Real Estate Gold

This article published in Bloomberg should give us pause, because it’s not only in China where real estate leverage has become too big to fail. (And our POTUS is a real estate magnate.) In the aftermath of the financial crisis of 2008, real estate portfolios were not allowed to fail and Fed credits were used to protect excessive investment. Now we have a stark divide in the fundamental values of real estate versus the inflated prices of a product that is tax-subsidized and priced solely on the margin. As a speculative trading asset rather than basic shelter, housing has now become the tail that wags the dog of our lives. This is pretty insane, and plants us back in the age of land feudalism.

The problem, which is not only a US problem but a global one, is excess cheap credit that has led to a generational credit-debt bubble in the private and public sectors. It promotes the imbalance between China and the rest of the world and drives inequality world-wide. It reflects coordinated central bank policy under the leadership of the US Federal Reserve that was made possible by the untethering of fiat currencies – giving governments world-wide discretion over the value of their currencies.  We’ve tried to grow faster than our productivity warrants. It has greatly increased systemic risk, price volatility, and uncertainty over price signals. For example, what is a house really worth? $100K of materials or $5 million based on the marginal value of land? Or how much somebody can borrow against it?

Ultimately, the value of scarce land will have to be taxed accordingly, an idea put forth by Henry George more than a century ago.

Evergrande Is Too Big to Fail Thanks to Its Huge Land Holdings

China’s Most Indebted Firm Is Too Big to Fail

This property developer is borrowing even more to expand into unlikely projects, such as electric vehicles. But there’s a method to the madness.

There’s a lot working against China’s most indebted property firm. China Evergrande Group is sitting on $113.7 billion in debt and its core profit fell 45% in the first half of the year. Real-estate growth is slowing, with banks under orders to curb home loans. President Xi Jinping’s refrain that houses are for living in, not speculation, has been cropping up more frequently. 

Time to rein things in, right? Not Evergrande. The company, whose portfolio already includes theme parks and a football club, now wants to become the world’s biggest electric-vehicle maker in the next three to five years. It’s burning through precious cash – 160 billion yuan ($22 billion) – to build factories in Guangzhou. 

Investors are voting on this folly with their feet. The company’s shares have fallen 30% this year, making Evergrande the worst performer among Hong Kong-listed Chinese developers. The property firm’s borrowing costs are among the highest in the offshore dollar market and its bonds are tumbling.  

For anyone gawking at Evergrande’s improbably ballooning debt load, just waiting for the doomsday clock to strike midnight, there’s a valuable lesson: This firm is too big to fail. Evergrande is one of China’s biggest developers – with projects in 226 cities – and its billionaire founder, Hui Ka Yan, is the country’s third-richest man. With property accounting for about a quarter of China’s gross domestic product, any instability in the sector has proven too much for Beijing to stomach. Time and again, the government has reluctantly reopened the credit spigots to boost a flagging real-estate market. Just look at 2008, 2011 and 2014. [As we have in the US, leading to a big gap between those who own real estate and those who rent or would like to buy.]

Crucially, Evergrande has China’s largest land reserve, with 276 million square meters (905 million square feet) of gross floor area, according to Citigroup Inc. While the developer has a lot of exposure to China’s smaller cities, where growth is slowing rapidly, it also dominates redevelopment in big, rich cities such as Shenzhen, where profit margins are robust. 

Land is scarce in Shenzhen, and urban renewal – demolishing old, low-density buildings to make way for high-rise apartments – is widely seen as the answer to the city’s growing population. These projects also give Evergrande access to cheap lots, which helps keep its land costs among the lowest of its peers, according to Toni Ho, an analyst at RHB Securities. If the protests in Hong Kong accelerate China’s plans to make Shenzhen the the next “global cosmopolis,” according to state-run Xinhua News Agency, Evergrande could be in a plum position.

The company’s diversification into electric cars is sure to bleed money for years, and competition is getting stiffer. During his visit to China last week, Elon Musk managed to score a tax break for Tesla Inc. But carrying out one of Xi’s signature projects has its perks: For example, clean-car manufacturers can get land much more cheaply from local governments than real-estate developers. That helps explain why a host of firms including Country Garden Holdings Co. and Agile Group Holdings Ltd. are jumping in.

Being in Beijing’s favor and securing low-cost inputs is no bad thing for a cash-strapped developer like Evergrande. Maybe there’s a method to the madness of its wild spending.

Money?

Good historical narrative of what really determines our economic fates, published in The New Yorker. The most relevant lesson:
 
“…the oldest and simplest reason of bankruptcy in finance: lending money to people who can’t pay it back.”
 
Those enthralled by Modern Monetary Theory should give this a bit of thought, especially our starry-eyed politicians.
 

Time is Money?

191090-strip

Yes, but no. The actual truism should be stated as: “Money is Time.” The difference, of course, is that time, not money, is the ultimate value. (The truism is probably most often stated in reverse because most people are confused as to the ultimate value of life, and thus respond better to the admonition that they are wasting money, not just time.)

Time is egalitarian. It is the great equalizer because in the course of a lifetime, an hour of time is equivalent to a rich or poor person alike, or a powerful or powerless person. Not equivalent as measured in terms of the currency of money, but equivalent as measured in time value.

“Money is Time” is also probably the most profound statement one can make in economics, because, in theory, economics uses money as the true measure of the value of time.

Think about this a little more deeply. What explains the differences in value between a horse, a car and an airplane? The difference in monetary value is explained by the efficiencies gained by a car over a horse, and an airplane over both. A horse can get one rider from Los Angeles to New York in probably about 2-3 months. A car can get maybe five or six people from LA to NY in about 3 days. An airplane can get 300+ people across the continent in about five and a half hours. If we compute and compare the three options in terms of man-hours expended, we can see why airplanes are valued that much more than a horse.

One could see this just as simply by comparing the productivity (in terms of time) of a tractor vs. a plow horse, or a computer vs. a typewriter, or a smart phone vs. a telegram. Technologies that allow us to make the most of our time are valued accordingly and displace less efficient technologies. And the time we gain is measured in monetary wealth.

This truism, that Money is Time, also has profound implications for how we control money as a measure of time. Money has been defined by its three functions: a unit of account, a store of value, and a medium of exchange. What money really does is tell us how much time value we have produced, saved, and stored up for future consumption. As such, money is merely an information signal that tells us if we are on the right track or not. If we are on the wrong track, being unproductive and wasteful, ultimately we have squandered time, not money.

I recently read a monograph by George Gilder, The New Information Theory of Money, that explores this relationship between time and money in depth. He observes that Neanderthal Man had the same natural resources that we have today, since all matter is conserved. Homo sapiens today is much wealthier because  we live longer, we spend less time working for food and shelter, and have much more opportunity for leisure and cultural pursuits. Our wealth is really a measure of how productive we have become with our time.

Gilder’s monograph analyzes what this means for our concepts of money. When we think of money as wealth, we come up with all sorts of schemes to increase the supply of money in order to increase wealth. When we consider the actions of the central banks for the past hundred years, we can see that this fallacy defines our misguided policies. This should be clear from the actions of the US Federal Reserve since the 2008 financial crisis, both leading up to that crisis and in reaction. Fed policy, referred to as Zero Interest Rate Policy and Quantitative Easing, has merely goosed the nominal prices of assets such as houses, collectibles, land, stocks, and bonds with the idea that more nominal wealth as measured in US$ will lead to greater productivity and real wealth as measured by the value of time.

It hasn’t quite worked that way. Why? Because the Fed is focused on managing inaccurate statistical measures of real wealth as denoted by GDP, money incomes, CPI price changes, etc. Policymakers focus on the monetary economy rather than the real economy because that’s what is measured by their statistical information. Perhaps it is the best proxy we have, but it is still a proxy.

You must ask yourself – are you richer in terms of time? More time for you and your family to spend as you see fit? Those few beneficiaries (the 1%) who have benefited directly from this misguided monetary policy can certainly answer yes, but for the aggregate body politic, the answer is no.

Money supply today is controlled by governments with their ability to expand and contract credit through the banking system. Thus, our monetary economies really operate according to the calculus of political power and influence. It is no accident that ZIRP taxes small savers in order to recapitalize large banks that made the bad loans that crashed the financial system. No wonder the majority of voters are disgruntled with the results.

Gilder explains the true value of money (as opposed to wealth), is as an information signal that helps us be efficient and productive with our time. When we distort this information source (which is exactly what the Federal Reserve does when it manipulates interest rates), we can only become less efficient and productive. He notes that gold was a more accurate basis for money information because its value was a direct function of the time and effort it took to get it out of the ground. Governments or private actors could not easily manipulate its value.

He applies this reasoning to an even better foundation for money, Bitcoin. Bitcoin is a digital currency that is “mined” by the application of mathematical algorithms that get more and more difficult to solve as time goes by. This means that in order for the supply of bitcoins to increase, we must become more and more efficient in terms of computing power. In other words, becoming more productive with time. You see, the more productive we are with time, the greater the wealth the monetary information signal should represent.

Currently, governments have little constraint over how much money they can create, meaning there is little hard discipline being imposed on political power. This can only be a dangerous state of affairs, as we know that power corrupts and absolute power corrupts absolutely. As I mentioned in a previous post, floating fiat currencies were intended (ala Milton Friedman’s monetarism) to discipline politics, but have failed miserably to do so. In fact, they have achieved the opposite, creating more volatility and chaos in the global economy.

But, with digital currencies, power, influence, and wealth have little or no sway over the supply of money, which means they cannot manipulate the value to suit their narrow interests. Of course, those who hold political or economic power are loathe to surrender it, so we can expect powerful forces to be opposed to taking control over the money supply away from them. But a money that is directly connected to the value of time must be the most efficient and productive information signal that will increase the value of wealth measured in time, while insuring both liberty and justice for all. Remember, time is the great equalizer.

Digital currencies today are not yet developed to the point of replacing fiat currencies, but if this discussion captures your interest I would recommend reading up on technologies such as bitcoin. Much of the literature focuses on the efficiency of a digital payment system, but the real payoff in throwing off the yoke of fiat currencies will be in terms of liberty,  justice, and true egalitarian democracy.

Rethinking Money

money-symbolsFor any of you who are too busy trying to make it to notice, we have a world-wide problem with government-issued (fiat) money. This article offers an interesting new conceptualization of virtual currencies that might weaken governments and strengthen individual freedoms world-wide. That should get the statists all in a tizzy.

From the WSJ:

Free-Market Money, Courtesy of the Web

Bitcoin was just the start for virtual currencies. Cloud-computing certificates, anyone?

 By BOB GELFOND

The digital currency called Bitcoin may or may not survive long-term, but it has already succeeded on one front: making people think seriously about alternative forms of money. More such alternatives to traditional currency will likely emerge.

The attraction of the Bitcoin is not just the anonymity it provides to users (an anonymity that the U.S. government has alleged some users have employed for money laundering). Bitcoin is also secure against traditional forms of counterfeiting. More important, the Bitcoin is designed to be scarce and thus immune to inflation. There is a limit to the number of Bitcoins—21 million—that is determined by a transparent rule and not by the whim of a central banker.

Gold used to serve this purpose. It was a commodity that was relatively scarce and not easily mined, thus reducing the risk of inflation. That valuable function has been superseded by today’s paper moneys. In this sense, Bitcoin is an electronic version of gold.

In the future, it is likely that other digital alternatives to currency will emerge, each one competing in the market to satisfy the needs of users. The possibilities are limited only by the imagination. Here is one:

Cloud-computing companies could issue certificates convertible into an hour of premium computing. Prices for other services could be quoted in terms of these certificates. The analogy is to traditional gold-backed currency, which was redeemable into physical gold at the option of the owner. While the dollar price of an hour of premium computing would vary with market conditions, the certificate would be guaranteed to always convert into one hour of premium computing. The maxim “time is money” would take on a new meaning.

Computing has become a fundamental element of virtually every technology, a common currency, so to speak, of doing business in today’s economy. Cloud-computing companies provide on-demand storage and computing at a price that varies with market conditions and the computing speed required. They compete on price and the quality and reliability of their cloud, which can be accessed from anywhere in the world at any time. Competition forces the companies to continually upgrade to the latest generation of computers and data-storage facilities.

Cloud-computing certificates could be redeemed at any time. The owner of a one-hour certificate, for example, could convert the certificate today or wait 18 months when presumably an hour of computing time would be able to do twice as much because of the increased computing speed that comes from Moore’s Law.

The certificates would never expire, so the owner need never convert them. Unlike gift certificates, they would not be fixed in price to a certain dollar value but to a fixed amount of computing time. If the public gained confidence that the cloud-computing companies were not flooding the market with certificates, the certificates might be viewed as stable and liquid enough to circulate as money. If the certificates were freely transferrable, they could come to be used to buy any product or service, or be saved as a stable store of value.

As confidence and familiarity in the certificates grew, the certificates could even be used as a basis for credit or any other thing that dollars are used for. Certificates would have an advantage over Federal Reserve-produced dollars as their supply and price would be completely dictated by the market.

During slow economic times, cloud-computing companies would have less incentive to expand their clouds and would reduce the number of certificates they issued. The reverse would happen in better economic times. The certificates would have an advantage over the Bitcoin: They could be converted into something of value, instead of just being based on relative scarcity.

It is impossible to predict what kinds of money a truly free market will create in an increasingly digitized world. But we can be confident in predicting that just as markets improve the quality of all products, they will do the same for money.

It’s 1984.

Breaking News (from the Financial Times):

G7 reaffirms commitment not to devalue currencies for domestic gain.

Finance ministers and central bank governors of the Group of Seven rich economies have reaffirmed a commitment not to seek to devalue their currencies for domestic gain.

After an informal two-day gathering in a country house hotel outside London with no communiqué, participants said on Saturday they were reassured by Japan that its revolutionary new economic strategy was not intended to weaken the yen.

And the results:

yen

What planet do these central bankers think we live on?

Honey, I Shrunk the Money

gold-fools

Here we go, or should we say it’s time to open our eyes to where we have been going for some time. The unelected heads of the world’s central banks now explicitly control our economic fates. But as I mentioned in a previous post, they have little experience or power to influence politics and so central bankers risk serious political fallout from their currency machinations. In the meantime, anyone holding dollars, or yen, or euros, or renminbi, or promises to be paid in any such paper, can watch the real value of their wealth slowly dissipate. This should have wonderful consequences.

From the WSJ:

‘Loose Talk’ and Loose Money

The G-20 concedes that central banks rule the world economy.

The main message out of the Group of 20 nations meeting in Moscow on the weekend boils down to this: Countries can continue to devalue their currencies so long as they don’t explicitly say they want to devalue their currencies. Markets got the message and promptly sold off the yen on Monday in anticipation of further monetary easing by the Bank of Japan.

This contradiction between economic word and deed shows the degree to which policy makers have defaulted to easy money as the engine of growth. The rest is commentary.

The days before the Moscow meeting were dominated by blustery fears about the “currency war” consequences of money printing in the service of devaluation. Lael Brainard, the U.S. Treasury under secretary for international affairs, gave a speech in Moscow warning against “loose talk about currencies.” She seemed to have in mind Japan, whose new prime minister Shinzo Abe has made a weaker yen the explicit centerpiece of his economic policy.

In the diplomatic event, all of that angst went by the wayside. The G-20 communique bowed toward a vow to “refrain from competitive devaluation.” But the text also repeated its familiar promise “to move more rapidly toward more market-determined exchange rate systems”—words that essentially mean a hands-off policy on currency values. So Japan can do what it wants on the yen as long as it doesn’t cop to it publicly.

That message was also underscored by Federal Reserve Chairman Ben Bernanke, who implicitly endorsed Japan’s monetary easing and declared that the U.S. would continue to use “domestic policy tools to advance domestic objectives.” When the chief central banker of the world’s reserve currency nation announces that he is practicing monetary nationalism, it’s hard to blame anyone else for doing the same.

The upshot is that this period of extraordinary monetary easing will continue. Economist Ed Hyman of the ISI Group counts dozens of actions in recent months in what he calls a “huge global easing cycle.” The political pressure will now build on the European Central Bank to ease in turn to weaken the euro. South Korea and other countries that are on the receiving end of “hot money” inflows may feel obliged to ease as well to prevent their currencies from rising or to experiment with exchange controls.

This default to monetary policy reflects the overall failure of most of the world’s leading economies to pass fiscal and other pro-growth reforms. Japan refuses to join the trans-Pacific trade talks that might make its domestic economy more competitive. The U.S. has imposed a huge tax increase and won’t address its fiscal excesses or uncompetitive corporate tax regime. Europe—well, suffice it to say that Silvio Berlusconi is again playing a role in Italian politics and the Socialists are trying to resurrect the ghost of early Mitterrand in France.

So the central bankers are running the world economy, with the encouragement of politicians who are happy to see stock markets and other asset prices continue to rise. Here and there someone will point out the danger of asset bubbles if this continues—ECB President Mario Draghi did it on Monday—but no one wants to be the first to take away the punchbowl. It’s still every central bank, and every currency, for itself.

————-

Prof. John H. Cochrane, writing in the Jan. 25 issue of the Hoover Digest:

Momentous changes are under way in what central banks are and what they do. We’re accustomed to thinking that central banks’ main task is to guide the economy by setting interest rates. Their main tools used to be “open market” operations, that is, purchasing short-term Treasury debt, and short-term lending to banks.

Since the 2008 financial crisis, however, the Federal Reserve . . . has crossed a bright line. Open-market operations do not have direct fiscal consequences, or directly allocate credit. That was the price of the Fed’s independence, allowing it to do one thing—conduct monetary policy—without short-term political pressure. But an agency that allocates credit to specific markets and institutions, or buys assets that expose taxpayers to risks, cannot stay independent of elected, and accountable, officials.

In addition, the Fed is now a gargantuan financial regulator. Its inspectors examine too-big-to-fail banks, come up with creative “stress tests” for them to pass, and haggle over thousands of pages of regulation. When we imagine the Fed of ten years from now, we’re likely to think first of a financial czar, with monetary policy the agency’s boring backwater.