost of the Iraq war is worth the gain in oil supplies secured. This is the only economic justification for the war and whether it is true will only be known years from now.

The only other economic justification for war is in self-defence, which should be self-explanatory.

We have looked at how the events of 9/11 set the US on a warpath that has bankrupted the nation. Osama Bin Laden's goal was to inflict terror on the US and send a message to the world. But he may have contributed to the downfall of the US.