Monday, December 05, 2022

The Bubble Economy's Credit-Asset Death Spiral

Who believed that central banks' financial perpetual motion machine was anything more than trickery designed to generate phantom wealth?

Central banks seem to have perfected the ideal financial perpetual motion machine: as credit expands, money pours into risk assets, which shoot higher under the pressure of expanding demand for assets that yield either hefty returns (junk bonds) or hefty capital gains as the soaring assets suck in more capital chasing returns.

As assets soar in value, they serve as collateral for more credit. Higher valuations = more collateral to borrow against. This open spigot of additional credit sluices capital right back into the assets that are climbing in value, pushing them higher--which then creates even more collateral to support even more credit.

This self-reinforcing feedback of expanding credit feeding expanding valuations feeding expanding collateral which then feeds expanding credit has no apparent end. Modest houses once worth $100,000 are now worth $1,000,000, and nobody's complaining except those priced out of the infinite spiral of prices and credit.

For those priced out of traditional assets, there's NFTs, meme stocks and short-duration options. The credit-asset bubble-economy casino has a gaming table for everyone's budget and desire to "make it big" via speculation, since the traditional ladders to middle-class security have all been splintered.

This financial perpetual motion machine distorts traditional incentives. Why bother renting a house bought for speculative gains? Renters are problematic, better to just let it sit empty and rack up huge capital gains.

Count the lighted windows at night in all those new condo high-rises. Are even 20% occupied? Probably not.

This is how you get a "housing shortage": investors would rather keep units clean and off the market rather than risk renting units. When credit and asset valuations are both feeding an infinite expansion, all that matters is leveraging capital to acquire as many assets as possible to maximize the gains from this self-reinforcing wealth-creation machine.

This machine also incentivizes fraud. To really maximize gains, why not borrow clients' capital? Indeed, why not?

But unbeknownst to the central bank sorcerers and the greed-crazed participants, all systems have limits and all consequences have their own consequences, i.e. second-order effects. There are many such dynamics which are eroding the apparently unbreakable financial perpetual motion machine.

One is debt saturation. Even low rates of interest eventually pile up consequential debt-service obligations, and any weakening in revenues, cash flow or income exposes the borrower to a cash crunch which can only be resolved by selling assets.

Another is the widening disconnect between financially sound valuations and "market" valuations set by rapidly expanding credit and collateral. Based on rental income or cash flow, Asset B is worth $200,000, but it's currently valued at $1 million, and still rising. Obviously, traditional methods of valuation no longer apply.

But weirdly enough, they do. Debt service doesn't matter when your collateral is expanding so fast you can borrow mountains of capital at "low, low prices" and not even consider debt service. But once collateral stops rising and interest rates start rising, suddenly all those absurd obsessions with cash flow start making sense.

But too late, too late: bubbles, regardless of how rock-solid the sorcery, tend to manifest symmetry: they fall at roughly the same rate and magnitude as they rose. As collateral declines, loans slide underwater as the asset is not longer worth more than the outstanding loan. Credit dries up and so does buying as greed-crazed buyers start worrying that perhaps the asset they're about to buy might actually be worth less next month (gasp).

Liquidity and the credit impulse aren't sorcery, they're herd behaviors. When the madness of the herd switches from greed to panic, buyers disappear and thus so does liquidity--the ability of sellers to find a Greater Fool to buy the depreciating asset.

Greater Fools are soon wiped out and then there's nobody left who's dumb enough to buy assets that are in freefall and still far above any financially prudent valuation. The magic circle reverses, and as valuations fall, collateral shrinks and credit collapses. Lenders who greedily reckoned valuations and thus collateral would rise forever are stuck with life-changing losses--along with all the punters who built shanties of credit and leverage they mistakenly viewed as permanent palaces.

In making the economy dependent on the financial sorcery of self-reinforcing credit-asset bubbles, central banks and all the greed-crazed punters who participated have guaranteed a self-reinforcing death spiral as the "virtuous" self-reinforcing wealth-creation machine reverses into a self-reinforcing wealth-destruction machine.

Who believed that central banks' financial perpetual motion machine was anything more than trickery designed to generate phantom wealth? Once the death spiral reaches its devastating end-game, the true believers will have fallen silent.



My new book is now available at a 10% discount ($8.95 ebook, $18 print): Self-Reliance in the 21st Century.

Read the first chapter for free (PDF)

Read excerpts of all three chapters

Podcast with Richard Bonugli: Self Reliance in the 21st Century (43 min)


My recent books:

The Asian Heroine Who Seduced Me (Novel) print $10.95, Kindle $6.95 Read an excerpt for free (PDF)

When You Can't Go On: Burnout, Reckoning and Renewal $18 print, $8.95 Kindle ebook; audiobook Read the first section for free (PDF)

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $24, audiobook) Read Chapter One for free (PDF).

A Hacker's Teleology: Sharing the Wealth of Our Shrinking Planet (Kindle $8.95, print $20, audiobook $17.46) Read the first section for free (PDF).

Will You Be Richer or Poorer?: Profit, Power, and AI in a Traumatized World
(Kindle $5, print $10, audiobook) Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake (Novel) $4.95 Kindle, $10.95 print); read the first chapters for free (PDF)

Money and Work Unchained $6.95 Kindle, $15 print)
Read the first section for free


Become a $1/month patron of my work via patreon.com.




NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Roxanne F. ($54), for your marvelously generous contribution to this site -- I am greatly honored by your support and readership.

 

Thank you, Patrick I. ($54), for your splendidly generous contribution to this site -- I am greatly honored by your support and readership.

Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.


Our Privacy Policy:


Correspondents' email is strictly confidential. This site does not collect digital data from visitors or distribute cookies. Advertisements served by a third-party advertising network (Investing Channel) may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative). If you have other privacy concerns relating to advertisements, please contact advertisers directly. Websites and blog links on the site's blog roll are posted at my discretion.


PRIVACY NOTICE FOR EEA INDIVIDUALS


This section covers disclosures on the General Data Protection Regulation (GDPR) for users residing within EEA only. GDPR replaces the existing Directive 95/46/ec, and aims at harmonizing data protection laws in the EU that are fit for purpose in the digital age. The primary objective of the GDPR is to give citizens back control of their personal data. Please follow the link below to access InvestingChannel’s General Data Protection Notice. https://stg.media.investingchannel.com/gdpr-notice/


Notice of Compliance with The California Consumer Protection Act
This site does not collect digital data from visitors or distribute cookies. Advertisements served by a third-party advertising network (Investing Channel) may use cookies or collect information from visitors for the purpose of Interest-Based Advertising. If you do not want any personal information that may be collected by third-party advertising to be sold, please follow the instructions on this page: Limit the Use of My Sensitive Personal Information.


Regarding Cookies:


This site does not collect digital data from visitors or distribute cookies. Advertisements served by third-party advertising networks such as Investing Channel may use cookies or collect information from visitors for the purpose of Interest-Based Advertising; if you wish to opt out of Interest-Based Advertising, please go to Opt out of interest-based advertising (The Network Advertising Initiative) If you have other privacy concerns relating to advertisements, please contact advertisers directly.


Our Commission Policy:

As an Amazon Associate I earn from qualifying purchases. I also earn a commission on purchases of precious metals via BullionVault. I receive no fees or compensation for any other non-advertising links or content posted on my site.

  © Blogger templates Newspaper III by Ourblogtemplates.com 2008

Back to TOP