The Panic Will Start with Property VIA BeforeTheCollapse
The situation is grave. That’s why I don’t say this light-heartedly, but I think it should be said nevertheless.
George Soros made it clear in “The Alchemy of Finance” (1987) that the debt situation became quite unsustainable already after 1982, and has been sustained only by a symbiosis of governments, central banks and commercial lenders, acting in a balance-of-fear type of environment. The banking system has been on the brink of collapse since then.
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Finding this out must make one slightly depressed, looking at the mountain of debt we have managed to amass mostly after the 1980s. PWC measured UK total debt to be 500% of GDP in 2012, no soul has had the courage required to measure it since.
The problem lies mostly with the human tendency to avoid short-term pain. Any top politician, or a central banker, who would come out now would most likely cause a crisis. And proving a counter-factual is very hard, as we know, so this person (or institution) would need to take an unbearable amount of blame. Many still blame the Fed for what happened in the 1930s! Sure, mistakes were made, but mistakes will always be made.
Let’s contemplate the detail, when personal debt started growing at a faster pace than personal income, it gradually replaced income as a source of demand, and so, it has to end in tears. A boom first, followed by a bust later, as the discrepancy between income and debt growth must mean that the debt burden will, sooner or later, become unserviceable. If much of that debt has been allocated to asset purchases, it will cause a financial crisis, as in 2008.
If left to unravel without state intervention, a financial crisis will crash asset prices and bring them in line with incomes once again (not incomes + debt). And we can hope to start all over again.
Unfortunately the myth that non intervention would have caused more pain to the poor than the rich was sold to the public in 2008, debt was jiggled around from one sector (financial) to another (state) as though, by magic, that would alter its overall level. Of course it didn’t, it simply meant that the poor were made to take on the losses and asset prices were protected.
The private sector is intended to be fallible, otherwise the price mechanism would not work and it would be pointless, and the public sector is intended to be infallible, and so imprudence is hidden but the costs are real. It has been intentionally constructed that way; it’s not some freak outcome or vestige of truth. The bailout of Wall Street was imprudent, the cost far too great, and so the real reason for printing money was hidden.
Unless it is accepted that demand must be tied to income growth, and not extra debt, we’re never getting out of this one. The concept that higher bank lending – in an era of stagnant incomes – was an encouraging sign for the economy was a ridiculous one. More ridiculous still are Western governments (last 6/7 years) trying to bolster the banks in order to get them to do precisely that, lend more. The current disconnect between high asset prices, stagnant incomes and increasing, overall debt levels, is both economically and politically unsustainable. And what is the ultimate result? Brexit politically and economically there is no housing market for our young workers. The first rung of the property ladder only existed when wage inflation was higher than house price inflation. Those days are gone, well and truly.
For not one politician or homeowner has the courage to see asset prices fall – as they assuredly would without endless money printing and zero interest rates. The result is a suppression of the natural market forces which would grab back property from overstretched speculators and see it distributed at sustainable prices to the productive young.The market for money itself would correct stratospheric house prices. Then prosperity would settle on those who produce in preference to those who already have.
And why the absence of valour? Why did the state do this? Because it cannot create growth. The root cause is the inability to create growth in the face of demographic changes. So instead they synthesized it. Aside from some Germanic nations, the West is experiencing a slow imploding collapse for she has been running at a loss for decades and successive governments have sought to shore up money creation by printing through housing. This point is central to an understanding of the crisis and highlights the enormity of what’s about to happen. The superficial mind presumes that money printing began after The Great Financial Crisis.
In actuality, neo-liberal economies such as the US, UK, Ireland, Australia, etc. were printing money for decades by providing an excess of credit money to purchase property. For example, affordability measurements for mortgage applications used to use the primary income as a benchmark (which was typically the income of the man); but this was changed to total household income. This permitted evermore future income to be sucked into the present for the purpose of consumption. This was money printing by sleight of hand. Thus, living standards dropped for the young while the elderly who owned property enjoyed a bonanza.
The West is now in a worse position than before she began this as the current monetary policy exacerbates misallocation of investment.
The UK establishment have been loathe to let supply match demand (as it did in Ireland) as it would have meant the collapse of house prices and the UK (and interconnected) banking systems and with it the West. I therefore posit that they never wanted to remedy the shortage of affordable housing and therefore rejected all suggestions as to how to fix the problem as meaningless. Alas, the dominant class did not envisage Brexit and the possible geopolitical consequences for asset prices in the UK, in particular, the property market.
Brexit is a Bear Stearns moment, not a Lehman moment. That’s not to diminish what’s happening (markets felt like death in March, 2008), but this isn’t the event to make you run for the hills. Why not? Because it doesn’t directly crater the global currency system. It’s not too big of a shock for the central banks to control. It’s not a Humpty Dumpty event, where all the Fed’s horses and all the Fed’s men can’t glue the eggshell back together. But it is an event that forces investors to wake up and prepare their portfolios for the very real systemic risks ahead.
There are two market risks associated with Brexit, just as there were two market risks associated with Bear Stearns.
In the short term, the risk is a liquidity shock, or what’s more commonly called a Flash Crash. That could happen today, or it could happen next week if some hedge fund or shadow banking counterparty got totally wrong-footed on this trade and — like Bear Stearns — is taken out into the street and shot in the head.
In the long term, the risk is an acceleration of a Eurozone break-up, which is indeed a Lehman moment (literally, as banks like Deutsche Bank will become both insolvent and illiquid). There are two paths for this. Either you get a bad election/referendum in France (a 2017 event) or you get a currency float in China (an anytime event). Brexit just increased the likelihood of these Humpty Dumpty events by a non-trivial degree.
What’s next? From a game theory perspective, the EU and ECB need to crush the UK. It’s like the Greek debt negotiations … it was never about Greece, it was always about sending a signal that dissent and departure will not be tolerated to the countries that matter to the survival of the Eurozone (France, Italy, maybe Spain). Now they (and by “they” I mean the status quo politicians throughout the EU, not just Germany) are going to send that same signal to the same countries by hurting the UK any way they can, creating a narrative that it’s economic death to leave the EU, much less the Eurozone. It’s not spite. It’s purely rational. It’s the smart move.
What’s next? Every central bank in the world will step up their direct market interventions, particularly in the FX market, where it’s easiest for Plunge Protection Teams to get involved. Every central bank in the world will step up their jawboning and “communication policy” to support financial asset prices and squelch volatility. It wouldn’t surprise me a bit if the Fed started talking about a neutral stance, moving away from their avowed tightening bias. As I write this, Fed funds futures are now pricing in a 17% chance of a rate CUT in September. Wow!
What’s the result? I think it works for a while, just like it worked in the aftermath of Bear Stearns. By May 2008, credit and equity markets had retraced almost the entire Bear Strearns driven decline. I remember vividly how the narrative of the day was “systemic risk is off the table.” Yeah, well … we saw how that turned out. Now to be fair, history only rhymes, it doesn’t repeat. Maybe this Bear Stearns event isn’t followed by a Lehman event. But that’s what we should be watching for. That’s what we should be preparing our portfolios for. Will the EU/ECB attack and in what way? Will the UK property market collapse and crater their financial systems?
The above is an extract from The Philosophy of Capitalism.