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LDQ: Michael Hudson Lays Out The Game

by ARGeezer Thu Jul 11th, 2013 at 02:52:29 AM EST

From the Bubble Economy to Debt Deflation and Privatization   Michael Hudson  naked capitalism

   The Federal Reserve's QE3 has flooded the stock and bond markets with low-interest liquidity that makes it profitable for speculators to borrow cheap and make arbitrage gains buying stocks and bonds yielding higher dividends or interest. In principle, one could borrow at 0.15 percent (one sixth of one percent) and buy up stocks, bonds and real estate throughout the world, collecting the yield differential as arbitrage. Nearly all the $800 billion of QE2 went abroad, mainly to the BRICS for high-yielding bonds (headed by Brazil's 11% and Australia's 5+%), with the currency inflow for this carry trade providing a foreign-exchange bonus as well.

    This financial engineering is not your typical bubble. The key to the post-2000 bubble was real estate. It is true that the past year and a half has seen some recovery in property prices for residential and commercial property. But something remarkable has occurred. So in this new debt-strapped low-interest environment, Hedge funds and buyout funds are doing something that has not been seen in nearly a century: They are buying up property for all cash, starting with the inventory of foreclosed properties that banks are selling off at distress prices.


  Something else that has not been seen for almost a century is the USA on a gold standard. Under a gold standard it was common for banks to call in loans in bad times and then buy up the assets those loans had financed on the cheap. TPTB have figured out how to accomplish the same thing with fiat currency in the hands of a compliant monetary authority by pretending that we labor under the same constraints as those imposed by a gold standard. So this time we are being crucified on a virtual cross of gold.


Back to Michael Hudson

   Ever since World War II, the operating principle of real estate investors is never to use their own money - or at least, to use as little of their own as possible. Debt leveraging leaves the rental income paid to the banks as interest. The absentee owner is after the capital gain at the end of the bubble's rainbow. That is what a bubble economy is all about. But the only way that investors can obtain current returns above today's miniscule rates is to buy assets directly for cash.
    In a bubble economy, falling interest rates (e.g., from 1980 to today) almost guarantee capital gains. But today's near-zero interest rates cannot fall any further. They can only rise, threatening capital losses. That is what is panicking today's bond and stock markets as the Fed talks about ending QE3's near-zero interest rate regime. So there is little incentive for bond buying. Once interest rates rise, we are in an "anti-bubble" economy. Instead of capital The outlook looks dim for corporate sales and hence earnings. So instead of debt-leveraged inflation of asset prices, we have debt deflation of the overall economy.
   To put this in perspective, from 1945 until interest rates rose to their peak in 1980, there was an almost steady 35-year downturn in bond prices. The Bubble Economy was fueled by interest rates being rolled back down to their 1945 levels and even lower. Credit flowed into the financial markets to buy stocks, peaking in the dot.com bubble in 2000, and then to inflate the 2001-2008 real estate bubble. So we are now in is the Bubble Economy's legacy. We can think of this as Phase 2: repayment time, along with foreclosure time. That is what happens in debt deflation. The Obama Administration has broken its 2008 campaign promises to Congress and to voters to write down mortgage debt to the ability to pay or to market prices reflecting realistic rental values. The debt legacy has been kept in place, not written down.

   Jerome noted that much of the 'wealth' created during the US real estate bubble was, essentially, counterfiet. A mortgage is a claim over wealth. If the mortgage is for twice what the property can possibly bring over time on the market then it is half counterfeit, no less so than if a silver or gold coin is actually half base metal. Naturally expecting people to pay back the face value of the mortgage after its fraudulent nature has been exposed produces a dual crisis. It makes the government complicit with the fraudsters and it creates a crisis in the economy, as it is not possible to make everyone whole except by an expansion of the money supply  comparable to the fraud and providing that money to the victims. But this is not what TPTB have in mind.

    The more active amongst the very wealthy are only too aware of the inability of most of the citizenry to comprehend what has happened. This is due to lack of relevant experience, sophistication and, in too many cases, even interest. Too many are too easily distracted by fabricated controversies over social and religious issues, etc. If the wealthy cannot get their money back they want to end up with an even larger share of the existing pie, of which they already have a disproportionate share. They plan to do this through the vehicle of 'privatizing' governmental functions. What government does will cost the average citizen more when any given function is sold to private interests. As Michael Hudson notes:

  In place of a new bubble, financial elites are demanding privatization sell-offs from debt-strapped governments. Pressure is being brought to bear on Detroit to sell off its most valuable paintings and statues from its art museums. The idea is to sell their artworks for tycoons to buy as trophies, with the money being used to pay bondholders. The same dynamic is occurring in Europe. The European Union and European Central Bank are demanding that Greece sell off its prime tourist land, ports, transport systems and other assets in the public domain - perhaps even the Parthenon. So we are seeing a neo-rentier grab for basic infrastructure as part of the overall asset stripping.
    This is a different kind of inflation than one finds from strictly financial bubbles. It is creating a new neo-feudal rentier class eager to buy roads to turn into toll roads, to buy parking-meter rights (as in Chicago's notorious deal), to buy prisons, schools and other basic infrastructure. The aim is to build financial charges and tollbooth rents into the prices charged for access to these essential, hitherto public services. Prices are rising not because costs and wages are rising, but because of monopoly rents and other rent-extraction activities.
    This post-bubble environment of debt-strapped austerity is empowering the financial sector to become an oligarchy much like landlords in the 19th century. It is making its gains not by lending money - as the economy is now "loaned up" - but by direct ownership and charging economic rent. So we are in the "economic collapse" stage of the financialized bubble economy. Coping with this legacy and financial power grab will be the great political fight for the remainder of the 21st century.

    I agree that coping with this power grab SHOULD be the great political fight of the 21st century, but I am still waiting to see anything but the supine being plundered by the wealthy. And they do not even understand what is happening.

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To reinforce Hudson's point about investors buying property for all cash, we have considered using some of our savings to buy a rental house locally. At least we could get some income from the rental. We have been deterred by the uncertainties and our lack of experience as landlords. Had we known someone of good character who would rent the property we likely would have done it, but I would have had to do the maintenance and I have enough maintenance to do at the property in which we reside.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jul 7th, 2013 at 09:29:24 AM EST
apparently some our wealthiest corporations got their start from buying property at bargain basement prices during the great depression.

rinse, repeat

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Sun Jul 7th, 2013 at 10:00:13 AM EST
Recessions and depressions are typically when economically strong actors consolidate or deepen their market position by buying up bankrupt competitors for pennies on the dollar, keeping anything useful, such as IP rights, selling what ever they can, such as last generation machine tools, preferably abroad, perhaps keeping a few key people and letting the rest go. In good times they expand horizontally, either geographically or into new markets. Rinse, repeat. The rich get richer, the rest get poorer.

But that was when manufacturing was a much more significant part of the economy and there is less scope for such activity today. Since the '80s we have had serial bubbles: financial bubbles, that were labled 'debt crises', with the crisis involving the need by the lenders to be made whole, as with the savings and loan fiasco and the Latin American debt crises in the '80s and in 'emerging markets' in the '90s; the stock bubble and dotcom bubble that burst in 2000; and then the mother of all bubbles in real estate that burst in 2008, taking stocks with it.

Were Treasury and Fed to create $800 billion of QE for the public, which would go a long way to reviving the economy, TPTB would scream their heads off, but creating $800 billion that mostly ended up in investments in the Brics, largely Brasil, produced only mild grumbling. Brazil became sufficiently concerned about the inflow of capital that they instituted capital controls - a tax on money that left before the required time. This flow was also a factor in Brazil and China agreeing to denominate their trade in Renminbi. The capital inflows from the US were causing the value of the Real to rise to levels that would have distorted trade with China otherwise.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jul 7th, 2013 at 11:53:49 AM EST
[ Parent ]
In a bubble economy, falling interest rates (e.g., from 1980 to today) almost guarantee capital gains. But today's near-zero interest rates cannot fall any further. They can only rise, threatening capital losses. That is what is panicking today's bond and stock markets as the Fed talks about ending QE3's near-zero interest rate regime.
That sounds reasonable, but there have also been rumblings from "investors" complaining that low interest rates make it impossible for them to make a profit.

So I think there are two kinds of speculators out there, the ones the are carry-trading the dollars and the ones that are investing in dollar assets, and whatever happens to interest rates one of the two groups is going to be hurt.

Finance is the brain [tumour] of the economy

by Migeru (migeru at eurotrib dot com) on Sun Jul 7th, 2013 at 02:22:28 PM EST
I think the real reason for the ZIRP is so the Fed and the Treasury can afford the QE life support for the TBTFs. As long as the TBTFs are never forced to mark to market their bogus paper those who own these institutions are not forced to take the writedown. Since the owners of the TBTFs also are the current lease holders on the US Government extend and pretend is the order of the day. The rest is just road kill.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jul 7th, 2013 at 03:53:57 PM EST
[ Parent ]
So I think there are two kinds of speculators out there, the ones the are carry-trading the dollars and the ones that are investing in dollar assets, and whatever happens to interest rates one of the two groups is going to be hurt.

Position seems to be replacing raw wealth as a source of income. Managers and other middlemen are reaping excess profits at the expense of investors owning traditional assets while participating in a carry trade requires credit lines and knowledge unavailable to retail investors.

by Jute on Sun Jul 21st, 2013 at 05:05:08 AM EST
[ Parent ]
So I think there are two kinds of speculators out there, the ones the are carry-trading the dollars and the ones that are investing in dollar assets, and whatever happens to interest rates one of the two groups is going to be hurt.

These two groups don't have to be distinct. The classic Japan Carry Trade, exemplified by GE, involved borrowing Jp. Yen at a few basis points and investing it in dollar denominated financial instruments paying several percent interest. I suspect that most current big players are still doing both, but now there is greater currency risk: TBTFs borrowed for a few basis points from the Fed and invested in US stock markets but also in the BRICs - especially Brazil. This play had the added bonus of driving up the Brazilian Real wrt US$, especially for the early 'investors'. But now nervousness about both the Fed and Brazil has led to a mass exodus from that play and woe to the laggards.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Jul 22nd, 2013 at 02:09:42 PM EST
[ Parent ]
It's Time to Levy the Land  Yves Smith  naked capitalism

Yves cites the following from a 2009 interview:

Our tax system favors debt rather than equity financing. By encouraging debt it has prompted a tax shift onto the "real" economy's labor and capital. The resulting interest charge and tax shift mean that we're not as efficient and low-cost producers as we used to be. This makes it hard to work out way out of our foreign debt.

You want to phase out the "tollbooth" economy that adds unnecessary charges to the cost of living and doing business - charges that have no counterpart in actual necessary cost of production. You want to avoid monopoly rent of the sort that Mexicans have to pay Telmex. And you want to avoid having the tax collector lower property taxes, leaving more revenue available to be pledged to banks as interest on higher mortgage loans. To get a lower-cost world, you have to counter political pressure from real estate owners and their bankers to shift taxes off rent-yielding properties onto labor and capital. Income and sales taxes add to the price of doing business, and hence reduce their supply and competitiveness. Most economists - even Milton Friedman - recommend that the more efficient tax burden is one that collects economic rent - property rent, fees charged for using the airwaves, monopoly rent, and other income that is basically an access charge. If you tax land rent, for instance, this doesn't raise the price of housing or office space. The rent-of-location is set by the market place. Taxes - or interest charges to buy such property - are paid out of the market price for using this space or natural resource.

"Rent-seeking" charges are paid out of prices. So taxing economic rent doesn't add to prices. It simply collects what nature or public infrastructure spending have provided freely - site value, the broadcasting spectrum, the rights to access the internet or other technology in cases where prices exceed the reasonable cost of production. Unfortunately, despite what Milton Friedman said, the economy today is increasingly about how to get a free lunch of this sort - and how to get the government to avoid taxing it, and shift the tax onto labor and industry instead. This loads down the economy with unnecessary costs and higher prices, especially when rent-yielding assets are bid up on credit. That's the essence of this decade's real estate boom....


We can see why the Robber Barons thought it so important to erase the contributions of Henry George from the public consciousness.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Jul 7th, 2013 at 03:16:46 PM EST
Not sure many Americans fondly remember the mid-twentieth century commons.

In place of a new bubble, financial elites are demanding privatization sell-offs from debt-strapped governments. Pressure is being brought to bear on Detroit to sell off its most valuable paintings and statues from its art museums. The idea is to sell their artworks for tycoons to buy as trophies, with the money being used to pay bondholders. The same dynamic is occurring in Europe. ...

Back when we didn't have so much stuff, but transportation, housing, art, and education were within reach of the lower middle class and working class.  Hell, even a MLB game or day trip to Disneyland is beyond the means for such families today.  

by Marie2 on Tue Jul 9th, 2013 at 05:38:36 PM EST
Even as late as the first decade of the 20th century the museums in LA were a cheap treat, and there were a bunch of them: LA County Museum of Art, George Page Museum at the La Brea Tar Pits, The LA County Museum of Natural History, The Huntington Museum, Gardens and Library, The Southwest Museum, The Getty at Malibu and the new Getty Center, The Autry Museum of the American West, for starters. And, of course, Griffith Park, Griffith Observatory, The Greek Theater, The LA Zoo, The Hollywood Bowl, on and on. The museums were a bargain, though the musical venues could be pricy.

Fortunately, through my work I had connections with many of the musical venues and got complimentary seats at the Hollywood Bowl through the IBEW. I was the only one regularly interested in classical music concerts and we had several summers where we went every Wednesday night during the summer for free. Likewise, through my work I could arrange free parking and access to the Getty. We had installed the fiber-optics, telephone system, and video surveillance.(the Getty did not use copper cable for data.)

Then there were the beaches and the California State Parks, many of which are jewels. We camped at various state parks up and down the state as well as the National Parks such as Yosemite and Sequoia, but also dry camped in the desert while rock hounding, etc. Most of this, while neglected, is still intact.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jul 9th, 2013 at 07:54:20 PM EST
[ Parent ]
You can still get into the Metropolitan Musuem in NY for $1. And most of the museums in Washington are free.
by gk (gk (gk quattro due due sette @gmail.com)) on Wed Jul 10th, 2013 at 02:05:55 AM EST
[ Parent ]
Now, however, we can no longer be sure if that will remain so.

res humą m'és alič
by Antoni Jaume on Wed Jul 10th, 2013 at 09:06:28 PM EST
[ Parent ]
New posts of Michael Hudson:

The Insider's Economic Dictionary - Part A

Unlike psychological terminology, which consists mainly of terms of invective (try to think of a desirable personality complex), today's economic vocabulary is euphemistic. One rarely hears the terms rentier or usury that played so central a role in the debates of past centuries.

China - Avoid the West's Debt Overhead: A Land Tax is needed to hold down Housing Prices

How can China avoid the "Western financial disease" - a real estate bubble followed by defaults and foreclosures? The U.S. How can China avoid the "Western financial disease" - a real estate bubble followed by defaults and foreclosures? The U.S. and European economies originally sought to avoid this fate by taxing the location's site value. A rent tax was the focus of Progressive Era reforms.

Enacting a rent tax remains China's main challenge to accompany its privatization of real estate and natural resources. If land rent were fully taxed, it would not be paid to banks as interest for rising mortgage loans - and governments would not have to tax income and sales. Holding down housing debt will reduce labor's cost of living, but not its living standards. and European economies originally sought to avoid this fate by taxing the location's site value. A rent tax was the focus of Progressive Era reforms.

Enacting a rent tax remains China's main challenge to accompany its privatization of real estate and natural resources. If land rent were fully taxed, it would not be paid to banks as interest for rising mortgage loans - and governments would not have to tax income and sales. Holding down housing debt will reduce labor's cost of living, but not its living standards.

Can China indeed invent a perpetum mobile?
by das monde on Wed Jul 24th, 2013 at 06:47:52 AM EST


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