Friday, May 13, 2022

Curveballs in the Housing Bubble Bust

All these curveballs will further fragment the housing market.

Oh for the good old days of a nice, clean housing bubble and bust as in 2004-2011: subprime lending expanded the pool of buyers, liar loans and loose credit created speculative leverage, the Federal Reserve provided excessive liquidity and the watchdogs of the industry were either induced (ahem) to look away or dozed off in a haze of gross incompetence.

The bubble burst was also straightforward: unsustainable debt, leverage, fraud and speculation all unwound in 2009-2011. The cause was obvious and the effect easily predictable.

Alas, today's housing bubble and bust has these curveballs:

1. A stupid amount of cash sloshing around the world.

2. Who has the cash and an interest in using it to buy houses.

I considered the two conventional explanations for the current bubble in Is Housing a Bubble That's About to Crash?: 1) a housing shortage and 2) the Federal Reserve buying mortgage-backed securities and flooding the economy with cheap credit, causing mortgage rates to plummet to record lows.

As the per-capita housing chart below shows, the number of housing units per person (per capita) is now at the same level as the previous bubble. This doesn't support the housing-shortage explanation on a national scale (though local scarcities could be driving prices much higher), and points to a speculative cheap-credit-fueled FOMO frenzy as the primary source of the bubble.

Now that mortgage rates have risen from 3% to 5%, the speculative credit-FOMO bubble is popping.

Unlike the national bubble bust in 2009 - 2011, the current bust will be highly fragmented due to the huge number of wealthy people with stupid amounts of cash at their disposal, thanks to the Everything Bubble that made the already-wealthy much, much wealthier.

The housing bubble will burst in places where buyers must borrow to buy, not where wealthy cash buyers want to live. Those with cash don't care much about mortgage rates, nor are they terribly sensitive to price. What matters is they get to live where they want to live.

One reason why people with cash will be interested in using it to buy a house is the urban migration is reversing. The rich people who snapped up tony homes in tony urban neighborhoods are quietly selling to the unwary and moving to rural towns and exclusive enclaves far from decaying urban centers.

The places the wealthy want to live don't want sprawl and new homes sprouting up, so supply will be limited. Locals who preceded the wealthy also have a dim view of sprawl, congestion, overcrowded schools, and all the other blights of building booms.

Strong demand from cash buyers and limited supply equal home prices which don't drop, they only notch higher. Note that 1) mortgage rates don't matter to those with stupid amounts of cash and 2) these are not the average speculative buyer, they're buying for themselves, and are protective of everything that makes the place somewhere they want to live: they are Super-NIMBYs (not in my back yard). "Growth" is fine as long as it's somewhere else.

A large number of people with insane amounts of cash are not U.S. citizens, and they're seeking safe havens and nice neighborhoods in places like Canada, Australia and the U.S. Smart populations (for example, Switzerland) place restrictions on foreign ownership for the obvious reason that foreign cash can quickly drive prices beyond the reach of the homegrown populace. Citizens become landless serfs in their own country.

Absent such limits on foreign ownership, housing prices in desirable locales quickly rise beyond the reach of the non-rich and keep on going higher.

Many of these foreign wealthy are escaping capital controls and the potential clawback of ill-gotten gains, and so they are highly motivated buyers.

Corporate owners and buyers are another curveball. Corporations which snapped up hundreds or thousands of rental houses may have confused greed with investing genius, and a nice little recession may leave them with hundreds of vacant homes or newly unemployed renters resisting eviction for non-payment of rent.

As these corporations unload their massive inventory, prices could fall considerably lower than pundits anticipate.

Yet another curveball is urban decay. It's been roughly 50 years since U.S. cities unraveled in a self-reinforcing spiral of decay, and so the conventional view is rapid decay of basic services and the resulting collapse of housing values is "impossible." Before making any rash conclusions about "impossibility," research New York City circa 1971 - 1980.

What's been forgotten is the urban decay of the 1970s was reversed by two one-off miracle-saves: the exploitation of recently discovered super-giant oil fields, which brought energy costs down in the 1980s and beyond, and 2) the hyper-financialization of the U.S. and global economies.

Discoveries of new super-giant oil fields has petered out. The planet has been scoured and there are no more. As for financialization, boosting debt and leverage are now negatives, not positives. There will be no miracle-save by expanding debt, leverage and speculation.

Urban decay--declining tax base and tax revenues, soaring costs and crime and the out-migration of the wealthiest taxpayers--is a curveball few understand. It's "impossible" until it's unstoppable. People vote with their feet.

All these curveballs will further fragment the housing market. If national home prices fall 20%, locales blighted by corporate dumping of rentals and urban decay could fall 50% on their way to "impossible" declines. Locales favored by the wealthy with stupid amounts of cash could go up 50%.

Generational and regional inequalities have reached extremes that further fragment the bubble bust. Folks who bought homes for $150,000 decades ago in bubblicious coastal areas are selling out for $1 million in cash, while those who paid roughly the same price in a less-bubble-blessed region have $250,000 after selling-- $100,000 less than the current median home price. When you bought and where you bought makes all the difference.

This will drive further fragmentation as the sorta-wealthy with $1 million in cash scoop up the tier below the mega-wealthy. The $2.5 million house in the exclusive enclave is out of reach, but the one for $950,000 in a highly desirable locale is still do-able for the top 5%. Those having to borrow a mortgage and make payments out of wages will have to look for locales that have good fundamentals but aren't quite attractive enough to be over-run by those with stupid amounts of cash.

Paul of Silver Doctors and I discuss these topics in depth in The Big Problems And Crash Dynamics Of The Spring/Summer 2022 Housing Market Crisis, Simplified (1:08 hr).








Recent podcasts/videos:

The Big Problems And Crash Dynamics Of The Spring/Summer 2022 Housing Market Crisis, Simplified (1:08 hr)

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If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.



My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 print); read the first chapters for free (PDF)

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


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Wednesday, May 11, 2022

Herd on the Street

The casino has become complex and there are no easy answers or predictable paths.

The Wall Street herd had it easy from 2009 to 2021. Life was simple and life was good: markets were easy to predict. As long as the Federal Reserve kept interest rates near-zero and increased its balance sheet to buy Treasury bonds, the stock market rose.

As long as the Fed increased its balance sheet to buy mortgage-backed securities, housing rose.

If the Fed tried to reduce its balance sheet, the market would quiver and shake and throw a tantrum, and the Fed would go back to keeping interest rates near-zero and increase its balance sheet.

To make money all one had to do was buy the dips. Easy-peasy.

Alas, life is not so simple these days, and the herd doesn't know quite which way to run. Dynamics that were relegated to the margins for 13 years have emerged from the shadows to complicate the process of making money in markets.

Inflation has risen from the depths, breathing fire, stampeding the herd. The herd hears all sorts of messages and it can't discern signal from noise: inflation in transitory, no it's embedded, supply chain issues will go away, no they won't, wage inflation will reverse, no it won't, and so on.

All this complexity has confused the herd mightily. Keep it simple, stupid (KISS) no longer works.

Then there's foreign exchange (FX): the relative value of currencies barely moved. Who cared what micro-moves the yen and yuan made other than currency traders?

But now FX moves are big and spooky. The herd became complacent, everyone forgot that currencies mattered, and now the herd is skittish: what the heck does the yen and yuan getting crushed mean? Nobody's sure, and that spooks the herd.

Globalization has also run off the tracks. It was all so easy for the past couple of decades: close the plant here, shift production to sweatshops overseas, drop the quality of goods to boost profit margins, and voila, nothing to do but watch corporate profits climb.

Now that globalization is reversing, the herd doesn't know which way to run. Where will the easy, guaranteed profits come from now?

Energy has been cheap for so long, the herd took it for granted. Now that it appears there are actual physical limits that might affect the financial castles in the sky, the herd is discombobulated. You mean the input costs of everything will go up? Bu-u-u-ut what about the guaranteed higher corporate profits?

After decades of being compliant pack animals, the workforce has started wandering off. Millions of workers are quitting every month, dissatisfied and restive.

The Wall Street herd believed the hype about robots doing all the work and so automation would force workers to accept lower wages, but a funny thing happened on the way to lower-wage-Nirvana--the workers' pay was no longer enough to pay rent, student loan payments, food, taxes, etc.

The herd has no response to Marx being right after all except a deer-in-the-headlights blank look. That labor might actually stop caving in to corporate capital is incomprehensible, and the herd is in a real spot of bother.

The herd--fat, dumb and happy after years of easy money-- also has no means to comprehend diminishing returns. The fuel for higher profits and markets is expanding debt: nothing could be easier. And since the Fed will keep interest rates near zero, there's no real limit on debt, so borrow as much as you want.

But borrowing more eventually ceases to generate the desired effect. Rather than boost revenues, taxes, profits and markets, borrowing more now has a cost, and that cost is weighing on the gravy train.

Then there's global capital flows. For the past 13 years, money sloshed around the world more or less making everyone who was already rich even richer. The herd liked this, a lot, as the herd skims a percentage of all wealth and an even bigger chunk of new wealth.

Governments liked this too, because governments also skim a percentage of income, profits and wealth that boosts capital gains and property taxes.

But now global capital is flowing from the periphery to the core, and that complicates things. There are now big losers in the global casino, and should the flow of global capital become a raging torrent, the winners could become losers faster than they thought possible.

The herd on the Street is whining, please just make it simple and easy to make money. Sorry, Herd on the Street. Now you'll actually have to work to make money from not producing any goods and services. The casino has become complex and there are no easy answers or predictable paths.

I'm hearing good things about the yen-quatloo-bat-guano-Slobovian-bond-volatility ratio. You might give that a try. Or just run with the herd and hope you don't go off a cliff somewhere.








Recent podcasts/videos:

The Big Problems And Crash Dynamics Of The Spring/Summer 2022 Housing Market Crisis, Simplified (1:08 hs)

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My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 print); read the first chapters for free (PDF)

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


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Monday, May 09, 2022

The Problem with Money

I'm simply pointing out "money" isn't simple, and "backing money with X" leads to questions about the nature of "money," collateral and the fluidity and complexity of the social construct we call "money."

The problem with money is it isn't just one thing. We think it's one thing because we use it to buy things, but it's actually a bunch of different things. This is why I often refer to it as "money:" in other words, one of the class of things that are stores of value, transactional grease, debts and various other bits and pieces.

Recall that "money" is not a fixed class of things; it is a social construct. People agree to use (or are forced to use) something to transact tax payments, debt payments, stores of value, etc. "Money" only has value in a socio-economic system that is a social construct with social contracts and power relations.

Everyone wants to pin down what money is, but it isn't that easy. Money stock in the U.S. is called M2, which is basically the total of cash in accounts. On the chart of total debt below (TCMDO), courtesy of the Federal Reserve St. Louis database (FRED), I've noted M2 is currently $21.8 trillion.

Is this all the "money"? No. If you own a Treasury note or bond--debt issued by the federal government-- or a bond issued by a state or local government agency, you can sell that debt instrument fior cash. All government debt instruments are also "money."

So are private-sector debt instruments. If you own a corporate bond or shares in a mortgage-backed security, you can sell those debt instruments for cash and buy whatever you want--or pay your taxes.

Notice how "money" expands. This isn't just from the Treasury printing currency bills, or issuing new bonds, or the Federal Reserve creating "money" out of thin air to buy those Treasury bonds, it's also government agencies issuing bonds, corporations issuing bonds, mortgages on real estate being originated, student loans being issued, auto loans being originated, etc.

Note that all this debt "money" is backed by some sort of collateral. It might be a tangible object like a house on a parcel of land, or it might be the income stream from a government, corporation or individual.

Let's say we want to back all our "money" with gold. Which kinds of "money" do we back with gold? All of it, or just M2? If we only back M2, i.e. cash, then what's going to back the issuance of new "money" via mortgages originations, Treasury bonds, student loans, etc.? If not more gold, then what?

You see the problem. There is $88 trillion in "money" and only $21.8 trillion in cash. If we only back the cash (which also expands--see chart below), then what backs the rest of the "money" when people sell their bonds, etc.?

There was about $7.5 trillion in M2 "money" in 2008. Now there is about $22 trillion. If we're backing that "money" with gold, do we triple the number of ounces of gold we hold to back the cash, or do we dilute the amount of gold backing each unit of currency by holding the same amount of gold?

Do we limit the issuance of debt based on collateral? In other words, do we limit new loans to M2 cash, meaning any lender that wants to issue a mortgage has to have all the cash in hand? Dp we limit corporations from issuing debt to the cash they have on hand?

If we allow the expansion of "money" based on collateral, then how do we back such a rapidly expanding stock of "money"? If we grant that collateral "backs money," and that income streams are a form of collateral, then why do we need to "back money" with gold or anything else?

If we back a quarter of "money" with gold and let the rest float on the value (i.e. supply and demand for) collaterized "money," then we have two forms of "money": cash which can be converted to gold in some sort of unit-for-unit conversion and all other forms of "money" which aren't backed until they are converted to cash.

So what happens when people sell half the collateral-based "money" to convert it into cash? The supply of cash increases, while the stash of gold backing cash stays the same. What's the value of the cash measured in gold, given that each unit of cash now has a smaller claim on the gold stash?

Backing "money" with tangible things like gold sounds like a splendid solution to problems like inflation, but it comes with knotty questions about exactly what counts as "money," what "money" is actually backed, and how is this "money" backed if it cannot be converted into whatever is backing it-- gold, wheat, land, shares in a corporation, etc.

Consider a mortgage. The mortgage is debt backed by the collateral of a house on a parcel of land. The house and land "back" the new "money" created when the mortgage is originated. When I pay off the mortgage, I'm converting my cash "money" into what "backed" the "money": a house and parcel of land.

In other words, I converted cash into what "backed" the money: a house. If gold "backs" money, then it's only actually "backing" money if I can convert my cash into gold, just as I can convert cash into a house by paying off the mortgage.

If we discount collateral as "backing money," then what sort of financial system and economy do we have? Is collateral not a worthy "backing" of "money"? If not, why not? Why is a house and land not worthy of "backing money" any more than gold? And if I can't convert my cash into gold, then what is backing my cash?

Wouldn't I be better off with "money" that can be converted into collateral I can use such as a house than "money" I can't actually convert into anything? These questions upend conventional beliefs about "value," "backing money with X" and convertibility of collateral and "money."

Am I proposing an answer to these knotty questions? No. I'm simply pointing out "money" isn't simple, and "backing money with X" leads to questions about the nature of "money," collateral and the fluidity and complexity of the social construct we call "money."






My new book is now available at a 10% discount this month: Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $8.95, print $20)

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My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 print); read the first chapters for free (PDF)

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


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Friday, May 06, 2022

What Happens When Complexity Unravels?

Those glancing at the appearances will be assured all is well and it will all sort itself out. Those who look behind the screen will move away as fast as they can.

When finances tighten, there are two choices: cut expenses or increase revenues. Monopolies, cartels and governments can increase revenues by increasing taxes or the price of goods and services because users / customers / taxpayers have no alternative. The rest of us have to cut expenses.

Making lasting cuts in expenses generally requires reducing sources of expense, and within institutions and enterprises, complexity is one systemic source of expense. But reducing complexity is difficult, so it's rarely pursued unless the only remaining choice is bankruptcy / collapse.

The problem is there are many constituencies defending complexity and none favoring slash-and-burn reductions of complexity. As a result, complexity is defended and the core functions of the institution are sacrificed instead.

I've posted the charts below reflecting the extraordinary expansion of administrators in higher education and healthcare in the context of the Ratchet Effect and bureaucratic bloat.

The Ratchet Effect is: costs and complexity only increase, they never decrease because organizations are optimized to expand, not shrink, and so there are no institutionalized pathways to reducing complexity and costs.

Everybody clamors for a larger budget and another assistant. Nobody clamors for a radically reduced budget and staff.

This raises a question few seem to ask: what happens when complexity unravels?

Why will complexity unravel? The answer is simple: it costs too much, and supply-side and labor costs are rising. Something's gotta give, and that something will be complexity.

Complexity serves us well when it radically increases productivity. But this type of complexity is rare. Most complexity is self-serving waste and friction that reduces the productivity of labor and capital.

Labor has been suppressed for 45 years, and now labor costs must rise so workers can afford a higher cost of living.

Costs will rise inexorably for another reason: supply chains have been optimized for a perfect world of endless expansion. Barry Lynn, executive director of the Open Markets Institute, summarized the dynamic nicely: "Corporations have built the most efficient system of production the world has ever seen, perfectly calibrated to a world in which nothing bad ever happens."

Recalibrating every corporate supply chain for all the bad things that are happening will cost a fortune.

These costs will be passed on to consumers, but as the purchasing power of wages declines, there will be limits on how much consumers will be able to pay.

These higher costs will depress profits which will depress employment and tax revenues.

Corporations have two pathways: one is to cling to the old model and go bankrupt (or decay to irrelevance) or radically reduce costs by reducing unproductive complexity.

Corporations have been able to borrow vast sums to mask their insolvency but now that the cost of credit is soaring, that door to zombie-corporate-Nirvana has closed.

Stripped of the option of cheap borrowing, corporations will have to adapt or perish. Yes, it really will be that simple. Enterprises that burn through their capital run out of money and vanish.

Public organizations have long been optimized to increase their revenues and complexity because an expanding economy also expands tax revenues. Nothing boosts local tax revenues like a real estate bubble, and nothing boosts state income taxes like a speculative bubble in stocks, cryptocurrencies, etc.

But all bubbles pop, and public agencies are incapable of reducing their budgets, staff and complexity, because one politically influential constituency or another favors every program. So there's no way to trim anything without igniting a political firestorm as whatever sacred-cow program that gets trimmed arouses the constituency committed to preserving that sacred-cow.

But beneath the surface, the administrators protect their fiefdom by slashing staff that actually does the real work.

So universities cut tenured teaching positions in order to maintain administrator positions.

Healthcare cut physicians and nurses to maintain administrator positions.

Building departments cut onsite building inspectors to maintain administrator positions.

And so on. Lifeguards will be cut, library hours slashed, etc., while administrative positions remain (behind the screen of public-relations) largely untouched because all the complexity and political battles must be managed.

The net result is critical systems will be hollowed out and cease functioning. Those of us who depend on these systems will have to find workarounds.

When it takes six months to get a building inspection before you can pour a foundation slab, the workaround will be to just build the house: forget getting permission, just ask for forgiveness. That process will probably take years.

When there's a six month wait to see a physician, the workaround will be to pay cash.

In other words, all the complexity will remain firmly in place because somebody somewhere will wage ruthless political warfare to keep it, making it impossible to resize the system to fit available resources.

Those with the power to protect their jobs will make the unstated choice to throw everyone without the power to protect their income overboard to save themselves.

Meanwhile, the solution is obvious to administrators: raise taxes and fees to get more money out of all those rich folks, i.e. anyone who owns a house, has a good job, etc.

You're welcome, Tax Donkeys. We had to double your property, sales and income taxes to fund essential programs.

Things will fall apart behind the screen of normalcy. Cities double their business license fees, raise other fees (for trash collection. etc.) by 20% a year, year after year. The real budget crises are still ahead. The tax donkeys who've had enough will vote with their feet, moving away, forcing cities and counties to raise taxes and fees on the remaining tax donkeys.

This is how complexity unravels. Agencies' ability to manage their budgets and employees decays, hiding the reality they lack the structure or the will to downsize their complexity and costs to protect the agency's core functions.

All the compliance and reporting will be cobbled together to maintain the desired appearance, i.e. the illusion of precision in two-inch thick financial statements.

The appearances of fulfilling all the requirements of complexity will be maintained. The constituencies defending each sacred-cow will be placated, even as the system supporting all the sacred-cow programs collapses behind the PR screen.

Those glancing at the appearances will be assured all is well and it will all sort itself out. Those who look behind the screen will move away as fast as they can.












My new book is now available at a 10% discount this month: Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $8.95, print $20)

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.



Recent Videos/Podcasts:

The Dam Has Cracked (37 minutes, with Gordon Long)


My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 print); read the first chapters for free (PDF)

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



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Wednesday, May 04, 2022

The Contrarian Curse

What if all the new consensus memes are as wrong as the ones they replaced?

I have the Contrarian Curse, and I have it bad. The Contrarian Curse is: as soon as the herd adopts your previously contrarian view, you start questioning the new consensus, just as you questioned the previous consensus.

Example #1: fiat currencies are doomed. After all, if creating "money" out of thin air solves all our problems, why not just let everyone print as much as they want at home? Oh, wait, only the super-wealthy and powerful get the newly created "money"? Oh, that makes it really sustainable, doesn't it?

Now the hot meme is the US dollar is expiring and gold / commodity-backed currencies will replace it atop the heap. Many of us on the fringes have pondered alternatives to fiat currency, and so this becoming mainstream is a real sea change.

Which immediately arouses my contrarian curse. Ok, so exactly how does a gold/commodity-backed currency work? If gold or wheat declines (as measured in purchasing power to everything else), does the quantity of currency shrink to reflect this decline in value? Can the currency supply only expand if gold/commodities rise in relative value? Can the issuing central bank just keep emitting new currency without expanding the reserves of gold/commodities?

What about private banking creating new "money" by originating new mortgages and other loans? What's backing all this new privately-created "money"?

Lots of knotty questions, few if any detailed answers to how a gold-backed currency functions in actual markets. An idea can be great as an abstraction but the execution of the details is what differentiates an abstraction from a real-world system that's functional, transparent and thus trustworthy.

Can I convert my gold-backed quatloo into gold? If not, then what exactly does gold-backed mean?

As for digital currencies issued by central banks or private banks, how are these different from existing fiat currencies, which are for all intents and purposes, already fully digital currencies?

Even more contrarian: what if the demand for US dollars pushes the relative value higher despite the intrinsic flaws in fiat currencies?

"Money" is a funny thing. You can print more, but expanding the supply tends to devalue the existing stock of "money," reducing the value of the newly issued currency. But if demand for the "money" exceeds supply, the relative value increases even as the supply continues to expand.

Here's another funny thing about "money." Take a bunch of loans--student loans, truck loans, mortgages, lines of credit, etc., and extinguish all that debt by writing them off as uncollectible, forgiving the loan, reducing the market value of the underlying collateral (if any), and so on. All that "money" goes to Money Heaven and the supply of "money" shrinks accordingly.

If demand remains steady, this reduction in the supply of "money" will push its relative value up. (Questions like this prompted me to write Money and Work Unchained.)

Example #2: yields and interest rates have to stay near-zero or the system implodes. Now that debt has ballooned to insane levels, there's no way to service the debt except at near-zero rates of interest which means Treasury yields also have to be near-zero.

Now that this is the consensus, I wonder: what if rates will continue rising anyway? What would it take for the 40-year bull market in bonds--i.e. 40 years of declining yields/interest rates--to reverse into a Bear market for bonds, i.e. yields/interest rates steadily marching higher?

What if entire mountains of debt are extinguished, effectively reducing the supply of "money"? If capital becomes scarce, then perhaps there will be a premium charged to borrow it.

Geopolitically, one way to reduce the burden of higher commodity prices is to increase the value of the nation's "money" by inducing demand while limiting supply. One way to induce demand is to treat capital fairly and transparently.

What if all the new consensus memes are as wrong as the ones they replaced? I told you it's a curse.




My new book is now available at a 10% discount this month: Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $8.95, print $20)

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.



Recent Videos/Podcasts:

The Dam Has Cracked (37 minutes, with Gordon Long)


My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 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.




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Sunday, May 01, 2022

Is Housing a Bubble That's About to Crash?

We are all prone to believing the recent past is a reliable guide to the future. But in times of dynamic reversals, the past is an anchor thwarting our progress, not a forecast.

Are we heading into another real estate bubble / crash? Those who say "no" see the housing shortage as real, while those who say "yes" see the demand as a reflection of the Federal Reserve's artificial goosing of the housing market via its unprecedented purchases of mortgage-backed securities and "easy money" financial conditions.

My colleague CH at econimica.blogspot.com recently posted charts calling this assumption into question. The first chart (below) shows the U.S. population growth rate plummeting as housing starts soar, and the second chart shows housing unit per capita, which has just reached the same extreme as the 2008 housing bubble.

Demographics and housing do not reflect a housing shortage nationally, though there could be scarcities locally, of course, and other factors such as thousands of units being held off the market as short-term rentals or investments by overseas buyers who have no interest in renting their investment dwellings.

On a per capita basis, housing has reached previous bubble levels. That suggests housing shortages are artificial or local, not structural.

Next, let's consider how the current housing bubble differs from previous bubbles in the late 1970s and 2000s. In my view, the previous bubbles were driven by demographics, inflation and monetary policy: in the late 70s, the 65 million-strong Baby Boom generation began buying their first homes, pushing demand higher while inflation soared, making real-world assets such as housing more desirable.

Once the Federal Reserve pushed interest rates to 18%, mortgage rates rose in lockstep and housing crashed as few could afford sky-high housing prices at sky-high mortgage rates.

The housing bubble of 2007-08 was largely driven by declines in mortgage rates (as the Fed pursued an "easy money" policy to escape the negative effects of the Dot-Com stock market bubble crash) and a loosening of credit/mortgage standards. These fueled a bubble that morphed into a speculative free-for-all of no-down payment and no-document loans.

This decline in the cost of borrowing money (mortgage rates) enabled a sharp rise in the price of housing, a speculative boom that was greatly accelerated by "innovations" in the mortgage market such as zero down payments loans, interest-only loans, home equity loans, and no-document "liar loans"--mortgages underwritten without the usual documentation of income and net worth.

These forces generated a speculative frenzy of house-flipping, leveraging the equity in the family home to buy two or three homes under construction and selling them before they were even completed for fat profits, and so on.

Needless to say, the pool of potential buyers expanded tremendously when people earning $25,000 a year could buy $500,000 houses on speculation.

Once the bubble popped, the pool of buyers shrank along with the home equity.

If we study this chart below of new home prices (courtesy of Mac10), we can see that the 21st century's Bubble #2 rose as the Federal Reserve pushed mortgage rates far below historic norms. Once rates reached a bottom, the 7-year inflation of home prices (from 2011 to 2018) began rolling over.

This deflation of home prices was reversed by the pandemic recession, as the Fed's vast expansion of credit and mortgage-buying, which pushed mortgage rates to new lows. Trillions of dollars in new credit and cash stimulus ignited a speculative frenzy in stocks, bonds and real estate, a frenzy which drove bubble #3 to extraordinary heights.

All this unprecedented fiscal and monetary stimulus also ignited inflation, and so rates are rising in response. Bubble #3 is already deflating, at least by the measure of new home prices.

But the current bubble has a number of dynamics that weren't big factors in previous bubbles.

One is the rise of remote work. Many people have been working remotely since the late 1990s enabled Internet-based work, but the pandemic greatly increased the pool of employers willing to accept remote work as a permanent feature of employment.

This trend has been well documented, but the consequences are still unfolding: remote workers are no longer trapped in unaffordable, congested cities and suburbs.

Several other trends have attracted much less attention, but I see them as equally consequential.

1. Housing in many urban zones are out of reach of all but the top 10% without extraordinary sacrifice, and now that employment isn't necessarily tied to urban zones, the bottom 90% of young people without family wealth or high incomes are coming to realize the benefits of urban living are not worth the extreme sacrifices needed to buy an overvalued house.

A middle-class life--home ownership, financial security, leisure and surplus income to invest in one's family and well-being--is no longer affordable for the majority of young Americans.

Few are willing to concede this because it reveals the neofeudal nature of American life. Those who bought homes in coastal urban zones 20+ years ago are wealthy due to soaring housing valuations while young people can't even afford the rent, much less buying a house.

If you're not making $250,000 or more a year as a couple, the only hope for a middle-class life that includes leisure and some surplus income to invest is top move to some place with much lower housing and other costs. That place is rural America.

2. The benefits of urban living are deteriorating while the sacrifices and downsides are increasing. Urban living is fun if you're wealthy, not so fun if you don't have plenty of surplus income to spend.

Urban problems such as homelessness, traffic congestion and crime are endemic and unresolvable, though few are willing to state the obvious. Americans are expected to be optimistic and to count on some new whiz-bang technology to solve all problems.

Unfortunately, problems generated by dysfunctional, overly complex institutions, corruption and unaffordable costs can't be solved by some new technology, and so the decay of cities will only gather momentum.

The hope that billions of federal stimulus funding would solve these problems is about to encounter reality as the funds dry up and all the problems remain or have actually expanded despite massive "investments" in solutions.

Few analysts have looked at the finances of high-cost cities. The decline in bricks-and-mortar retail, rising crime, soaring junk fees, rents and property taxes have all made urban small business insanely costly and therefore risky.

Small businesses are the core sources of employment and taxes. As high costs, crime, etc. choke small businesses, employment and tax revenues drop and commercial real estate sits empty, generating decay and defaults.

Once office and retail space is no longer affordable or necessary, commercial real estate crashes in value as owners who bought at the top default and go bankrupt.

People need shelter but they don't need office space or to start a bricks-and-mortar retail business.

As urban finances unravel, cities won't have the funding to run their bloated, inefficient, overly complex and unaccountable bureaucracies.

3. In geopolitics, we speak of the core and the periphery. Empires have a core (Rome and central Italy in the Roman Empire) and a periphery (Britain, North Africa, Egypt, the Levant).

As finances and trade decay and costs soar, the periphery is surrendered to maintain the core.

In urban zones, the same dynamic will become increasingly visible: the peripheral neighborhoods will be underfunded to continue protecting the wealthy enclaves.

Crime will skyrocket in the periphery even as residents of the wealthy enclaves see little decay in their neighborhoods.

This asymmetry--already extreme--will drive social unrest and disorder. This is a self-reinforcing feedback: as the periphery neighborhoods deteriorate, the remaining businesses flee and the smart money sells and moves away.

Tax revenues plummet and city services decay even further, persuading hangers-on to move before it gets even worse. Cities compensate for the lower revenues by increasing taxes on the remaining residents and cutting services.

Each turn of the screw triggers more closures and selling and fewer tax revenues.

4. Dependency chains will become increasingly consequential: the greater a city's dependency on essentials trucked/shipped from hundreds or thousands of of kilometers/miles away, the more prone that city will be to disruptions of essentials: food, energy, materials and infrastructure.

Though few are willing to dwell on such vulnerabilities, most cities are totally dependent on diesel fueled fleets of trucks, rail and jet fuel for luxuries flown in from afar for virtually all goods. Cities produce very little in the way of essentials such as food and energy.

The past reliability of long supply chains has instilled a confidence that these supply chains stretching thousands of kilometers and miles are unbreakable and forever. They aren't, and the initial disruptions will be a great shock to Americans who believe full gas tanks and fully stocked store shelves are their birthright.

5. As I've explained in my new book Global Crisis, National Renewal, the era of cheap, reliable abundance has drawn to a close and now we are entering an era of scarcity in essentials.

Another reality few discuss is the relative stability of global weather over the past 40 years. As weather becomes less reliable, so too do crop yields and food supplies.

Globalization has poured capital into expanding acreage under cultivation to the point that the planet's forests are being decimated to grow more soy to feed animals to be slaughtered for human consumption.

On the margins, land that was once productive has been lost to desertification. Fresh water aquifers have been drained and glaciers feeding rivers are melting away. Soil fertility has declined even as fertilizer use has expanded.

The low-hanging fruit of GMO seeds, fertilizers, insecticides, herbicides and Green Revolution hybrids have all been plucked. The gains have been reaped but now the downsides of these dependencies are becoming increasingly consequential: fertilizer costs are rising fast, insects and diseases are evading chemicals and vaccines, and the vulnerabilities of mono-crop, industrialized agriculture and animal husbandry threaten to cascade into crop failures, soaring prices and shortages.

6. This will have two consequences: rural incomes which have been falling for decades due to globalization (i.e. bringing in cheap food from places with no environmental standards, cheap labor and few taxes / social costs) will start rising sharply, fueling a reversal in the long decline of rural communities based on agricultural income.

The soaring costs of essentials will reduce the disposable income of the bottom 90%, reducing the money they'll have to spend on eating out, retail shopping, etc.--all the surplus spending that drives cities' economies and tax revenues.

Few (if any) commentators forecast a cyclical reversal of the demographic trend of people moving from rural locales to cities. I think this trend has already reversed and will gather momentum as cities become increasingly unlivable, disposable incomes decline as scarcities push prices higher and people flee for lower cost, more secure environs.

7. As I often note, following what the super-wealthy are doing is a pretty sound investment strategy because the super-wealthy spend freely to buy the best advice and are highly motivated to protect their wealth.

People who live in well-known, highly desirable rural towns (Telluride, Jackson Hole, Lake Tahoe, etc.) are describing a feeding frenzy of wealthy urbanites buying multi-million dollar homes. Small cities such as Bozeman, MT and Ashville, NC are experiencing a flood of new residents that is straining infrastructure and pushing housing prices out of reach for local residents with average wages.

8. Rural towns in the U.S., Italy, Japan and even Switzerland are trying to attract new residents with offers of free land, subsidized rent, low cost homes, etc. This shows that the trends are global and not limited to any one nation. Would you take free land in rural America?

The decay of urban life isn't yet consequential enough to push people into making a major move, but once someone has been robbed, repeatedly found human feces on their doorstep or experienced scarcities that trigger the madness of crowds, the decision to leave becomes much, much easier.

Some cities will manage the decline of employment and tax revenues more gracefully than others. Most will suffer from the dynamic I've often described on the blog: the Ratchet Effect. Costs move effortlessly higher as tax revenues have increased in one speculative bubble after another, but once revenues drop, cities have no mechanisms or political constituency to manage a sharp, long-term decline in revenues.

They then become prone to the other dynamic I've described, the Rising Wedge Breakdown (see chart below): as agencies and institutions become sclerotic, unaccountable and self-serving, even a relatively modest cut in revenues triggers institutional collapse, as the system requires 100% funding to function. A 10% reduction doesn't cause a 10% decline in service, it causes an 50% decline in service, on the way to complete dysfunction.

Few believe cities can unravel, but remote work, geographic arbitrage (discussed below), tightening credit, rising crime, the decline of commercial real estate, end of massive stimulus, scarcities, the madness of crowds, the decline of civic services and amenities and an insanely high cost of living all have consequences and second-order effects.

What were beneficial synergies become fatal synergies as dynamics reverse and begin reinforcing each other.

So let's put all this together.

A. The cycle of declining interest rates and inflation has ended and a cycle of much higher interest and mortgage rates and inflation is beginning. Higher mortgages rates will depress housing prices as only the highest income households will be able to afford today's prices once mortgage rates rise.

B. The decay of urban finances and quality of life will accelerate as stimulus ends, credit dries up and inflation decimates disposable income.

C. The stress of trying to make enough money to afford the high costs of city/suburban living as the real estate bubble pops and the benefits of city living decline will burn out increasing numbers of people who will have no choice but to find more affordable, more secure and more livable places.

D. While the wealthy have already secured second or third homes in the toniest desirable towns, there are still opportunities for lower cost, more secure residences in rural areas.

E. This migration, even at the margins, will further depress urban housing prices and push prices in desirable rural locales higher.

F. This migration will have regional, ethnic and cultural variations. For example, some African-Americans leaving the upper Midwest are finding favor with communities in the South where family, church and cultural ties beckon.

G. Correspondent John F. used the phrase geographic arbitrage which means earning money remotely in high-wage sectors while living some place that's low cost and secure.

I wrote about this many years ago in my post about young Japanese maintaining a part-time remote-work gig while pursuing farming in rural communities: Degrowth Solutions: Half-Farmer, Half-X (July 19, 2014).

H. Though monetary / inflationary forces will pop housing prices based solely on low mortgage rates, this doesn't mean housing everywhere will decline: as burned out urbanites seek lower cost, more secure and livable places in rural locales, homes in desirable towns and small cities could rise sharply because they're starting from such low levels.

I. If urban areas decay rapidly, housing prices could plummet much faster than most people think possible.

When cities lose employment, tax revenues and desirability, they can go down fast. Property values can fall in half and then by 90%.

How is this possible? Supply and demand: if demand falls off a cliff, there won't be buyers for thousands of homes that come on the market all at once. This is just like a stock market in which buyers disappear, as no one wants to buy an asset that's rapidly losing value.

As I've noted many times, prices for assets are set on the margins: the last sale of a house resets the price for the entire neighborhood.

The stock market is easily manipulated by the big players, who can stop a slide in prices by buying huge chunks of stocks and call options. There are no equivalent forces which can stop a decline in housing prices.

And since rates will rise regardless of what the Federal Reserve does because global capital is demanding a real return above inflation, then the hope for lower mortgage rates to support bubble-level housing prices will be in vain.

How low could housing go? As explained above, there will likely be very asymmetric declines and increases in housing valuations going forward. But on a technical-analysis level, we can anticipate a general decline to previous lows, first to the 2019 lows and then to the 2011 lows.

Some analysts believe inflation will funnel capital into housing as investors seek assets that will go up with inflation, but this is a murky forecast: the bottom 90% of American households are already priced out of coastal housing, so inflation only robs their wages of purchasing power. They don't have any hope of buying a house anywhere near current prices.

Corporations are buying thousands of houses for the rental income, but once all the stimulus runs out and the excesses of speculation reverse, they'll find few renters can afford their sky-high rents. At that point corporate buyers become corporate sellers, but they won't find buyers willing or able to pay their asking prices, which are based on bubble pricing, not reality.

All these swirling currents will affect housing valuations in different places differently. Some areas could see 50% declines while others see 50% increases, regardless of mortgage rates or Fed policy.

What will become most desirable is a low cost of living, security and livability, which includes community, reduced dependency on long supply chains and local production of essentials.

We are all prone to believing the recent past is a reliable guide to the future. But in times of dynamic reversals, the past is an anchor thwarting our progress, not a forecast.

This essay was first published as a weekly Musings Report sent exclusively to subscribers and patrons at the $5/month ($54/year) and higher level. Thank you, patrons and subscribers, for supporting my work and free website.










My new book is now available at a 10% discount this month: Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $8.95, print $20)

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com.



Recent Videos/Podcasts:

The Dam Has Cracked (37 minutes, with Gordon Long)


My recent books:

Global Crisis, National Renewal: A (Revolutionary) Grand Strategy for the United States (Kindle $9.95, print $25, 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).

Pathfinding our Destiny: Preventing the Final Fall of Our Democratic Republic ($5 Kindle, $10 print, ( audiobook): Read the first section for free (PDF).

The Adventures of the Consulting Philosopher: The Disappearance of Drake $1.29 Kindle, $8.95 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, Gunnar G. ($5/month), for your marvelously generous pledge to this site -- I am greatly honored by your support and readership.

 

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