bill grennon wrote:
This is one of the most cogent brief statements I have
read that incorporates many of the issues I've been
thinking about that will us...

bg

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GLOBAL DEPRESSION 2006---?

Gavin R. Putland
December 4, 2005

Assets ain't assets; Taxes ain't taxes; The
speculative
motive; Blowing bubbles; The cause of recessions;
The
remedy; Self-funding infrastructure; The biggest
bubble
in history; The U.S. dollar bubble; Soft on
terrorism;
Rogue states; End-game.

ASSETS AIN'T ASSETS

One cannot understand economic downturns -- let alone
prevent
them -- without understanding certain facts about
asset markets.
First of all, one must understand that the assets
conventionally
grouped under the heading "means of production"
actually fall
into TWO categories:

* Assets that taxpayers can neither create nor
destroy nor
move out of the taxing jurisdiction are LAND-LIKE
assets.

* The rest -- that is, assets that taxpayers can
move and/or
destroy and/or refrain from creating -- may be
called (for
want of a better analogy) HOUSE-LIKE assets.

By this terminology, HOUSE-LIKE assets used as means
of
production include not only fixed structures, but also
industrial and commercial equipment (fixed or movable)
and stock
in trade. The great classical economists from Adam
Smith
(1723-1790) to Max Hirsch (1853-1909) called such
assets
CAPITAL. Because the production of capital adds to
the total
wealth of humanity, and because the PROFITS from
capital are an
incentive to produce it, humanity gains from the
private
ownership of house-like assets and the private
retention of
profits derived therefrom.

LAND-LIKE assets include land (not buildings), other
natural
resources (which cannot be created by human effort),
and
statutory monopolies and limited licenses (which can
be created
only by governments, not by taxpayers). Returns on
land-like
assets, net of the demands of labor and capital, are
called
ECONOMIC RENT [1]. From the viewpoint of taxpayers,
land-like
assets cannot be PRODUCED, but can only be ACQUIRED.
Acquiring
an asset that cannot be produced adds nothing to the
total
assets of humanity. While the economic rent received
from a
land-like asset may be partly contingent on the
application of
labor and capital, it accrues to the owner AS OWNER
even if the
labor and capital are applied by others, and is
therefore not an
incentive to do anything except ACQUIRE the asset.
Thus the
argument justifying the private retention of returns
on
house-like assets is NOT APPLICABLE to land-like
assets.

TAXES AIN'T TAXES

A HOLDING TAX is a periodic tax on ownership of an
asset -- in
contrast to a TRANSACTION TAX, which applies to (e.g.)
changes
of ownership. All transaction taxes impede commerce.
All taxes
on house-like assets reduce the incentive to produce
capital.
These effects hinder production and therefore raise
prices,
fueling inflation and increasing the dismally-named
NATURAL RATE
OF UNEMPLOYMENT, which is the minimum unemployment
rate
consistent with non-accelerating inflation. But
HOLDING TAXES
ON LAND-LIKE ASSETS have none of these ill effects
provided that
the taxes take no more than the economic rent, which
is NOT an
incentive for production.

THE SPECULATIVE MOTIVE

An increase in demand for LAND-LIKE assets cannot be
offset by
an increase in private production. And indeed the
effective
demand for land-like assets tends to increase due to
population
growth, economic growth (which increases capacity to
pay for the
assets), and provision of infrastructure (which
increases the
amenity of certain types of assets, especially land).
So
land-like assets tend to appreciate in real terms.
This causes
SPECULATIVE DEMAND for land-like assets as individuals
and firms
buy assets in the hope of reselling them for higher
prices, or
try to save money by early acquisition of assets that
they
intend to use later.

BLOWING BUBBLES

In a RATIONAL market, the CAPITALIZED (or "lump-sum")
value of a
land-like asset is the DISCOUNTED PRESENT VALUE of the
future
rent stream. (That is, the capitalized value is the
lump sum
that would yield an interest stream equal to the rent
for the
same risk, or the sum of the future rental payments
individually
discounted for time and risk.) But speculation tends
to make
the market IRRATIONAL. When people see prices rising,
they want
to buy into the market. In so doing, they accelerate
the rise
in prices, inducing more people to buy in, and so on,
causing a
speculative BUBBLE -- that is, a state in which prices
are
decoupled from rents and are supported solely by the
circular
argument that prices will continue to rise.
Eventually the
illusion becomes unsustainable and prices stop rising,
taking
away the alleged justification for current prices, and
so on:
the bubble BURSTS. But eventually the natural
appreciation of
land-like assets leads to a new bubble in the same
asset class.
So the market for any land-like asset class is CYCLIC.

THE CAUSE OF RECESSIONS

A bursting bubble in a particular asset market has two
counteracting effects. On the one hand, it drives
investors
away from that asset class and, by default, towards
some other
asset class that may also be susceptible to bubbles.
On the
other hand, those who have invested heavily in the
collapsed
market must reduce their expenditure, and some (most
likely
those who have bought their assets with borrowed
money) become
insolvent. As one agent's expenditure is another's
income, and
as one agent's debt is another's asset, a chain
reaction ensues,
reducing the funds available for investment in other
asset
markets, possibly causing them to collapse, and so on.
After an
isolated bubble-burst, the former effect tends to
dominate; thus
the land burst of the mid 1920s led to a stock-market
bubble [2]
and the stock-market crash of 1987 led to a land
bubble. But
when that second bubble bursts, the cumulative
belt-tightening
and bad debt tend to cause a recession; thus the
stock-market
crash of 1929 led to the Great Depression, and the
land burst of
1989 led to the recession of 1990-91.

In short, a burst in one asset market interferes with
the cycles
of other markets, sometimes pushing them out of
synchronism by
encouraging secondary bubbles, and sometimes drawing
them into
synchronism by triggering further bursts (and a
recession).
This mutual interference, complicated by external
shocks, makes
it difficult to discern the autonomous cycles of some
asset
classes, and causes irregularities in cycles that can
be more
easily discerned. The clearest cycles are the
residential land
cycle (typically 9 years in duration) and the
commercial land
cycle (typically 18 years). The exceptional size and
unique
importance of the land market mean that a bursting
land bubble
is the most reliable SINGLE predictor of a recession
[3]; in
particular, the global recessions of 1974-5, 1981-2,
and 1990-91
were heralded by bursting "property" bubbles, i.e.
land bubbles.

THE REMEDY

To prevent recessions, we must prevent speculative
bubbles.
This is done by imposing a sufficiently heavy HOLDING
TAX ON
LAND-LIKE ASSETS in lieu of taxes on transactions and
house-like
assets. If this holding tax is based on capitalized
values or
changes in capitalized values, it reduces the
attractiveness of
"capital gains" and forces speculators to consider the
tax
implications before bidding up prices. If it is based
on
changes in rental values, it directly reduces the
changes in
after-tax rents that translate into "capital gains".
The
heavier the holding tax, the more productively the
owner must
use the asset in order to cover the tax, and the less
attractive
it is to hold the asset for PURELY speculative
purposes.

SELF-FUNDING INFRASTRUCTURE

To share in the benefit of a public infrastructure
project, one
must live or do business in the area served by the
infrastructure, for which purpose one must have access
to the
real estate in that area. Hence the economic benefit
of the
project is measured by the UPLIFT IN LAND VALUES in
that area.
If the benefit exceeds the cost, the cost can be
covered by
reclaiming only PART of the benefit through the tax
system,
leaving the rest of the benefit as a windfall for
property
owners in the affected area, without burdening the
taxpayers
outside that area. In this case the windfall does not
come at
anyone else's expense, but is part of the overall
increase in
human welfare attributable to the project.

Any holding tax based on CAPITALIZED land values
indeed reclaims
only PART of the benefit of an infrastructure project.
When
such a tax is in place, property owners' tax bills do
not
increase unless their land values do, and their land
values do
not increase unless, in the judgment of the market,
the owners
are better off in spite of the tax. If the tax is
based only on
CHANGES in capitalized values, property owners do not
lose even
in the initial INTRODUCTION of the tax. The higher
the marginal
rate of the tax, the greater the range of public
projects that
will pay for themselves through uplifts in land
values, hence
the greater the number of projects that will proceed
FOR THE
BENEFIT OF PROPERTY OWNERS -- and the faster the rate
at which
old taxes can be reduced or abolished, thanks to the
surplus
revenue caused by projects whose benefit/cost ratios
exceed the
self-funding threshold.

Property owners should therefore welcome land taxation
as a
means of investing in public projects that return
profits in the
form of SUSTAINABLY higher property values -- not
bubbles.
Unfortunately their self-interest has not been so
enlightened.

THE BIGGEST BUBBLE IN HISTORY

The first years of the 21st century were marked by a
global
property bubble. The inevitable burst began in
Australia in
early 2004. It has spread to the British Isles and
Europe, and
in due course must reach the United States [4].
Although this
global bubble was confined to "housing" (i.e.
residential land),
it was the biggest asset bubble in history in terms of
the
combined GDPs of the affected countries [5] -- and
that measure
fails to account for the number and economic weight of
the
countries involved. The bigger the bubble, the bigger
the
burst. The bigger the burst, the bigger the
recession.

But even that is understating the problem.

THE U.S. DOLLAR BUBBLE

For half a century the U.S. dollar has been the de
facto
international currency. So the growth in
international trade
causes growth in the global demand for U.S. dollars,
allowing
the U.S. to export dollars -- which cost nothing to
produce --
and receive real goods and services in return. That
is how the
U.S. manages to import 50 percent more goods and
services than
it exports [6]. When the exported dollars are
invested, they
can be invested only in U.S. assets, creating a demand
for
U.S. Treasury Bills without high interest rates, and
inflating
the price/earnings ratios of U.S. property, stocks,
bonds and
bills. So the value of the U.S. dollar is out of
proportion to
its earning capacity (yields on dollar-denominated
assets).
That is one characteristic of a BUBBLE.

The U.S. dollar is also the dominant currency -- and
until
November 2000 was the exclusive currency -- for
international
trading in oil. Hence the reinvestment of exported
dollars in
U.S. assets is sometimes called RECYCLING OF
PETRODOLLARS. Any
increase in the global demand for oil or the price of
oil causes
a corresponding increase in global demand for the U.S.
dollar
and boosts its value, protecting the U.S. economy
against the
inflationary effect of higher global oil prices. Such
appreciation of the dollar allows the U.S. to increase
its trade
deficit -- and makes U.S. goods and services less
competitive,
CAUSING the said increase in the trade deficit.

In 1971 the U.S. dollar ceased to be backed by gold.
The U.S.
trade deficit appeared in the late 1970s, increased
temporarily
in the mid 1980s, and began its present uncontrolled
blowout in
about 1997. These developments made the dollar's
position
increasingly dependent on its use in the oil trade, so
that the
argument supporting the dollar became increasingly
circular:
dollars would buy oil because oil exporters would
accept dollars
because dollars would buy other products because
exporters of
other products would accept dollars because dollars
would buy
oil! Valuation by circular argument is another
characteristic
of a BUBBLE.

One thing that could burst the bubble is a credible
alternative
to the dollar -- such as the euro.

SOFT ON TERRORISM

In November 2000, Iraq began selling oil for euros
instead of
U.S. dollars. The following year, the new U.S.
administration
was so busy looking for excuses to attack Iraq that it
ignored
multiple warnings about al Qaeda, and was consequently
caught
flat-footed on September 11 [7]. When Iraqi oil
exports resumed
after the U.S.-led invasion, payments were again in
dollars [8].
But this situation will not necessarily continue if
U.S. forces
are withdrawn.

ROGUE STATES

Iran expressed interest in the euro from 1999, and had
converted
most of its currency reserves to euros by late 2002.
In 2003,
Iran began accepting payment in euros for oil exports
to Europe
and Asia. In mid 2004, Iran announced that it would
establish a
euro-denominated international oil bourse (exchange),
which is
now due to start trading by March 2006 [9,10].

Since September 2000, Venezuela and 13 other
Latin-American
countries have entered into barter agreements whereby
Venezuela
sells oil for goods and services instead of dollars.
In mid
2005, Venezuela decided to move its currency reserves
out of
U.S. banks and liquidate its investments in U.S.
Treasury
securities. By early October, about 60 percent of its
reserves
had been converted to euros [11].

In 2004, Syria and Iraq signed a barter agreement
whereby Iraq
would supply crude oil in return for refined petroleum
products,
without using U.S. dollars [12].

Russia and Norway, on the edge of the Eurozone, have
no reason
to keep selling oil exclusively for U.S. dollars.
Japan and
China will not keep accumulating dollar reserves
forever in
order to finance the ballooning U.S. trade deficit.

END-GAME

Given that the value of the U.S. dollar must fall,
nobody wants
to be the last sucker holding dollars. Therefore any
perception
that the crash is imminent will trigger selling of
dollars in an
effort to pre-empt the crash. That selling will
amplify the
perception, causing more selling, and so on; so the
perception
will become reality. Worse, the rush to sell dollars
will
extend to dollar-denominated assets, including U.S.
property,
stocks, bonds and bills. So the burst of the dollar
bubble may
be the trigger for the expected burst of the U.S.
property
bubble -- among other things.

If, on the contrary, the U.S. property bubble bursts
of its own
accord, the falling value of this class of
dollar-denominated
assets will reduce the attractiveness of holding
dollars.
Worse, the recession precipitated by the property
burst will
bring down other dollar-denominated asset markets. If
the
initial collapse of the U.S. property market is not
enough to
prick the dollar bubble, the ensuing collapse of other
dollar-denominated asset markets will certainly be
enough, and
the dollar crash in turn will drive further selling of
dollar-denominated assets.

In either case, there will be a multiple burst
involving not
only the global property bubble, which is already
deflating
outside the U.S., but also the U.S. dollar bubble and
every
other asset bubble that has been pumped up by recycled
petrodollars.

The bigger the burst, the bigger the recession.

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NOTES

[1] The so-called "rent" of real property comprises
the rent of
the land plus the hire of any building(s) attached to
the land;
only the former is economic rent. The so-called
"rent" of a
vehicle is not economic rent, but a return on capital.

[2] Most corporate shares are PARTLY backed by
land-like assets.
Moreover, the speed with which shares can be traded,
relative to
the speed with which they can be created and
destroyed, makes
their behavior land-like in the short term.

[3] No person can live, and no business can trade,
without
access to land. Moreover, a land bubble tends to be
accompanied
by a construction boom (as buyers try to justify the
exorbitant
prices paid for sites) and a consumption binge (as
owners borrow
against inflated land values to buy goods and
services). These
MULTIPLIER EFFECTS work in reverse when the bubble
bursts.
Because of the long transaction times in the land
market, a
burst is initially manifested as slower sales rather
than lower
prices, allowing sellers and their agents to pretend
that the
market has "plateaued" when in fact it has crashed.
This state
of denial worsens the liquidity crisis that follows
the crash.

[4] THE ECONOMIST, November 8, 2005;
http://economist.com/finance/displayStory.cfm?story_id=5132938
.

[5] THE ECONOMIST, June 16, 2005;
http://economist.com/opinion/displayStory.cfm?story_id=4079458
,
http://economist.com/opinion/displaystory.cfm?story_id=4079027
.

[6] "America's trade deficit with China is 28% higher
than
America's total oil import bill... US imports of
industrial
supplies, capital goods, automotive vehicles, and
consumer goods
all exceed US oil imports." -- Paul Craig Roberts,
"Still No
Jobs", COUNTERPUNCH, November 8, 2005,
http://counterpunch.org/roberts11082005.html .

[7] Benjamin DeMott, "Whitewash as Public Service: How
the 9/11
Commission Report defrauds the nation", HARPER'S,
October 2004,
http://harpers.org/WhitewashAsPublicService.html .

[8] William Clark et al., "U.S. Dollar vs. the Euro:
Another
Reason for the Invasion of Iraq", PROJECT CENSORED,
#19 for
2002-3,
http://projectcensored.org/publications/2004/19.html ;
5 refs.

[9] William Clark et al., "Iran's New Oil Trade System
Challenges U.S. Currency ", PROJECT CENSORED, #9 for
2004-5,
http://projectcensored.org/censored_2006/index.htm#9 ;
5 refs.

[10] Cóilín Nunan, "Petrodollar or Petroeuro? A new
source of
global conflict", FEASTA REVIEW No.2,
http://www.feasta.org/documents/review2/nunan.htm ; 32
refs.

[11] Gregory Wilpert, "Venezuela's Central Bank
Confirms it
Deposited $20 Billion in Swiss Bank",
VENEZUELANALYSIS.COM ,
Oct.5, 2005,
http://venezuelanalysis.com/news.php?newsno=1777 .

[12] See e.g.
http://www.gasandoil.com/goc/news/ntm43368.htm .

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