Exposing the Heart of the ‘Bubble’ Economy

Exposing the Heart of the ‘Bubble’ Economy

In early August, Gerald Cavendish Grosvenor — the UK’s Duke of Westminster — died aged 64. It’s estimated his landed estate is worth 9.35 billion pounds. He was one of Britain’s richest men. The estate now passes to his eldest son. No death duties are involved, since the estate is well and truly wrapped up in a trust that bypasses these ‘middle class’ laws.

The Grosvenor Group’s holdings include 300 acres in Belgravia and Mayfair — two of London’s most exclusive districts — plus extensive holdings in Scotland and Spain. The family can trace the beginnings of its property empire as far back as 1677.

Throughout Britain’s tumultuous history over the last 300-plus years, the Grosvenor family has added and expanded to its real estate holdings and property management business. Ultra-wealthy families like this almost never sell.

They just keep collecting the rents and living off the income their holdings generate. And the progress of society just keeps enriching them — regardless of whether or not they actually contribute anything to the world. The Grosvenors are one of the many landed estates of the British aristocracy. This model of the economy is thought to be dead in the 21st century.

But actually, we live in a neo-feudal society that mimics the 18th century.

That position is also in accord with findings from a new report by a prestigious economist. So if you and your family want to get ahead in life, you have to understand how this system has a grip on the economy.

 

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Finance is not the economy

American economist Michael Hudson, alongside Dutch professor Dirk Bezemer, has written a research piece titled ‘Finance Is Not the Economy’. Michael Hudson is the author of Killing the Host and several other notable books.

As absurd as it sounds, the standard economic models — those taught in universities and used to analyse the economy — do not incorporate credit, debt, banks or the financial sector.

Mainstream economic analysis does not recognise that the FIRE sector (finance, insurance and real estate) is actually a burden on the productive economy (because of rent and interest payments). Michael Hudson likens the sector to a parasite attached to a host. As Hudson and Bezemer put it, credit flowing into financial assets is ‘not investment in the economy’s productive capacity, but extraction from the surplus it produces.’

Financial assets are not ‘wealth’ in the classic economic sense. They’re claims upon wealth. That might sound odd because we’re conditioned to think of wealth as money, shares and bonds.

Remember that real wealth is goods and services that satisfy human desires in their infinite number. Any manmade object is ‘real’ wealth: cars, scissors, blankets, tables, computers, airplanes, spectacles, books, heaters, etc.

Or you can think of the distinction this way: A man on a deserted island can’t do much with a land title paper, stock certificate records, or bits of plastic paper with pictures of the Queen and other luminaries. But he sure can use a knife, rope, a boat and matches — plus other tools and materials — to build shelter and find food.

However, the economy today — via the tax system and government licences — is geared to favour those who produce claims on wealth, instead of those who produce real wealth! In their research paper, Hudson and Bezemer refer to this system as the ‘bubble’ economy.

The paper also draws an important conclusion highly relevant to us: that the centre of every Western economy is ‘real estate assets and household mortgage debt’. So it is NOT government deficits or GDP, or the stock market, or even all the other factors the mainstream media points you towards.

This is why the US housing collapse was so damaging to the economy in 2008. This blind spot is also why so many mainstream analysts miss the importance of the recovery in the US (and UK and elsewhere) housing market today.

Hudson and Bezemer show most bank credit is actually used in the purchase and transfer of property and financial assets already in place. This credit inflates asset values.

The winners and losers in today’s economy

That means the asset-less, and those who rely on wages, fall further and further behind their propertied and asset-rich peers. Interest payments on debt, along with further transfer payments, divert income from the circular flow between consumers and producers to the FIRE sector.

This is a major part of the huge inequality across the Western world. So much financial activity is actually rent seeking, and not genuine business investment and wealth creation.

As the report says, ‘An economy based increasingly on rent extraction by the few and debt buildup by the many is, in essence, the feudal model applied in a sophisticated financial system.’

But ‘Finance Is Not the Economy’ also highlights what we’ve try to highlight for you in Cycles, Trends and Forecasts.

There is a high correlation between growing bank credit creation and expansion in the economy (and asset values). When bank credit expands, so does the economy. But we also have to distinguish where that credit is going. The more credit that goes into the ‘real’ economy, the higher the nominal GDP will be.

This type of credit creation — which flows into business — is what creates productive economic growth and rising wages. The more credit goes into property and shares, however, the higher asset prices will go — but the economy will become more fragile. This is what happens as the real estate cycle progresses. More and more bank debt is funnelled into the property market. This drives up the value of real estate — hence the windfall profits you hear about — but weakens the very foundations of the economy.

This is because most buying of real estate and stocks in the secondary market (which, from an economic point of view, is just swapping land titles and share certificates) does not produce actual income to pay off the debts being incurred to pay for the assets. This is why, ultimately, the real estate boom MUST end in a crash.

The only question is the timing. So you can make money on the way up, and keep it — as long as you know when the ‘boom’ times have gone on too long. If you want the best guide as to when that will be, go here.

Regards,

Callum Newman,
Associate Editor, Cycles, Trends and Forecasts

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Callum Newman
Callum is a feature editor for The Daily Reckoning . He covers areas of interest arising from world markets and the global economy that could mean new investment opportunities for Aussie investors. If you're already a subscriber to these publications, or want to follow Callum's financial world view more closely, then we recommend you join him on Google+. It's where he shares investment insight, commentary and ideas that he can't always fit into his regular Money Morning essays.

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