"Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens....Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose." ~ John Maynard Keynes
'Bubbles are for bathtubs.' ~ Condoflip.com
Pilots are trained to deal with a phenomenon that may sometimes occur on final approach: Microbursts (also referred to as windshear).
Imagine a large downdraft of air rushing straight down some distance in front of an aircraft on final approach. The air flow curves outward as it approaches the ground, becoming a horizontal flow (called 'outflow'). As the plane approaches, it first gets lift from the outflow. An inexperienced pilot might be inclined to push down on the stick or decrease power to counteract the lift effect. As it flies into the downdraft, the massive flow of air pushes the plane down hard. Now the pilot, compensating for excessive lift, finds him or herself pushing down on the stick or at lower power when the plane is blasted by a massive downdraft. Occurring with the plane close to the ground, this effect can obviously be catastrophic for the flight.
This metaphor aptly fits the current housing market. The FED 's manipulation of interest and credit creates 'windshear' in the economy. Home buyers and property speculators can be thought of as pilots trying to land in windshear.
The Lift Effect
High prices due to outrageous demand signaled developers to increase production to profit from the high demand. Yet this demand was false. It was an unsustainable mania. How do we know? Booms happen for two-reasons: a change in time preferences of the consumers who wish to start buying after a period of saving, or by the influx of massive amounts of liquidity created from debt ('out of thin air'). Americans dipped into negative savings for the first time since the Great Depression. Clearly, the boom was not due to a massive number of new buyers with wealth created from savings and investment. It was a circle of speculation by a largely na've group of flippers. In time, people started realizing that the demand for property was not ultimately driven by consumers with real capital. They are now starting to realize that the money really is not there. The mania resulted from borrowing on cheap credit and against inflated equity. These would-be real estate tycoons are now stretched thin, committed to multiple properties, or to more house than they can afford, believing prices would always go up. Our housing bubble pilots have pushed too hard on the stick during the updraft.
There is no question that the mania in the housing market has subsided. The demand has tapered off. Yet hundreds of new homes, town homes, and condos are under construction and coming on the market'the result of developers attempting to address the market signals at the height of the mania. Unless the FED can find a new bubble to inflate, there will be no place for the mountain of dollars created in the past decade or so to go but into general circulation chasing consumer goods. More money chasing the same amount of goods, all other things being equal, will raise prices. Folks normally get really grumpy when that happens. The FED claims to try to target about two percent inflation. With the ridiculously huge amount of credit and currency created, a pin-prick of that bubble will land us in a sea of worthless money. Their song and dance about two percent inflation will evaporate. The FED will have to significantly raise interest rates (think Paul Volker in the late '70s under Carter) or otherwise attempt to remove a vast amount of 'liquidity' from the market ' removing currency from the market means less cash chasing the same amount of goods. Prices fall ' bad news for the plethora of aggressive home-owners and speculators who thought housing prices would always increase. Now that the mania has subsided, our intrepid pilots are realizing the updraft has shifted to a downdraft. In a panic, they will attempt to correct their mistake.
The over-stretched home-owners will begin to realize that prices will not recover. They see all the for-sale signs up. They see the new neighborhoods going up that were put in motion at the height of the mania. They begin to realize the inevitable ' 'I will have to compete with these new homes if I'm going to sell.' As each month sees higher and higher, payments due to reckless adjustable rate mortgages, many homeowners will come under greater pressure to sell. They will continue to reduce prices until it becomes a race to the bottom. There will be a panicked crash in housing prices. For those properly positioned, it will be a field-day of cheap property.
Modern RADAR technology has given the commercial aviation industry powerful tools in dealing with the microburst phenomenon. Like RADAR to windshear, Austrian economic theory gives us powerful tools to recognize a bubble phenomenon and proceed with caution. Now, imagine if the air traffic controllers maintained a strangle-hold on which technologies got implemented into the system. Imagine if they scoffed at RADAR, came up with outlandish excuses and smears to discredit it, and prevented all but the most independent air traffic controller from even being aware of its existence. This scenario is what faces the Austrian School of Economics (www.mises.org) and its potent analytical tool, the Austrian Theory of the Trade Cycle.
We have the tools to see a bubble and to understand why bubbles occur. But to use these tools is to expose the need for freedom and laissez-faire in the marketplace. It exposes the 'need for government intervention in the marketplace' as cynical propaganda used to maintain government control over society. It is as if the air-traffic control folks prohibited RADAR because it might lessen their monopoly on control. Let them crash ' we will not give up control.
Unfortunately, this microburst will not be a mere local phenomenon. There will be a lot fewer pilots very soon.