2008 was not supposed to be possible again. Low interest rates and the newly discovered “right” to home ownership, as well as the earliest phases of DEI that promoted mortgage loans to unqualified applicants strictly because of their race (swinging that pendulum to the opposite of a vile practice of redlining) was amplified by Wall Street’s invention of another new way of selling risk to others at a profit--mortgage-backed securities. Bear Stearns, Lehman Brothers, and others were sacrificed on the Fed’s altar while the rest of the players were spared, Isaac-like. None of the inventors or marketers of fantasy value were ever held accountable. Sarbanes-Oxley sought to plug the holes in the dike of our fiat economy. But that law may now mainly be used to prosecute the political opposition to the elected half of the political-investment complex. Meanwhile, where the concrete meets the dirt, two new bubbles of fiat finance on opposite sides of the world and economic philosophy are bursting. Despite all efforts to hide their collapse, the splatter may yet affect worldwide economic well-being.
China’s version of interventional capitalism is verging on collapse from many factors, one being a massively over-built and over-leveraged housing market. As reported widely for the last several years, they have produced huge amounts of high-rise housing, in fact whole new giant cities, to “upgrade” the lifestyles of that large proportion of their population that is still rural to semi-rural. These new urban nesting sites were to feed their rapidly expanding population of urban workers required by astounding levels of growth in industrial and commercial production. That growth, organized and directed by central government authority, is reminiscent of America after WWII. In that latter case the productive capacity of the Western world had been destroyed by war, leaving only America as the Arsenal of Production. On the other hand, China won the WTO war, as transportation, communication, and especially native labor became cheaply available. CCP’s China followed the much earlier Japanese example, at first producing shoddy goods cheaply, gaining access to our avarice. Then rapidly acquiring, through means legal and paralegal, the technological know-how to match and exceed the quality of goods produced elsewhere. China’s supply of cheap labor readily imported from ever-more collectivized rural communities seemed endless. Energy was no problem; coal and other power plants burst forth like spring wildflowers. Needed infrastructure could not be opposed when the central government dictated what was environmentally friendly (an expanding economy was the only environment recognized) and private property was completely subservient to social welfare. Both efforts, seeded by fiat currency and an incoming flood of U.S. dollars and debt, accelerated the rate and worth of employment of the population. That controlled centralization of the economy bred the need for a controlled centralization of the population. The final uncontrolled factor, the Chinese Communist Party thought, was the raw materials for their holistic industrial domination.
Here the CCP had learned from recent history. Unlike the Japanese, who understandably had been desperate to acquire control of needed raw materials and staples, the CCP decided to engage in a worldwide, rather than regional, war of economic conquest. Thus was born the Belt and Road Initiative, initially conceived as the New Silk Road but then broadened as China’s ambitions grew. The giant profits from “unfair” trade and labor practices (as well as U.S. debt instruments?) were used to entice many second and third world nations or their greedy leaders into exclusive agreements to provide any and all the resources China needed from beyond their shores to continue expanding their economic cornucopia. Most of those nations have learned that the deals were very one-sided. Facilities and infrastructure were almost always built by Chinese companies, often with Chinese labor, with little direct economic benefit to the population of that nation other than under the table payments to corrupt oligarchs. The rights to raw materials are often exclusively China’s for many decades. And the costs and conditions for human labor often border on the inhumane. The success of these efforts inflated China’s domestic supplies, demands, and expectations as the perceived need for affordable housing expanded well beyond reality.
China’s self-inflicted domestic disaster of Covid may have been the needle that popped the unsustainable balloon of building on ever more leveraged and finally unsupportable credit. In Marxian fashion they exported both the virus they had created and the social, cultural, and economic kill-off designed to extinguish it. Their totalitarian lockdown extinguished their economy, and most consumptive markets of the world all followed their lead. With no production came no work and no incomes, and no need to frantically centralize the population. China’s new middle class could no longer afford their place in newly built urban beehives of commerce that had ceased building or failed to start. This exposed the overleveraging behind most of the newly and partially built ghost cities as demand for that housing disappeared and those that had already purchased on credit would no longer perform on their loans. Evergrande and other large Chinese real estate producers/financers began to implode and carry the economy downward despite the central governments’ rescue attempts. That implosion metastasized to all areas of the CCP economy. Whether that bubble will deflate or disappear remains to be seen.
CCP China’s real estate deflation has amplified our economy’s own reactive contraction. At the behest of our Executive branch, Treasury and Federal Reserve waved the magic wand of credit expansion and fiat money creation providing massive quantities of “funds” sustaining consumption while production, socialization, worship, and education were arbitrarily shut down during the Covid hysteria. Our pre pandemic Roaring 2000’s were the explosion of quantitative easing via artificially low interest rates limiting the 2008 meltdown. For more than two years we have had interest rates that were essentially zero to negative in central banking terms. Flush with cash and credit provided by an experiment in a kind of national universal basic income during the pandemic, and flush with time due to mandated inactivity, our demand rapidly outstripped supplies constrained by international shutdowns of production and transport. Inflation is not a rise in prices; it is a devaluation of a fiat currency due to excessive money supply which is partially fiat currency but mostly credit. All but our oldest had forgotten the double-digit Misery Index of 1970’s inflation and stagnation. The shocking rise in all prices was attacked with a shocking rise in interest rates designed to lead to a soft touch-down of the economy (or at least its financial sectors) at a “proper” level of 2% inflation. (I’ve never seen a simple explanation in layman’s terms as to why long-term devaluation of our currency, based only on our faith in our government, is desirable.)
Businesses just beginning to recover but hampered by employees unwilling to come into work have been caught up in the earliest phase of a price-wage spiral, with workers as usual falling rapidly behind in real income. Credit to finance new business and acquisition of still scarce and higher priced materials for production or sale is scanty and more difficult to obtain. A predictable “retrieval” of funds by large financial entities from several regional banks resulted in bank failures. Now proposed regulations will require greater banking reserves which will further reduce available credit creation. Even though regular folk usually recognize the falling “time value of money” in an inflationary environment and often exchange current cash for hard goods before it devalues further (see Venezuela and Argentina)—which is occurring here after arbitrary pandemic restrictions and mandates were lifted—they do recognize the limitations of the job market and income vise and aren’t engaging in longer-term indebtedness such as homes. They are priced out of the market by inflation and high interest rates meant to reduce that artificial rise in value. These and many more complex factors may lead us into a stagflation like that of the Japanese economy for the past few decades. We still have our own Chinese real estate problem.
As noted, creation of new money by bank or financial institution credit creation through loans is faltering due to deliberate reduction in supply (higher required reserves, higher interest rates, and a flight of “loanable” capital to safer higher interest-bearing instruments) and reduced demand (cautionary contraction of business activity and perceived personal inability to pay for loaned capital at current interest rates unmatched by inflation of income). One journalist has opened a package that may contain the pipe bomb of the U.S. real estate bubble.
Peter Grant, in his January 17, 2024, Wall Street Journal column of The Property Report, exposes the details of a commercial real estate market on the precipice. As a layman I was astonished to learn that commercial property mortgages for offices, shopping, and multi-family residences are “interest only”, meaning the borrower pays only the interest on the loan required to gain control of the property and then must pay off the principal at some predetermined future date with a new loan. In my layman’s mind, that means no business ever truly owns commercial property—they simply lease it, so to speak, from a financial lender who sells off the risk to the principal in other financial instruments. Sound familiar? Perhaps, to us simpleton consumers, analogous to the “mortgage-backed securities” leading to 2008. Grant notes the problem at hand is a massive amount of simultaneously maturing such loans. Over one-half Trillion dollars in such loans came due in 2023, dealt with largely through extensions of the loans by equally desperate borrowers and lenders as well as some new lending. However, that process will increase yearly to a peak of Six Hundred and Two Billion dollars in 2027, coincident with the earlier deals expiring as well. Meanwhile, due to economic and behavioral factors noted above, vacancy rates are high and rising, with no relief in site on interest rates. Commercial real estate in the U.S. is in its own price-wage spiral. As a result, delinquencies in paying off loans are increasing and expected to increase further, accelerated by a rapid drop in perceived value of commercial properties. Mr. Grant notes that Fitch Ratings projects increasing delinquencies of industrial, retail, hotel, and office properties, perhaps to be followed by multifamily properties as a coincident consequence. The Financial Stability Oversight Council was created following the 2008-2009 financial crisis “to monitor risks to the financial system”. Grant quotes that apparently impotent Federal sinecure: “Sales of financially distressed properties can…lead to a broader downward valuation spiral and even reduce municipalities’ property tax revenues.” In simple terms, large amounts of commercial real estate will have large amounts of its “value” extinguished; property tax revenue streams will drop and either services reduced and/or more money will have to be withdrawn from the private economy to replace those lost revenues. The businesses using these properties will not necessarily be able to continue their occupancy at some cheaper rate if there are no new “owners” to take over the administration of the properties. Given the contraction in economic activity, lenders may husband their funds or seek other more credit-worthy opportunities over the short to medium term. After all, the FSOC said in its 2023 report quoted in Peter Grant’s WSJ article, ‘financial institutions need to “better understand” their exposure to commercial real estate’. We know that these same institutions did not understand their exposure to mortgage-backed securities, and that is what led to the 2008-2009 financial crisis. Even if that does not happen again, the expanding whirlpool of value looks very much like recession, if not deflation. And despite their best efforts at buying up farmland and factories for strategic and financial reasons, neither the Chinese nor the Europeans (especially Germany) can rescue our situation with an infusion of foreign capital or repatriation of U.S. debt and dollars, the latter of which would bring its own disasters regarding the value of the dollar.
Of course, one sure method of staving off “economic justice” is available. Should the Federal Reserve reduce bank rates substantially, our domestic economy might escape an immediate reckoning. Mr. Grant quotes Matthew Anderson of data firm Trepp: “For commercial real estate, rate cuts can’t come fast enough”. This, and the upcoming national elections, probably will lead to a politically mandated drop in interest rates, and a declaration of success in a “soft landing”, even if on quicksand. That quicksand is a vast international pool mainly occupied by the world’s foremost predatory producer, the CCP Chinese, and the world’s greediest consumer, the U.S. Given the massive weight of their unused or under useable real estate, it may be an even bet as to whether one, the other, or both, sinks.