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Bubble Watch: A Compendium

Image: Alain B

Image: Alain B

With the massive amounts of monetary stimulus unleashed into world economies over the past decade by central banks, it stands to reason that much of that money is creating bubbles in numerous sectors. Much attention has been paid to the larger, more important bubbles such as the stock market bubble or the bond bubble. But other, smaller bubbles can also serve as leading indicators of bubble activity.

According to Austrian Business Cycle Theory, injections of money and credit by central banks lead to artificially low interest rates, incentivizing investment into longer-term, more capital-intensive projects that wouldn’t be profitable at higher interest rates. When those projects are completed the realization comes that there is insufficient demand for them. Resources have been malinvested, put to use in producing goods not demanded by the market. Companies are forced to lower prices, liquidate assets, and lay off workers in order to put their malinvested resources back to productive use.

Similar things happen on a smaller scale in households. As money flows into the economy and salaries rise, people feel flush with cash and begin to increase their discretionary spending. Expectations about the future increase too, leading people to believe that the good times will never end. As the bubbles burst, however, and the layoffs begin, people begin to realize what is coming and pull back on their spending. Dining out is replaced by dinners at home, cars and houses may be downsized, and spending on frills and luxuries is curtailed.

It’s been a while since we’ve put together a bubble watch post, so here is a little compendium of some news items from the past few months that might be indicators of bubbles. While it isn’t always possible to identify which bubbles are going to burst and when, nor how important such bubbles bursting may be, smaller bubbles can serve as leading indicators of overall bubble creation or point to even larger bubbles in the overall economy. The skyscraper index is a well-known example of a smaller bubble indicator, but it’s not the only one.

Bubble Watch: Chinese Housing

Empty city in China.

Empty city in China.

The Chinese economy is notoriously in a bubble, particularly its real estate market. For years reports have come out of China about brand new cities being built in the middle of nowhere, built to house millions but only being inhabited by the workers building the empty skyscrapers. Enormous airports and shopping malls were built to handle millions of visitors per year, but the only people to visit are the maintenance personnel who keep everything clean and polished at the end of the day. Despite this overbuilding, China is still rife with real estate speculation, as citizens newly able to invest their money begin to buy apartments in the hope of flipping them for a profit at some point in the future. Now that the stock market is beginning to falter, the Chinese government is obviously looking to keep the economy from crashing. To that end, China’s central bank announced that down payments on first time homebuyers in many cities would be lowered from 25 percent to 20 percent. This is obviously an attempt not just to stimulate the economy but also to keep capital from leaving the country, as Chinese buyers are currently flocking to the US to purchase real estate. Will this move help to stimulate the Chinese economy, is it too little too late, or might we see even further down payment reductions in the future?

Image: Adam Cohn

Bubble Watch: Home Equity Loans & Loose Lending Standards

The Fed’s unprecented monetary easing in the aftermath of the financial crisis has led to bubbles forming all throughout the economy. And while the housing market hasn’t been quite as overheated as it was before the financial crisis, there is always the risk that a new housing bubble could form. In an era of near-zero interest rates, there aren’t a lot of good options for those seeking a return. As other markets become saturated with investors and bubbles in other sectors start to grow or burst, more money will flow back into the housing market, looking either to buy houses or lend to buyers.

According to a Federal Reserve survey, banks eased lending standards for home mortgages and auto loans in the fourth quarter of 2015. Even though the easing was supposedly only slight, will this become a continuing trend over the course of the year? Will we have to worry about returning to the bad old days of subprime NINJA loans? Then there’s the news that homeowners are once again beginning to draw on the equity in their houses as a source of cash. The numbers are nowhere near their pre-crisis highs, but if this trend continues it could portend a growing housing bubble. As prices are stimulated higher through more money pouring into the housing market, you would expect more and more people to treat their houses as ATMs once again. These are just two possible indicators of a developing housing bubble, so we’ll remain on the lookout for others.

Image: David Chao

Bubble Watch: House Flipping Tech Startup?

You know that the economy has reached peak bubble when you start combining two bubble categories: house flipping and tech startups. Queue startup Opendoor, which has been in the news recently. It’s a startup that looks to buy homes quickly, then flip them for a profit. It’s more or less a “Cash For Houses” business, except that it does its business over the Internet. The business has raised a fair amount of money, and apparently has a line of credit sufficient to enable it to buy a fair number of houses. Opendoor thinks it can make a profit by buying houses that are undervalued and flipping them quickly to other buyers, but it is operating in a market whose prices are completely distorted by and dependent on central bank monetary policy. With so much easy money having been pumped into the financial system, everything looks like a sure bet. But when the Fed begins to really tighten policy, will Opendoor still be able to operate? When the Fed tightens, housing prices will begin to sink again and Opendoor will undoubtedly face difficulties in finding buyers for the homes it purchases at the prices it expects. As losses mount, its line of credit may shrink or even disappear. Like many other tech startups that have found easy going in the past seven years of easy money, Opendoor will likely find out the hard way that its business model is unsustainable without a steady boost of newly-created money from the Federal Reserve.

Image: Images by John “K”

Bubble Watch: Planes, Trains, and Automobiles (Okay, Just Planes and Ships)

Boeing 747-8 Freighter

Boeing 747-8 Freighter

Boeing is cutting production of its 747 in half. Demand that had been expected for the 747-8 freighter, in particular, never materialized. Is this just the result of airlines and air freight companies preferring twin-engine jets to the four-engine 747? Is there overcapacity among airlines, making it cheaper to buy or lease used planes than purchase them new? Or is the market for airplanes, in particularly freighters, declining as a result of the oncoming recession manifesting itself in a decline in air cargo?

Remember that the Baltic Dry Index, which represents the price of shipping raw materials, has been declining precipitously in recent days, reaching an all-time low last week. While some argue that that is due more to an oversupply of ships versus cargo to carry, could it not be indicative of a collapse in global trade? The HARPEX index, which reflects container shipping rates, i.e. finished goods, is declining as well. And of course the stock indices have started the year off in the red as well. When everything is declining at once, it’s a pretty ominous sign that bad times are on the way.

Image: Boeing Dreamscape

Bubble Watch: Billionaire Boating

The superyacht industry is back to its pre-crisis levels. Indicative of another bubble? Our series of Bubble Watch posts has sought to highlight industries that may be entering or firmly into bubble territory. Any time you hear “has reached pre-crisis levels” or “has returned to levels not seen since the financial crisis”, alarm bells should start to go off. One of the more pernicious effects of the boom and bust of the business cycle is that people begin to view the boom period as the model of what the economy should look like. Even though growth rates, price levels, etc. during the boom phase are unsustainable, those boom-time figures nonetheless remain the goal that people want to achieve. The only way to do that, however, is to reflate the bubbles, which is exactly what central banks do with their loose monetary policy. Slow and steady growth may not be attractive to those with a “get rich quick” mindset, but that’s how true economic growth and progress is made.

Image: Steve Corey

Bubble Watch: Is The Auto Loan Bubble Ready To Pop?

Ferrari Dealership
Is the Auto Loan Bubble Ready to Pop?
By Tommy Behnke

On Tuesday, it was announced that over seventeen million new vehicles were sold in 2015, the highest it’s ever been in United States history.

While the media claims that this record has been reached because of drastic improvements to the US economy, they are once again failing to account for the central factor: credit expansion.

When interest rates are kept artificially low, individuals are misled into spending more than they otherwise would. In hindsight, they discover that their judgment errors wreaked havoc on their financial well-being.

This is a lesson that the country should have learned from the Subprime Crisis of 2008. Excessive credit creation led too many individuals to buy homes, build homes, and invest in the housing industry. This surge in artificial demand temporarily spiked prices, resulting in over four million foreclosed homes and the killing of over nine million US jobs.

Instead of learning from the mistakes that sent shock waves throughout most of the planet, the Federal Reserve has continued with its expansionist policies. Since 2009, the money supply has increased by four trillion, while the federal funds rate has remained at or near zero percent. Consequently, the housing bubble has been replaced with several other bubbles, including one in the automotive industry.

Continue reading this article at the website of the Ludwig von Mises Institute…

Image: Alan Gore

Bubble Watch: Numismatics

1880 $4 Coiled Hair Stella Pattern

1880 $4 Coiled Hair Stella Pattern

We’re always trying to be on the lookout for more bubbles in this economy, plagued as it is by the Fed’s easy money. From Coin Update comes news that 2015 set a record for the most rare US coins reaching $1 million or more at auction. 17 coins achieved or exceeded that sum, up from 12 in 2014. Is the rare coin market in a bubble, just like the art market and markets for other expensive luxury goods?

Bubble Watch: They’re Baaaaack…

A credit union in San Francisco is offering a $2 million, no down payment mortgage loan to borrowers. And while this is being offered by a credit union, credit unions of necessity being more cautious lenders than banks, and the credit union will no doubt vet potential borrowers very carefully, what could be more indicative of a bubble than a no down payment, adjustable rate jumbo loan? Sure, this may not be a NINJA loan, but it’s being offered because of the huge amount of easy money pumped into the financial system by the Federal Reserve.

Bubble Watch News Roundup

A roundup of the top bubble-related news headlines from the past couple of weeks.

  1. This Palace-Style Mansion in Florida Just Boosted Its Price Tag to $159 Million (MarketWatch)
  2. Why Hong Kong’s Property Bubble Looks Set to Deflate (CNBC)
  3. London Office Development Hits Highest Level in Seven Years (Wall Street Journal)
  4. Chinese Billionaire Buys Modigliani Nude for $170 Million at Christie’s (Financial Times)
  5. Another Bubble Bursts: Ultra Luxury London Home Prices Tumble 12% (Zerohedge)
  6. Constellation Brands to Buy Craft Beer Maker for $1 Billion (Wall Street Journal)
  7. Dallas v Houston: Texas Property Is Booming Despite Low Oil Price (Financial Times)
  8. Baltic Dry Index Falls to New Record Low (gCaptain)
  9. Prime Central London House Prices Cool Down (Wall Street Journal)
  10. UK Fund Management Industry Swells to Record $1 Trillion (Bloomberg)
  11. Here’s How the Boring German Housing Market Turned Piping Hot (Bloomberg)
  12. Pie-Mania? Legendary Singer’s Pies Create a Stir Amid “Incredible Demand” (CNBC)