Video presentation: Chanos on China’s state-sponsored bubble

Thanks to Pej for finding this:

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Chanos relays a great quote from Milton Friedman: He was brought to watch the Chinese built a canal, and when he asked why they were using shovels and not bulldozers, he was told that machinery was being eschewed in order to create more jobs. Friedman replied with something like, “Oh, I thought you were building a canal. If it’s jobs you want, why don’t you give them spoons?”

Like the Chicago school that he founded, Friedman was great on most issues except for money. He couldn’t come to terms with the idea that the very existence of a central bank and legal tender laws create insurmountable moral hazard and will always lead to bubbles.

Ok, so how big is China’s commercial real estate bubble? Under construction right now, there are 25 square feet of office space for every person in China.

Family savings are being invested as down-payments for investments in highly-speculative developments. The bust will take care of a lot of the middle class’s much-touted savings.

Charlie Munger: “Basically, it’s over.”

Charlie Munger is the other billionaire from Berkshire Hathaway, the one who has never pimped for Hillary Clinton and still retains a great deal of common sense. He’s written an essay for Slate.com on how the US has come to ruin:

In the early 1700s, Europeans discovered in the Pacific Ocean a large, unpopulated island with a temperate climate, rich in all nature’s bounty except coal, oil, and natural gas. Reflecting its lack of civilization, they named this island “Basicland.”

The Europeans rapidly repopulated Basicland, creating a new nation. They installed a system of government like that of the early United States. There was much encouragement of trade, and no internal tariff or other impediment to such trade. Property rights were greatly respected and strongly enforced. The banking system was simple. It adapted to a national ethos that sought to provide a sound currency, efficient trade, and ample loans for credit-worthy businesses while strongly discouraging loans to the incompetent or for ordinary daily purchases.

Moreover, almost no debt was used to purchase or carry securities or other investments, including real estate and tangible personal property. The one exception was the widespread presence of secured, high-down-payment, fully amortizing, fixed-rate loans on sound houses, other real estate, vehicles, and appliances, to be used by industrious persons who lived within their means. Speculation in Basicland’s security and commodity markets was always rigorously discouraged and remained small. There was no trading in options on securities or in derivatives other than “plain vanilla” commodity contracts cleared through responsible exchanges under laws that greatly limited use of financial leverage.

In its first 150 years, the government of Basicland spent no more than 7 percent of its gross domestic product in providing its citizens with essential services such as fire protection, water, sewage and garbage removal, some education, defense forces, courts, and immigration control. A strong family-oriented culture emphasizing duty to relatives, plus considerable private charity, provided the only social safety net.

The tax system was also simple. In the early years, governmental revenues came almost entirely from import duties, and taxes received matched government expenditures. There was never much debt outstanding in the form of government bonds…

…But even a country as cautious, sound, and generous as Basicland could come to ruin if it failed to address the dangers that can be caused by the ordinary accidents of life. These dangers were significant by 2012, when the extreme prosperity of Basicland had created a peculiar outcome: As their affluence and leisure time grew, Basicland’s citizens more and more whiled away their time in the excitement of casino gambling. Most casino revenue now came from bets on security prices under a system used in the 1920s in the United States and called “the bucket shop system.”

The winnings of the casinos eventually amounted to 25 percent of Basicland’s GDP, while 22 percent of all employee earnings in Basicland were paid to persons employed by the casinos (many of whom were engineers needed elsewhere). So much time was spent at casinos that it amounted to an average of five hours per day for every citizen of Basicland, including newborn babies and the comatose elderly. Many of the gamblers were highly talented engineers attracted partly by casino poker but mostly by bets available in the bucket shop systems, with the bets now called “financial derivatives.”

Many people, particularly foreigners with savings to invest, regarded this situation as disgraceful. After all, they reasoned, it was just common sense for lenders to avoid gambling addicts. As a result, almost all foreigners avoided holding Basicland’s currency or owning its bonds. They feared big trouble if the gambling-addicted citizens of Basicland were suddenly faced with hardship. (cont.)

Basically, Munger blames derivatives and speculation for Basicland’s demise, and much to my surprise, he believes that the current over-levered state of affairs is an outcome of the free market:

These economists had intense faith that any outcome at all in a free market—even wild growth in casino gambling—is constructive. Indeed, these economists were so committed to their basic faith that they looked forward to the day when Basicland would expand real securities trading, as a percentage of securities outstanding, by a factor of 100, so that it could match the speculation level present in the United States just before onslaught of the Great Recession that began in 2008.

Of course, Austrians like myself could not disagree more with his implication of the market. We have anything but a free market in the US, nor have we had much of one in banking since 1913 when JP Morgan, JD Rockefeller, Jacob Schiff and friends secretly wrote the Federal Reserve Act and slipped it through Congress the night before Christmas Eve. With a government-sponsored cartel (the only lasting kind, by the way) and the power to bail themselves out, the bankers were freed from the restraints of the market. They created credit willy-nilly and blew bubble after bubble, each followed by a crash, only to outdo themselves each time.

Of course, if we are talking about the demise of a nation, there is a lot more to it than the banking cartel. I wouldn’t blame oil prices at all, and I would certainly blame welfare (moral hazard for the masses to match that for the bankers). I would also blame military adventurism, and I would put a very heavy stress on the ever-growing web of regulations that strangle enterprise and entrepreneurship, making everyone poorer while bestowing favors on particular corporations and interest groups.

Munger may not be an Austrian, and he may have a tad more respect for government than it is due, but he is a brilliant and honest guy, so his essay is definitely worth a read. Actually, his Almanac is a lot more fun.

One more way to stick it to the bank

Patrick.net writes about a 2009 federal law allows renters to stay in foreclosed homes to the end of their lease so long as they are current on their rent and the new owner does not make it their primary residence. This means that in addition to a long period of rent- and mortgage-free living, people choosing to default can rent out their homes at very low prices, and the banks will be forced to honor those contracts. So, the logic goes, why not offer your cousin a sweet long-term lease on the home you’re about to lose?

Unethical? Maybe. Deserved? Probably.

Banks often employ shady lawyers and contractors to try to scare misinformed tenants into vacating, but the law is on renters’ side:

Before May 20, 2009, most renters lost their leases upon foreclosure. The rule in most states was that if the mortgage was recorded before the lease was signed, a foreclosure wiped out the lease (this rule is known as “first in time, first in right”). Because most leases last no longer than a year, it was all too common for the mortgage to predate the lease and destroy it upon foreclosure.

These rules changed dramatically on May 20, 2009, when President Obama signed the “Protecting Tenants at Foreclosure Act of 2009.” This legislation provided that leases would survive a foreclosure — meaning the tenant could stay at least until the end of the lease, and that month-to-month tenants would be entitled to 90 days’ notice before having to move out (this notice period is longer than any state’s non-foreclosure notice period, a real boon to tenants).

An exception was carved out for the buyer who intends to live on the property — this buyer may terminate a lease with 90 days’ notice.

Nolo further opines:

Does It Make Sense to Evict Tenants?

New owners may want to terminate existing tenants because they believe that vacant properties are easier to sell. Common sense suggests otherwise. In many situations a building full of stable, rent-paying tenants will be more valuable (and command a higher price) than an empty building. Emptied buildings are also prone to vandalism and other deterioration — after all, no one is on site to monitor their condition. When entire neighborhoods become a wasteland of empty foreclosed multifamily buildings, their value drops even further. It’s hard to understand why new owners choose to pay lawyers to start eviction procedures instead of paying a modest fee to a management company to collect rent and manage the property while they wait to sell.

Another point to note is that if a tenant is writing checks to his old landlord after foreclosure, the bank is probably not going to pay for maintenance, so it would be best to negotiate reduced rent as compensation.

Of course, anyone actually thinking about this or walking away from a mortgage should consult a real estate attorney in their state.

The bubble down under

5-year view of the ASX 200:

Source: Bloomberg

Australia has a huge property bubble that has yet to burst. The average home there, at AU$502,492, is priced at eight times average household income, compared to about three times income at the height of the US bubble (though higher in places like California and Florida). This is a country with a population density of just 7.3 per square mile, compared to 83 for the US!

Aussies are still in the denial stage, which says a lot about the nature of group-think, since they can look at the rest of the world and see the exact same dynamic at play, though a couple of years ahead.

China appears to be in about the same place, with prices even more out of whack with incomes and rents, twice as overvalued as the most overvalued California houses in some cases. Australia and China also have plenty of froth in their equity markets, though those resemble the US and the rest of the world.

What would happen to Australia if housing prices, stock prices and commodity prices all collapsed at once? Come to think of it, Canada is in a very similar position, and their housing bubble, while not as wild, has still yet to deflate.

Keep an eye on the junk:quality ratio

Put this down in the list of no-fuss, no-brainer, long-term trades. Simply buy 10-year Treasury notes and short junk bonds. There is no purer deflation play than this. It doesn’t even matter if Treasury yields rise (unlikely anytime soon IMO), since you’re playing the spread and junk yields will always include Treasury yields plus a risk premium.

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What are some other such no brainers for deflation? The closer something is to cash, the better.

- Long gold, short stocks. (Remember, I’m a gold bear for 2010).

- Long gold, short a basket of commodities (silver, platinum, copper, zinc, lead, oil, sugar, lumber, grains, etc).

- Long Treasuries (2, 5, 10), short stocks. This bet is safer the shorter the duration of the treasuries, but to make it work with short-dated notes, you’d have to go long a greater notional value of Treasuries than stocks. This is easy with futures: for example, for every $1M short in ES (S&P500), go long $3M ZF (5-year notes).

- Long US dollar, short hot “developing nation” or commodity nation currencies (Brazil, Australia, Canada, Russia, India, South Africa, etc).

- For later, not just yet: long 5-year treasuries, short 30-year.

- The most hard-core deflation trade of all: long stacks of $100 USD notes, short everything else, or safer yet, don’t even bother with the trading. Just wait for the market to make you an offer you can’t refuse, like a 10% dividend yield on the S&P, or $0.30 copper, $20 oil or $0.05 sugar.

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To make the spread trades work, you’d have to watch your margins, set loose stops and then just leave the trades to do their thing for the next 2-5 years.

Cleared to fall

A lot of markets have had more than sufficient clearing rallies, and their charts would exhibit a nice proportionality if they were to top right around these levels. I think it’s likely that they meander or float a little higher for the next 2-5 days, but they could just as easily reverse hard at any moment.

The Australian dollar looks like a lot of these charts right now:

Prophet.net

The same wobbly pattern of rolling over can be seen here, in this Russian market ETF:

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The charts of the Canadian and New Zealand dollars, oil, copper and platinum are also remarkably similar to these above.

In the major US indexes like the Dow, seen below, the initial crack from the highs was much more violent, so the same impulses have not brought prices near to the old levels. This is similar to when the post-crash rally was broken in 1930 (2nd chart below).

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The Euro had a decent rally early in the week, but like the British pound after its June highs, its spirit is looking broken and it has fallen out of pace with the pack:

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Of course, if the current urge to speculate persists, I think a short-squeeze in the euro is still very possible.

One last chart here, the VIX (90-day view), which really shows the ebb and flow of fear and greed. Wouldn’t it be pretty if it bottomed right here?

Kick Lincoln out of Washington’s holiday

Below I’ve posted the audio of a talk by economist and historian Murray Rothbard on America’s only two just wars, the American revolution and the war for southern independence.

Here is Rothbard’s definition of a just war, from an essay based on this talk:

My own view of war can be put simply: a just war exists when a people tries to ward off the threat of coercive domination by another people, or to overthrow an already-existing domination. A war is unjust, on the other hand, when a people try to impose domination on another people, or try to retain an already existing coercive rule over them.

By the way, Rothbard points out in his voluminous history of the US, Conceived in Liberty, that Washington was no Jefferson when it came to the principles of small, decentralized government and personal freedom.  Lincoln, however, was an absolute tyrant. He abolished habeas corpus, jailed newspapermen and others for dissent, and waged total war on civilians, all to support the agenda of northern railroads, steel mills and banks.

Here’s a little more on the war for southern independence from that essay. The war of course was really about taxes and corporatism, and Lincoln was as big a racist as anyone in his day (and a longtime advocate of shipping America’s blacks off to Africa or South America).

His (Lincoln’s) major emphasis was on Whig economic statism: high tariffs, huge subsidies to railroads, public works. As one of the nation’s leading lawyers for Illinois Central and other big railroads, indeed, Lincoln was virtually the candidate from Illinois Central and the other large railroads.

One reason for Lincoln’s victory at the convention was that Iowa railroad entrepreneur Grenville M. Dodge helped swing the Iowa delegation to Lincoln. In return, early in the Civil War, Lincoln appointed Dodge to army general. Dodge’s task was to clear the Indians from the designated path of the country’s first heavily subsidized federally chartered trans-continental railroad, the Union Pacific. In this way, conscripted Union troops and hapless taxpayers were coerced into socializing the costs on constructing and operating the Union Pacific. This sort of action is now called euphemistically “the cooperation of government and industry.”

But Lincoln’s major focus was on raising taxes, in particular raising and enforcing the tariff. His convention victory was particularly made possible by support from the Pennsylvania delegation. Pennsylvania had long been the home and the political focus of the nation’s iron and steel industry which, ever since its inception during the War of 1812, had been chronically inefficient, and had therefore constantly been bawling for high tariffs and, later, import quotas. Virtually the first act of the Lincoln administration was to pass the Morrill protective tariff act, doubling existing tariff rates, and creating the highest tariff rates in American history.

In his First Inaugural, Lincoln was conciliatory about maintaining slavery; what he was hard-line about toward the South was insistence on collecting all the customs tariffs in that region. As Lincoln put it, the federal government would “collect the duties and imposts, but beyond what may be necessary for these objects, there will be no invasion, no using of force against . . . people anywhere.” The significance of the federal forts is that they provided the soldiers to enforce the customs tariffs; thus, Fort Sumter was at the entrance to Charleston Harbor, the major port, apart from New Orleans, in the entire South. The federal troops at Sumter were needed to enforce the tariffs that were supposed to be levied at Charleston Harbor.

Of course, Abraham Lincoln’s conciliatory words on slavery cannot be taken at face value. Lincoln was a master politician, which means that he was a consummate conniver, manipulator, and liar. The federal forts were the key to his successful prosecution of the war. Lying to South Carolina, Abraham Lincoln managed to do what Franklin D. Roosevelt and Henry Stimson did at Pearl Harbor 80 years later – maneuvered the Southerners into firing the first shot. In this way, by manipulating the South into firing first against a federal fort, Lincoln made the South appear to be “aggressors” in the eyes of the numerous waverers and moderates in the North.

Outside of New England and territories populated by transplanted New Englanders, the idea of forcing the South to stay in the Union was highly unpopular. In many middle-tier states, including Maryland, New Jersey, and Pennsylvania, there was a considerable sentiment to mimic the South by forming a middle Confederacy to isolate the pesky and fanatical Yankees. Even after the war began, the Mayor of New York City and many other dignitaries of the city proposed that the city secede from the Union and make peace and engage in free trade with the South. Indeed, Jefferson Davis’s lawyer after the war was what we would now call the “paleo-libertarian” leader of the New York City bar, Irish-Catholic Charles O’Conor, who ran for President in 1878 on the Straight Democrat ticket, in protest that his beloved Democratic Party’s nominee for President was the abolitionist, protectionist, socialist, and fool Horace Greeley.

The Lincoln Administration and the Republican Party took advantage of the overwhelmingly Republican Congress after the secession of the South to push through almost the entire Whig economic program. Lincoln signed no less than ten tariff-raising bills during his administration. Heavy “sin” taxes were levied on alcohol and tobacco, the income tax was levied for the first time in American history, huge land grants and monetary subsidies were handed out to transcontinental railroads (accompanied by a vast amount of attendant corruption), and the government went off the gold standard and virtually nationalized the banking system to establish a machine for printing new money and to provide cheap credit for the business elite. And furthermore, the New Model Army and the war effort rested on a vast and unprecedented amount of federal coercion against Northerners as well as the South; a huge army was conscripted, dissenters and advocates of a negotiated peace with the South were jailed, and the precious Anglo-Saxon right of habeas corpus was abolished for the duration.