The Collapse Has Started

Money is the virus that spreads the disease

There is a rather serious problem on this planet which needs to be addressed. It cant have escaped the notice of anyone that things are not going well at any level in what is these days called The Collective West.

The first impact of bad news tends to hit the banks. That filters through to pretty well everything else because of the collective west’s addition to debt, which is available mainly from the banks. The real problem with this is that in a modern fiat currency society, value is generally grounded in real estate, which is why that word “real” is in the definition.

The most spectacular real estate problem exists in China, which is in some respects like the West. But only in some respects.

Let me explain.

The political grounding of the Chinese economy is supposedly communist. However, the Chinese have traditionally been business oriented, which means they are interested in trade and the capitalist side of the economic divide.

Unfortunately, communism suffers from a serious problem which is routed in medieval concepts. A medieval economy is a very limited economy. It is based upon a very personal view of life and relationships. Even as late as the early nineteenth century in the UK, which was at the time the most advanced economy on the planet, the average worker would be lucky to be paid at all, and if that payment was in money it would have averaged at about £1 a year.

What could one do with that money? Buy a few beers at the local hostelry but not much more. Shops are a modern invention. In feudal times people grew their own food, got their meat from the pigs and chickens they kept, and they made their own clothes and built their own homes, mainly from wood which they cut from the nearby forest.

The king technically owned the land, which he gave to various barons in return for money and for men to serve in the various wars which were created by the monarch.

This system carried on until in the middle ages the concept of the division of labour started to appear, in which social mores, work and money started to change. A more divided and mixed society grew up and money started to become important as the medium of exchange.

Work as defined as being labour which you hire out in return for money, started to overtake the feudal self sufficiency of the average household, and over time money came to have more and more power until we entered into the modern age where money has become a servant which you can lend out to do work for you.

Welcome to the world of capitalism.

The trouble with societies based around the concept of communism is that it is still based around the concept of land being the ultimate grounding of wealth. In feudal times the king owned the land. In communist countries the government has become the equivalent of the king, and owns the land.

In China that means the local authority sells rights to companies to develop land. Those rights provide money for the local authority to function. When property companies start to go bust the whole financial structure of a communist society starts to collapse. That is what is happening now in China. Unless China starts to operate a different financial system the entire economic structure of the country will implode. This requires a new think, not some fiddling with the existing structure.

In the West we have allowed matters to go in the same direction by devaluing money, and getting addicted to credit.

The big problem with credit is that it is based upon counterparty risk. Who these days looks under the hood to check out the counterparty?

Things took a serious turn for the worse when banks succumbed to the concept of modern monetary theory.

So, you get paid, and you pay money into the bank.

Have you ever considered that concept?

You give your money to the bank. It is no longer yours. You have literally given it to the bank. The bank now owes you that money. Supposing they cant pay you back? Tough! You’ve lost it. It isn’t your money, you are now just a creditor of a bankrupt institution.

Welcome to fiat currency concepts.

Welcome to modern monetary theory.

Welcome to a world based upon counterparty risk.

Money in the West is no longer based upon an abstract concept routed in a solid commodity like gold or silver, or even land.

Modern fiat money is based upon risk.

That’s ultimately ridiculous. No wonder things have gotten so out of control. When risk is small, no-one considers it important. However, in this modern age risk has grown so huge that if someone panics, that will start a run on everything, and as everything unravels you end up with a game of musical chairs where millions of people are left fighting over two or three chairs.

That’s counterparty risk in spades.

To find out where the value of risk is at any time look at a country’s value. But how do you define that value?

Look at the assets, then look at the liabilities, then subtract the liabilities from the assets and see what you have left. If the figure is a plus then all is probably well. If the figure is minus, then that country is in trouble.

The generally agreed figure for the danger threshold is 90% of GDP. That’s when money borrowed to be used now will no longer produce an increase in wealth. And the higher that figure is, the worse that country is financially speaking. In other words, if the country keeps on borrowing money, the interest payments will be higher than the value created by the money borrowed.

The fun part of this equation is that as interest rates rise, so does the cost of servicing the money borrowed. That is why I always maintain that the time to borrow to buy assets such as real estate is when interest rates are high but falling. If you borrow when rates are low they can only rise, and that means you are living on top of a time bomb. If the interest rate is high to start with but falling, things can only get easier for the borrower.

Unfortunately we are now in an era when interest rates are rising, and are likely to stay high for some time. In other words the cost of money borrowed is likely to be higher than the value of the asset it was borrowed to buy. That way lies bankruptcy.

That’s why property markets are crashing in rather a lot of countries, and the crash has only just begun.

I’ll continue this discussion next week, but for the moment let’s just look at where countries in the West are on the Debt to GDP level.

Japan is way out in front with a figure well in excess of 200.

The USA is at 120, and rapidly heading higher.

The UK is at 105 and also rapidly heading higher.

Rising interest rates make these figures even worse. Let me give a simple example.

If I decide to buy an apartment so I can rent it out to provide myself with a pension I must have a financial equation that turns in a usable profit.

For example: I buy a small place for £20,000. Let’s say I dont have the cash so I have to borrow. The interest rate is 5%. That means the money borrowed is going to cost me £1,000 a year. If I can rent out the place for £500 a month, that’s £6,000 a year. Not much of a pension, but I’m borrowing to make a profit. All is well.

Now let me give you an example which hit my email account only last week.

An estate agent is offering a one bedroomed apartment in the Algarve for €240,000. The hard sell points out that you could rent out the place and make 5% on your investment. That equals €12,000 a year.

Wait a minute. Let’s do the same sum as the deal suggested above. 5% interest of the purchase price is €12,000. That’s the cost of the money borrowed. Where’s your profit? It’s a zero sum game. The rent goes to pay for the money borrowed so what’s the point in borrowing?

The smart-arse argument would be that house prices are likely to go up, so that’s where the profit would be. In other words you are taking a risk that prices will rise. You are investing in risk. Didn’t I point this out earlier?

In today’s market, prices are guaranteed to fall. In fact they are falling. So in this second example you are betting on a falling market to make you money.

In other words your brain is on the blink. You need medical treatment.

You are investing in a dead-cert loss. You are going to go bust.

The second example is precisely what the average government is doing when they are borrowing money to pump into a scheme which is guaranteed to lose money, and every government in Europe is doing precisely that. If you want to support that type of money management all I can say is that I hope you can smile when the system goes bankrupt.

The obvious conclusion is that I cant see how a country can get out of such financial problems without a complete overhaul leading to a massive initial cut in the standard of living. But let’s start this voyage of discovery by looking at all the related aspects, and then see what, if anything, can be done about it.

Tune in again next week.