Money Changes Everything: the Party is winding down

Money Changes Everything: the Party is winding down. By Charles Hugh-Smith.

When the value of a modest home skyrockets from $200,000 to $1 million in a few years, that $800,000 in gain was not the result of any improvement in utility. The house provides the same shelter it did when it was worth 20% of its current value. The $800,000 gain is the result of the abundance of low-cost credit and the global search for a yield above zero.

Eventually, this vast expansion of “money” chasing yields and seeking places to park all the excess cash trickles into the real economy and the result is inflationary.

Consider how soaring home prices affect rents… The investor who buys the modest home for $1 million has much higher costs … The property taxes and insurance are much higher, and the comparable market rent of similar houses reflects the expected yield on investing $1 million: If investors expect a 3% yield after all expenses, then the rents have to rise so the investor/owner nets $30,000 annually … even though the house hasn’t materially gained any utility at all. The rent has to be high to justify the purchase price of $1 million.

“Free money” (credit at near zero interest rates) corrupts everything:

This is why all credit-asset bubbles are self-liquidating: Once the cost of credit drops to near-zero, there’s no discipline left: Any loan for any investment can be justified by the “guaranteed” increase in value/collateral. Since everything will rise in value, then it makes sense to leverage up as much debt as possible to gain control of as many assets as possible, as the means to maximize gain. …

All this nearly free money sloshing around seeps into the real economy, jacking up prices (such as rents) without increasing the production of goods and services or improving productivity. Costs rise solely as a result of the bubble, pressuring wage earners and enterprises.

But now it is ending:

Central banks are eventually forced to raise interest rates and reduce credit expansion to put the brakes on the bubble’s inevitable offspring, an inflationary spiral. Once credit is no longer expanding rapidly, the air starts leaking out of the asset bubbles.

Marginal borrowers can no longer roll over their debt based on ever-higher collateral (as valuations rise, so does the collateral to support new loans) and default becomes inevitable once markets tighten. …

But inflation generated by bubbles is “sticky.” Landlords are reluctant to drop rents, as they’ve been trained by central bank bailouts and decades of easy money/credit to expect a prompt resumption of the bubble’s expansion. This mentality permeates the entire economy.

Liquidation is almost on the horizon:

Once valuations stop rising like clockwork, the bubble “prosperity’ is revealed as illusory. All the “wealth” was illusory; it wasn’t generated by improvements in productivity or the production of more goods and services; it was all based on soaring valuations driven by cheap, abundant credit and the bubble-mentality faith that bubbles never pop and so the “wealth” created by soaring stocks, bonds, collectibles and real estate would only continue expanding forever. …

Financialization isn’t real wealth:

The only source of real prosperity is improvements in productivity that generate more goods and services with fewer inputs of capital, labor, materials and energy.

So here we are: The global credit-asset bubbles are popping, and the illusory “prosperity” generated by the bubbles is about to tumble off a cliff. The $20,000 week at the posh resort was fun, as was the $80 lunch for two (two avocado toasts and two beverages), but it was all fake, phony, a fraud.

Jacking the valuation of a bungalow fivefold doesn’t actually improve productivity or create any new goods and services. It jacked up prices and property taxes, but it didn’t actually create any real wealth.

Alas, the natural order of markets is mean reversion and the collapse of whatever is unsustainable. This includes speculative manias, credit bubbles, asset bubbles and projections of endless expansion of margins, profits, sales, consumption, tax revenues and everything else under the sun.

The 40-year everything bubble: