Cheap money, artificial credit, zero interest policies and no yield – they all create distortions in the economy.
These lead to what the better class of economist might call ‘malinvestment’.
You and I would call it – bubbles.
All sorts of bubbles have been blown since the financial crisis of 2008.
Today, I want to consider three that are ready to pop.
Bubble No.1: cranes, cranes everywhere nor any place to live
Estate agents were probably happier than anyone at last week’s election result. No mansion tax, no increase in higher-rate income tax, no ‘attack the rich’.
Business would go back to normal. At last, the cause of London’s low transaction volumes has been dealt with. Indeed, many reported huge increases in trade from high-end overseas buyers the day after the result.
I think the celebration might be premature.
UK builders tend to manage new market supply quite carefully. But they are not in control of the building boom in London. That is overseas investment. There is no management of supply.
A few months ago, we heard that 54,000 homes were planned or under construction (courtesy of Lonres, Dataloft and PropertyVision), “in the priciest areas of the capital”.
Most will cost “close to or above the £1m mark” and most are two-bed flats. These are likely to come to market over the next year or two. In the same areas last year, just 3,900 homes were sold for more than £1m.
Where are the buyers going to come from? Londoners will not buy these properties.
Families don’t want two-bed flats. Buy-to-let won’t pay for itself at those rental values. And the young dude who has more than £1m to spend on a two-bed flat will not choose a mass-produced wannabe hotel room. He’ll opt for a groovy pad in Shoreditch or something similarly unique.
That’s why these flats are mostly marketed overseas. And while there may be an extremely large supply of newly rich Asian buyers, there is all sorts of dirt under the mat.
Some flats are bought as a place to live. Many are bought as investments (although not to rent out). Many are bought as a means to get UK citizenship. Some are bought as a means to get money offshore, to evade tax and launder money.
There are all sorts of rumours flying about of overseas lending fraud (that never ends well). And I’ve had several ‘insider’ emails as a result of previous articles on this topic about poor build-quality.
A bubble is a market that has lost touch with reality. This market is divorced from the city around it. Houses are bought to be lived in (either by the owner or tenants) not to be left vacant. London is a desirable place because there’s a lot going on – not because it’s a ghost town. How will these people sell? And who to?
Throw in the spectre of a vacant homes tax – remember the Tories are running huge deficits, and need to increase the tax-take as well as cutting spending. A vacant homes tax will generate as much revenue as a mansion tax, only without the aggro.
This bubble has got everything. Anyone got a new build in London they’ll lend me to sell? I’ll buy it back off you in two or three years.
Bubble No.2: Biotech has burst before, and it will burst again
Back in 2010 you could have bought the US Biotech ETF (NDX: IBB) for less than $75. In 2011, it was $85.
Now it’ll cost you more than $350 – and that’s the sector tracker! Many individual companies have risen by much, much more.
Of course, there have been incredible breakthroughs in the technology. Of course, biotech is incredibly important – it can save lives. And, of course, a biotech small-cap can more than double overnight – there are fortunes to be made.
But nothing lasts forever. This boom is now seven years old. The last four years have been mega.
The bottom line is that 85%-95% of all new drugs fail to meet approval. That kind of failure rate is not being priced in. A biotech company is as unlikely to make it as a mining company. But rather like the mining boom of 2009-11, success is being expected, companies are being given the benefit of the doubt and warning signs are being ignored.
As someone who has made and lost a fortune in mining, I can tell you that when the sector gets exhausted and the cycle turns, the baby gets thrown out with the bathwater.
Even the companies that do have drugs that will ‘make it’ will fall in value. Investment stories are no longer believed. Blue sky becomes black cloud. Sales pitches are met with cynicism and incredulity. Short-sellers have a field day. Investors can’t get out quickly enough. Liquidity dries up. And now nobody believes anything until the numbers show up on the balance sheet.
Biotech has got all that ahead of it.
Bubble No.3: government bonds – the bubble that could bring on 2008 MKII
Thus one has had a lot of press in the last few weeks. Perhaps most notably, ‘bond king’ Bill Gross (who, like all of us, has been wrong about bonds before) described German bunds, as “the short of a lifetime”.
The noise makes me wonder if the recent sell-off has been nothing more than a correction. There might still be more air to blow.
But that bonds are a bubble, of that there is no doubt.
Yes, consumer price index (CPI) inflation is around zero. But you can pick lots of holes in CPI. It does not incorporate asset prices. And consumer goods are – thanks to greater productivity – inherently deflationary.
But even ignoring all that, the idea that fiat money is going to be worth more in ten or 20 years from now than it is today is delusional. The system doesn’t work like that.
If we were talking about a finite system of money such as gold or bitcoin, then, yes, I get it. But debt-based fiat money in an age of massive government overspending, unpayable debts and so many vested interests aiming to get inflation over 2%? CPI does not represent the value of money.
So when I look at negative government-bond yields in various parts of Europe, ten-year UK gilts yielding under 2%, and 30-year American bonds at under 3%, I’m incredulous.
It may be the ‘new normal’, but it would have been unthinkable once upon a time. It may go on – this is an extremely ‘protected’ (some might say ‘rigged’) market, but it will not go on forever.
As with all bubbles, the market is divorced from reality.
So there we go – three big bubbles, primed to pop. The question is when?
I’m minded of German economist Rudiger Dornbusch’s famous comment: “In economics things take longer to happen than you think they will, and then they happen faster than you thought they could.”
Nobody knows when. But fortune favours the prepared.
And in my own anti-bubble hysteria, I find myself wanting to add that the whole money system itself is a bubble waiting to pop. But I think I’ll save that for another day.
• Dominic Frisby is the author of Life After The State and Bitcoin: the Future of Money.
Category: Market updates