This Too Shall Pop

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The monsoons came to an end yesterday afternoon…more below…

In the meantime, the Financial Times, on the final page of the first section, reports the big news:

“China…is back in bubble land.”

After the expansion comes the contraction. After the bubble comes the clean-up. After the storm comes the sun.

But what is going on in China? What comes after the biggest export-led bubble ever? Another bubble?

It doesn’t seem possible. China’s number one customer is broke. It has far too many factories for those that are left. It should be closing up shop…and waiting out the bad weather. And yet, China is growing. A combination of hot money…and hot financial policy…is falling on everyone’s favorite green shoot like Miracle-Gro. Its trade surplus and foreign direct investment — the usual source of reserves of foreign currencies — are only half what they were last year. But the speculators are coming in…and they are bringing cash. This has boosted Chinese reserves past the $2 trillion mark…and provided the liquidity for another round of bubble-like conditions. Trading volumes in Chinese stocks, for example, are running three times last year’s.

The world’s investors and economists think they are looking at the Second Coming. Chinese growth will power the world out of its slump. Hallelujah…we’re saved! Things will be u201Cback to normal,” soon. Stocks rose yesterday in anticipation — with the Dow up.

Readers are warned: this too shall pop.

Back to normal is not where we want to go. u201CNormal” in the bubble years was perverted…odd…queer…weird…and unhealthy. What really makes people wealthier is capital formation — the accumulation of machines, resources, and skills. But instead of forming capital, the bubble economy consumed it. As the longer the u201Cnormal” bubble years went on, the poorer and more vulnerable people became.

But the big bubble has already popped. And these echo bubbles won’t bring it back. For behind the bouncy figures are the same limp facts we have been looking at all year. Americans aren’t buying. Mortimer Zucker in the Wall Street Journal:

“Households, overburdened with historic levels of debt will also be saving more. The savings rate has already jumped to almost 7% of after-tax income from 0% in 2007, and it is still going up. Every dollar of saving comes out of consumption. Since consumer spending is the economy’s main driver, we are going to have a weak consumer sector and many businesses simply won’t have the means or the need to hire employees. After the 1990—91 recessions, consumers went out and bought houses, cars and other expensive goods. This time, the combination of a weak job picture and a severe credit crunch means that people won’t be able to get the financing for the big expenditures, and those who can borrow will be reluctant to do so. The paycheck has returned as the primary source of spending.”

Americans aren’t buying; so China isn’t selling. Exports…the source of its real wealth…are down. And there’s no reason to think they’re coming back anytime soon.

But what about buying from inside China itself…and from its neighbors? Ah, we knew you were going to ask that question. So we prepared an answer:

It will come…but not right away. The typical Chinese consumer doesn’t want the same things the typical American wants. His house does not look like the typical American house, either. And it is full of different stuff too. It will take a while to restructure the Chinese export machine for the domestic market. In addition to the factories, the distribution and sales channels need to be restructured. And it will take a while for the Chinese consumer to change his habits. While the American consumer becomes an ant — busily stocking away food for hard times…the Chinese consumer must become a grasshopper, a spendthrift with an eye for luxury.

And as for China’s neighbors…such as Korea, Singapore, Taiwan, Vietnam, Thailand, Malaysia and Indonesia… they all soared thanks to the China boom. Now they’re going bust in kind.

“Korean production alone is already down 14%,” The Richebcher Letter’s Rob Parenteau tells us. “Japan is off 20%. Taiwan’s exports have dropped 28.5%. Singapore is already deep into recession. Thailand’s decayed into political crisis.

“Until US and European consumers come out of their shells, the new Asian meltdown doesn’t end any time soon.”

u201CCreative destructionu201D is what it takes — with the usual bankruptcies, disappointments, workouts, and dislocations.

The transition won’t be easy…or quick. Unemployment rises. The export economy must be destroyed before a new economy can be created. And while this is going on, the Chinese consumer is actually losing income. There may be riots and or even civil war.

Eventually, this will probably turn out okay. In the meantime, there is Hell to pay.

“This is not normal for Ireland,” said a colleague. “We’re used to rain, but this is not Irish rain. This is coming down hard.”

It came down hard — off and on — for three days. Then, about 3PM yesterday, the monsoons ended. The clouds parted; the sun came out.

Ireland has been hit hard by financial storms too. Its inflation rate has turned negative…for the first time since the Great Depression. Unemployment — which we reported near 14% earlier this week — is said to be closer to 12%, according to the local paper. That’s still more than twice what it was during the boom years.

“We see it everywhere,” explained an Irish colleague. “The roads used to be crowded with lorries (trucks). Now, they’re pretty empty. House prices are down about 30% (about the same as the US). And the Poles have left.”

The boom in Ireland attracted immigrants from Eastern Europe. For the first time since the English conquered the country, people from the outside were moving in. Ireland — a major exporter of people for hundreds of years — was flattered. Then annoyed. When we last visited practically all the waitresses and barkeeps we saw were Polish. There were signs in Waterford written in Polish. There was even a Polish-language TV station.

“The place was being taken over by the Poles,” grumbled an Irishman.

But now the Poles were gone.

But when we went to a fancy restaurant last night, the waitresses were…you guessed it…Polish.

“Well, the Poles and the Irish always got along,” continued our colleague. “Catholic…on the margins of Europe…uncivilized… We understand each other.”

Ireland was transformed in the boom years; it will never be the same. Prices rose and attitudes changes. Thousands of houses were built — in a dreadful style. Office and apartment buildings went up too — also with little concern for how they looked. Or maybe the Irish like ugly houses; we don’t know…we didn’t like to ask. American tour groups still come. But the people on the tours are older and grayer. The younger generation of Irish-Americans is less Irish and more American. They feel less attachment to Erin’s Isle… They have married Jews and Italians…gone on the Pill…and take their vacations in Paris and Cancun.

Meanwhile, in America, the citizens are increasingly turning to their government to fix the mess that the country is in. But the irony here is that our friends on the Hill knew exactly where this speeding train was heading…and let it just keep right on going, turning a blind eye to wreck that would inevitably occur.

As our own Addison Wiggin recently told an interviewer, “The House of Representatives did an investigation in 2005, following a paper that was published on their own website, showing that the derivatives risk that both Fannie Mae and Freddie Mac had exposed themselves to was potentially a disaster for the mortgage market.

“And they buried that paper, and fired the guy who wrote it. So, they were well aware of what was going on in 2005, but the market for mortgage-backed securities continued for two more years.

“They [the government] could have put the breaks on there.”

You can watch Addison’s full interview here.

In the USA, the deadheads are at it. They didn’t see the crisis coming. Then, they didn’t understand it when it hit. But that doesn’t stop them from trying to fix it — by giving the world more of what caused the crisis in the first place: stimulus!

What caused U.S. consumers to go so deeply into debt? Stimulus. What caused the Chinese to build so many factories? Stimulus. How come Americans have so many malls, so many houses, and so many bills they can’t pay? Stimulus! They were stimulated to borrow by low interest rates and rising house prices — both produced in whole or in part by federal policy.

In the old days, a country would have to settle up its trade deficit in gold. As gold was called away by surplus countries, deficit countries would have to raise rates to attract more gold and reduce consumption. They system always rebalanced itself. Then, when the United States went off the quasi-gold standard, the imbalances became huge. Americans were able to go deeper and deeper into debt…while the foreigners built up more and more capacity (and more and more dollars).

But who cut the dollar lose from gold? The feds. Who made it possible for US consumers to spend far more than they earned for far longer than they could afford? The feds. Who held down the prime rate below the inflation rate for nearly four years — long after the supposed “emergency” that called for such drastic action? Oh dear reader, we don’t have to tell you, do we? The feds.

That was how the feds caused the bubble in the property and the financial sector. But after the bubble blew up, they blamed Wall Street, called for more regulation, gave Wall Street trillions that taxpayers hadn’t even earned yet…and provided more stimulus! And now they’re talking about a “son of stimulus,” yet more stimulus to an economy that is already fritzed out on stimulus.

Dead companies are kept alive. Smelly, dead-fish assets are kept on the books. And brain dead economists find employment in the Obama administration… explaining why more stimulus will set everything right again. Has the average taxpayer seen any of that “stimulus”? Not likely.

And for a while, it looked liked a summer day in Ireland. We looked out the window, delighted. “See how pretty it is…wet…and glistening in the sun…” Then, the monsoon rains started up again…we turned…and went back to work.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century and Empire of Debt: The Rise Of An Epic Financial Crisis and the co-author with Lila Rajiva of Mobs, Messiahs and Markets (Wiley, 2007).

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