On CBS, 60 Minutes ran a piece about China’s real estate bubble.  You can watch it here.  While I’m not a big fan of watching news programs on regular television, I do find that 60 Minutes tends to be more educational than most.

I have been talking about a real estate bubble in China for a few years now.  I suppose this makes it the perfect bubble, because it lasts longer than what seems possible.

I am impressed by the growth of China’s economy over the last three decades.  It is remarkable what a little liberalization will do.  A crack in the door for the free market has led to hundreds of millions of people finding their way out of poverty.

With that said, China cannot escape the Austrian Business Cycle Theory.  A loose money policy and artificially low interest rates have led to an artificial boom.  It will eventually result in a bust.  China will experience its first modern day recession and it will be a bad one.

I have known for a while that the Chinese real estate market is out of control.  Watching the segment on 60 Minutes, I was still surprised.  I had no idea it was this bad.  There have been cities built for millions of people which are virtually vacant right now.  Most people in China are still too poor to afford the housing that has been built.  The only way to solve this problem will be for a dramatic drop in prices.  But this will be really painful for a lot of people.

The Chinese real estate bubble will make the U.S. real estate bubble look benign.

There are objections to my predictions of a Chinese real estate bust.  Some people say that we can’t be in a bubble because there are too many people talking about a bubble.  When the U.S. housing bubble popped, there weren’t that many people predicting it.

But just because some people see a Chinese real estate bubble now, it doesn’t mean it can’t be a bubble. 60 Minutes is an American program.  It is often easier to see from the outside.  If you talk to the average Chinese guy on the street, you will probably get a different sense.  The average Chinese guy will probably sound more like the average American did in 2005.

Another objection is that there is less leverage being used in China.  They aren’t taking out these creative mortgages that we saw in America.  Many properties in China are bought with 50% down payments.  Chinese people tend to be quite frugal and save a lot of money.  Real estate is a place that people have found to try to protect their savings.

So while this might ease the burden on banks and even the property owners (except that it makes it harder to walk away), it doesn’t mean there can’t be a bubble.  There was a gold bubble in 1980, but it was not all due to leverage.  The tech stock bubble in the late 1990’s was mostly through people buying stocks with saved money.  There was not a huge amount of leverage involved, at least relatively speaking.

People can drive up the price of an asset without using a lot of leverage.  If it is being driven up due to false signals from the central bank’s monetary policy, then we should expect a bust.

I fully expect a real estate bust is coming in China.  It will be very painful for people living there.  It will have its effects on the American economy.  The question is not so much if, but when.

Similar to the U.S. and elsewhere, there is a giant misallocation of resources that has taken place in China.  It needs to be corrected through a deep recession.  Maybe then China can try true free market capitalism.

With Obama proposing an increase in the minimum wage from $7.25 per hour to $9.00 per hour, it has become a topic of discussion.

One thing that I always find interesting is how the minimum wage debates come up.  There is a lot of Republican opposition to Obama’s proposal right now.  But where were they yelling and screaming when Bush was president?  While the last increase to $7.25 occurred in July 2009, it was because of legislation that was passed in 2007, while Bush was president.  Overall, that increase was bigger than what Obama has proposed.

And if Democrats are so much in favor of the minimum wage, why didn’t they pass it when they had the majority in Congress?  They could have passed legislation in 2009 or 2010 making it as high as they wanted.  Yet they waited to bring it up when the Republicans controlled the House.  You have to wonder if they understand that it is bad for employment, but just bring it up when they know it is harder to pass, so they can just blame Republicans for hating the poor.

I don’t want to rehash all of the libertarian arguments against a minimum wage, at least from an economic standpoint.  There has been a lot written by libertarians and conservatives that explain why a minimum wage is harmful, particularly to employment of low-skilled workers.

One important point to remember regarding the economics of the minimum wage is that an increase will not always cause higher unemployment.  If the minimum wage is low enough that most workers can still work and be profitable to the employer, then it may not matter much.  In other words, what would happen if we set a minimum wage of 10 cents per hour?  In some poor third-world country, it might cause an increase in unemployment.  In America, where there is much greater wealth and capital investment, a minimum wage of 10 cents per hour would affect virtually no one.

I would be willing to hire someone for a dollar a day to be my personal assistant.  I’m sure there are many people who would be willing to pay $20 per day for a personal assistant, assuming the person was competent and willing to work.  Since almost nobody would be willing to work for less than 10 cents per hour, the law would have virtually no effect.  I suppose it is possible someone might want to work for 5 cents per hour or for free just to gain experience.  But ironically, while you can’t get a job for $7.00 per hour, you can get one for $0.00 per hour.  It is called an internship and people do it so they can gain experience.

While most of the focus tends to be on the economic effects, I think it is important for libertarians to argue the moral side too.  Like most laws, the minimum wage is interfering in the voluntary process of the marketplace.  It is using the threat of government force to punish someone who offers a job to another person for less than the stated minimum wage.

There might be some people who simply can’t find a job in today’s market.  It could be a teenager or a mother who wants to work part time while the kids are in school.  It could be anyone.  But this person is forbidden to get a job that pays less than $7.25 per hour, unless it is an internship.  You could have someone willing to work for $6 per hour and an employer willing to pay it, yet they are forbidden because of the threat of government violence.

There are two questions you can ask  a supporter of the minimum wage.  The first question is an economic one.  If the minimum wage is good and will help people, why not raise it to $20 per hour or even $100 per hour?

The second question (or questions) is a moral one.  If someone desperately needs a job and finds a potential employer who can only pay $6 per hour, what would you do to them if they agree to these terms?  Would you send in police officers with guns?  Would you be willing to throw the people in jail?  Would you shoot them if they didn’t comply?

It is always important for libertarians to point out the government guns.  After all, virtually all laws are backed by the use of government guns.  At some point, if someone doesn’t comply with the law, then government guns will come out.  We must continually make people aware of this.

I have been hesitant to write on this subject.  Whereas everyone was tired hearing about the “fiscal cliff” back in December, now everyone is growing tired hearing about “sequestration”.  It is a confusing topic and it is hard to rely on the mainstream media for any kind of accurate reporting.  The term “sequestration” is probably not even being used accurately in these discussions.

Some people claim that we will have draconian cuts that will dramatically cut services, hurt employment, and hurt the overall economy.  There are even some who claim it will harm our defense, although I think they are really talking about offense.

Others say that these so-called cuts are not really cuts at all.  They are simply reductions in the already projected increases in spending.

This article on Forbes gives a good example of what we are dealing with.  In some ways, both sides are correct, if you cut out the Keynesianism.  If the sequester goes through and the projections hold true (which they rarely come close), then there will be an increase in overall government spending over the next ten years.  However, it isn’t as clear when you factor in inflation, which we will surely have.

There will be actual cuts in certain particular things.  On the other hand, it is also true that the overall federal budget will go up for the year.

I think we are going to see a lot more of this in the future.  It’s just a guess, but for at least the next ten years, we are likely to see these kinds of debates continue.

One of the major factors in all of this is so-called entitlements.  In particular, it will be Medicare and Social Security.  The government no longer runs a major surplus in payroll taxes.  It is actually shifting the other way around, where there is a shortage of payroll taxes in comparison to what is paid out.  It doesn’t matter if the so-called Social Security trust fund cashes in on some of its government debt or whether Congress directly funds the difference.  It is all the same.  It is just a difference in accounting.  Either way, Congress, in order to keep its promises, has to spend increasing amounts of money on these programs.  So you can have the overall federal budget going up while still seeing cuts in many programs.

Of course, even if there were actual cuts of nearly a trillion dollars over the next decade, it is still a drop in the bucket.  The government is currently running deficits over a trillion dollars in one year.  So even if these so-called cuts held, the federal government will still have accumulate another, say, $9 trillion in debt, as opposed to $10 trillion.  It is a small difference that won’t mean much in the long run.  The whole thing is unsustainable and it is just starting to unravel.

Anyone who is a libertarian, or even slightly leaning that way, should be advocating actual cuts that are far more significant.  It would be a good start to cut the federal budget by $1 trillion immediately, and stop running up the national debt.  While this would certainly be painful for many, it would start to flush out all of the malinvestment and maybe we could start on a real road to recovery.

The longer we take in getting significant spending reductions, the more painful this will ultimately be.  There is going to be a giant default down the road in some form or another.  Then these “sequester cuts” will seem like nothing.

A society, or even a person or household, gets richer by saving.  It would be very difficult, or perhaps impossible, for a society to get richer if everyone consumed everything and saved nothing.  The same generally holds true for a person or household, although someone could make a higher income and have a higher standard of living (at least as long as the higher income lasted) without saving anything.

Savings is required for capital investment.  Capital investment is what leads to better production and better technology.  In an advanced society, it leads to higher wages, lower prices, and an overall higher standard of living.

If someone were stranded on an island alone, let’s say he could catch two fish every day.  It took him from sunrise to sunset to catch just two fish.  At sunset, he had to go into his cave and sleep and stay safe from wild animals.  If he always consumed two fish every day, then he would never get ahead.

Let’s say the guy on the island consumed only one fish per day and found a way to preserve the second fish he caught.  The next day, instead of fishing, he might have some time to build a better shelter.  He wouldn’t need to fish the whole day, as he would be able to eat from his prior savings.  The guy could also spend a day building a fishing net.  This might help him catch 4 fish in a day, instead of just 2.  The fishing net is capital investment.  He was able to make it because of his prior savings (a fish).  He deferred consumption of a fish so that he could build a net.  Through savings and capital investment, he has increased his productivity.  Now he can fish for just half a day, consume two fish, and still have time to do other things.

Some people who don’t understand economics, finance, and even math, think that if you save some money, that you will always have a lower standard of living until you tap into that savings.  They don’t understand the benefits of compounding interest.

Henry Hazlitt made a point similar to this in his classic book Economics In One Lesson.

If you make $100,000 per year (after taxes for the sake of this argument) and you always save 10% of your income, let’s see what happens.  The first year you save $10,000 and you spend $90,000.

The second year, you still make $100,000 and you save $10,000 again.  But let’s also say that you make a 5% return on your initial $10,000 that you saved last year.  So you actually made an extra $500 or $100,500.  You could simply decide to consume 90% of the $500 and continue to save 10%.  So your consumption in year two would actually be $90,450 and your savings after year two would be $20,050 ($10,000 in savings for two years, plus $50 saved from your first year returns).

If this situation continues, then eventually your consumption will be over $100,000, while the savings continue to add up.  By deferring consumption, you are actually able to have a higher standard of living than when you started off, even if you had consumed everything in the first year.

Of course, you could save even more aggressively and consume less of your return, which in this case starts out at $500.  Once you get your total savings up to $200,000, then just a 5% return would be enough to make up for the $10,000 in income that you save each year.  At that point, you could consume the full $100,000 you earn each year and your savings would continue to grow just from the interest.

While interest rates are currently very low, there are still ways to get a positive return on your savings.  The magic of compounding interest has not gone away.  It is a wonderful thing.  Compounding interest is what enables many people to get wealthy and it also enables societies to get wealthier.

I recently wrote a post about the decline in the gold price.  I said that it could mean one of two things.  The first scenario is that it is a temporary downturn before we see another big run in the gold price.  The other possible scenario is that we are headed into another recession.

In response to this, I received the following comment:

“In general I agree with your expectation for gold to rise in price.  But I note that there is a 3rd possibility… that we are emerging from the deflationary recession depression and in the early stages of a return to prosperity.  If that is the case gold could be on the express elevator ride to the basement.  Remember the 80’s and 90’s.”

He is technically correct that this third possibility exists.  But I give it no more than a 1% chance.  The only way I see this happening is if we have some major technological breakthrough in tandem with Congress finding fiscal discipline.  Perhaps I should say that I give it no more than a .01% chance.

So what is my reasoning for this?  First and foremost, the Federal Reserve has more than tripled the monetary base since 2008.  It is on its way to being quadrupled.  This is unprecedented.

We had a major recession in 2008 and the federal government, along with the Fed, did not allow the full liquidation to take place.  Instead, it propped up failing companies, tried to prop up housing, and has continued to bail out banks and create massive amounts of new money out of thin air.  We are actually in a worse situation now than we were in 2007, at least in terms of distortions in the economy.

All of this massive malinvestment will have to be corrected at some point.  If it is not, then our living standards will decline immensely.  Until we see a shakeout of all of the misaligned resources, we are not going to return to prosperity.  We may see false prosperity in terms of higher housing prices and higher stock prices, but that is only because of the massive monetary inflation that has taken place and continues to take place.

The last sentence in the comment above is: “Remember the 80’s and 90’s.”  But this is a perfect example of why we will not return to real prosperity any time soon.  This can’t be like the 80’s and 90’s.  If anything, we are in the early 70’s right now.  It would not surprise me to see us advance into something like the late 70’s with high price inflation and high unemployment.

While a part of the boom of the 80’s and 90’s was false prosperity from a loose monetary policy, it was, at least relatively speaking, good economic times.  But the reason we were able to have good times is because we took the right medicine before that.  Paul Volcker came in at the Fed and halted the printing presses.  He allowed interest rates to rise to what would be unthinkable levels today.  With no more monetary inflation to prop things up, he essentially saved the dollar, which also resulted in severe recessionary conditions in the early 80’s.  We went through the pain of the correction.  Resources realigned to better uses and we saw a new wave of investment and productivity.  We were only able to return to prosperity when the malinvestment was flushed out.

We have not taken the right medicine yet today.  Instead, Bernanke and friends keep putting poison in our bodies.  Sometime the poison has an illusion of masking the painful symptoms, but it is actually making us sicker.  Until we stop taking the poison and start taking the medicine (while experiencing some pain), we are not going to return to prosperity.

I recently wrote a post on booms and busts and interest rates.  I received the following comment/ questions from this post:

“Assume that we haven’t seen the level of inflation that one would expect given the tripling of the monetary base since 2007.  Further, assume that, in large part, the reason for that is a lack of velocity.  If we assume both of these things, how are they squared with the argument that in a artificially created low interest environment, people tend to spend rather than save?  If people are spending, that’s velocity, right?”

Let’s take the first two sentences first.  I assume that the commenter’s use of the term “inflation” is referring to price inflation.  We don’t really have to assume that we haven’t seen significant price inflation after a tripling of the monetary base.  This is in fact what has happened.

Secondly, we don’t have to assume that velocity is a large reason for this.  If there is a huge increase in the supply of money and it hasn’t translated into significantly higher prices, then there must be a higher demand for money (lower velocity).  The other major reason, which really goes along with a higher demand for money, is that bank reserves have increased dramatically.

So with everything going on, we would expect to see higher velocity, meaning money changing hands faster.  This would mean more consumer spending.  It would lead to higher prices.

But there is an assumption in the comments that I don’t completely agree with.  The commenter used the phrase “artificially created low interest rate environment”.  But we cannot really know how much is artificial and how much is not.  While the Fed has been buying a lot in the way of government debt and mortgage-backed securities, and this has certainly contributed to lower interest rates, I’m not so sure we wouldn’t have seen low interest rates anyway, given the previous mess created by the Fed.

We are in an environment of fear and we mostly have been for almost 5 years now.  The general public is scared of recession and unemployment.  People are not generally as scared about price inflation.  In some ways, this can be a self-fulfilling prophecy by the general public.

In a recessionary environment, it is common to see low velocity.  Cash is usually king in a recession.  This means there is a high demand for money.  People are afraid of losing their jobs and they try to build cash and pay down debt.  This is not to say that things can’t change quickly if enough money floods the system.

Right now, real interest rates (rates adjusted for inflation) are negative.  But they are not negative by a lot.  We still have relatively low price inflation, at least as stated by the government’s CPI numbers.  If price inflation were at 10% and interest rates were still really low, then we could be more certain that they are being kept down artificially.  Such a scenario would also likely result in much more spending (higher velocity), even in recessionary conditions.  We saw this happen in the late 1970’s.

I think we will likely see much higher velocity, and hence higher price inflation, in the future, assuming that the Fed keeps creating new money out of thin air at a rapid rate.  We have to get to a point where the general public is more fearful of a depreciating currency than it is of a recession.  At that point, we can expect to see significantly higher prices.  We can also expect another huge run in the gold price.

Sometimes it is important to take a step back and look at the big picture.  It is also good to help others do the same.  We get bogged down in these debates about tax rates, deficits, and specific programs, and part of this is due to the media and the politicians.  But let’s take a broad look at where we are today in nice round numbers.

The federal government (this doesn’t include state and local spending, unless it was money that came directly from the federal government) spent almost $3.8 trillion in fiscal year 2012.  It likely won’t be any lower in 2013.  There are approximately 315 million people living in the United States.  This means that each individual’s share of government is approximately $12,000 per year.  Of course, this is for each person, which includes 90-year old people in nursing homes and little babies.  Again, remember that this doesn’t even include state and local government.

If you are a family of four, then your share is $48,000.  That is every year.  Of course, it is not distributed equally.  Your share may be higher or lower than $48,000.  A guy who is unemployed and homeless is not paying $12,000, although he is probably paying some share in some way.

If you go by the number of households, the numbers just look worse.  There are approximately 115 million households in the U.S.  This is an estimate.  That would make the average household’s share of government spending at the federal level about $33,000 per year.  Would you be willing to give up your favorite federal programs for an additional $33,000 per year?

You could ask a proponent of big government how much the average family should spend to fund government each year and I’m guessing at least 9 out of 10 would not answer anything higher than what it actually is.  That is why this is such an important statistic.

Most people make the mistake of just looking at their income tax.  Perhaps they might also look at their payroll taxes too.  But we pay in some fashion for every dollar that the government spends.  Taxes that employers pay lower our wages.  Corporate taxes lower wages, make prices higher, and also hurt investors.  There are a lot of hidden sales taxes and excise taxes that we pay.  And of course there is the hidden tax of inflation that devalues our money over time.

That is why it is so critical to look at overall government spending and not just taxes.  Total government spending gives us a better picture of how much the government is consuming in the way of resources.  Most government spending, even if it isn’t completely wasteful or harmful, is still a misallocation of resources.  This makes us poorer than we would otherwise be.

Even if state and local government stayed about the same and the federal budget were cut in half, that would mean an extra $16,500 for the average household.  That is every year.  What would you do with an extra $16,500 every year?

I’ll bet that would make a huge difference in a lot of lives.  It would probably mean a lot less stress for millions of people who struggle to pay their bills.  It would allow most people to live better.  You could save more, give more to charity, pay off debt, get a bigger house, send your kids to private school, help out a loved one, start a new business, take a family vacation, and the list goes on.  But it would be your choice.  It is your money that you earned.  It doesn’t belong to the government.  We should not be shy in pointing this out.

The Austrian Business Cycle Theory (ABCT) teaches us that a loose monetary policy, with low interest rates, will send false signals to the marketplace.  The extra money and artificially low interest rates misleads people to believe that there has been more prior savings than what has actually occurred.  This leads to artificial booms in certain sectors.  When the loose monetary policy ends, or at least tightens somewhat, then the previous false signals become evident and the boom turns to bust.

We saw this happen with real estate.  It boomed up until about 2006 or 2007.  When it became evident that it was unsustainable and that the long-term savings just weren’t there, then the housing boom turned into a housing bust.

Interestingly, the Federal Reserve buys mostly government debt.  It has, just in recent years since the housing bust, bought some mortgage-backed securities.  Therefore, the Fed has a significant impact on interest rates.  By buying government bonds, it bids up the price of the bonds.  As long as there is no major expectation of severe price inflation, then the Fed’s buying will generally lower interest rates.  Again, this sends false signals to the marketplace, although we are in a much different economy now than when the rates were artificially low 10 years ago.

So what would happen if the Fed created money out of thin air, but did it in a way that didn’t directly affect interest rates?  The Fed, with a monopoly over the money, can buy almost anything.  It could decide to buy big screen televisions, although I’m not sure what it would do with them all.  It could buy stocks.  It could buy gold, which ironically, just like buying stocks, would bid the price up through its actual buying and from the monetary inflation.

But let’s even say that the Fed could create monetary inflation more uniformly.  It is impossible to do it completely uniformly because the new money has to go somewhere first.  And if you just handed out new money to everyone, do you do it with equal amounts to everyone or do you do it on a proportional basis of how much each person already holds?

I suppose the Fed could simply pay for the government’s bills without formally buying government debt, but even here there would be booms in whatever the government spends it on.

Regardless of how the Fed creates new money out of thin air, I contend that it would have some kind of impact on interest rates.  But even if that were not the case, the monetary inflation would still cause distortions in the marketplace.  So maybe the booms and busts would take on a different way of playing out.  Maybe we would see different sectors experiencing the bigger booms and busts.  But no matter how you cut it, there will be a misallocation of resources.

Just with the presence of inflation, certain behavior is affected.  It encourages more debt.  It encourages consumption at the expense of saving.  If your money is continually devalued, you are less likely to save it and watch it lose value.  You are more likely to buy something that will more likely hold its value or that you can at least use.

So while manipulating interest rates plays a big role in the Fed’s policies, I contend that monetary inflation alone, no matter how it is done, will misallocate resources.  As long as we get monetary inflation from the Fed, our standard of living will be less than it should be.

There is a trap that libertarians often fall into.  It is a trap set by someone challenging the libertarian philosophy, whether it is intentional or not.  Sometime the challenger is simply asking, with no ill intentions, and is looking for a serious answer.

The trap is when libertarians feel the need to have all of the answers.  But that is actually the great thing about libertarianism and we should use it to our advantage.  You don’t really have to know much in the way of answers at all.  The only answer you need to provide is for the free market, consisting of peaceful individuals, to solve the problem, if there even is a problem.

For example, let’s say you get into a discussion about roads.  As a libertarian, you suggest that roads would operate better without the government.  Maybe you go so far as to say that the government, at all levels, should get out of the road building and operation business entirely.  Now someone will challenge you, asking how you would build roads and asking how much the tolls will be.

It is important not to fall into the trap.  You don’t have to have all of the answers.  You don’t have to have any of the answers, other than letting the free market work its magic.  It would help convince the challenger though if you could provide some examples of possibilities.

Maybe different housing subdivisions would handle their own roads.  Maybe businesses would get together and build roads so that customers can access their stores.  Maybe some charities would build roads to better their community.  Maybe some entrepreneurs would build roads and sell an annual pass to travel on them, or else pay a one-time toll.  With modern technology, you could probably pay a toll without stopping your car.

Just because roads would be built and operated outside of the realm of government, it doesn’t mean that everyone will necessarily pay for them directly.  You don’t have to pay to park at most shopping malls. The malls actually provide these parking spots for free, in hopes that you will be more likely to go to the mall and buy things.

It is important to point out to your challenger that you are not a road entrepreneur.  You don’t really know the best way to build roads or operate them.  But even if you are an expert in building roads, you still don’t have all of the answers.  Only feedback via the marketplace can answer what is right.  Only the consumers know what is right.  You may build an excellent road that is much better and safer than the average government road.  But someone else may come along and use your ideas and improve on them and make an even better road.

Again, you don’t have to have all of the answers.  It is helpful if you can provide suggestions and possibilities.  But it is always important to point out that not having all of the answers is central to your libertarian philosophy.  You understand your own limited capabilities.  You understand that it is not possible for one person or one small group of people to centrally plan in an effective way.  We must rely on prices and profits and losses, as dictated by consumers, to send information as to what works and what doesn’t.

Of course, this doesn’t just apply to roads.  It applies to most issues.  That is the great thing about libertarianism.  You don’t have to know how everything works and you don’t have to know the answers.  Why do you have to know the answers when you don’t want to centrally plan other people’s lives?  Why do you have to know the answers when there are billions of other people in the world, some of whom do know the answers?