Last week I watched “The Big Short.”
The movie portrays, really well, how unregulated capitalism set itself on fire less than a decade ago during the meltdown of the housing market. As I was watching it, my mind would link each of the events that preceded and followed the housing crash to the commodities crash we are living through today and, if history repeats itself, I could even picture what comes ahead.
The Bubble Shapes
All bubbles share similar characteristics. It all starts with strong demand for some object, whether it’s stocks, homes, commodities or tulips. In a very simplified way, the housing bubble started as banks gave loans to any individual, regardless of their income. As anyone could get a loan to pay for their home, housing prices started to pick up as demand increased. But higher prices weren’t a reflection of growth, they were just caused by easy money given out by banks.
In commodities, a bubble formed on hopes that China’s rapid growth would feed an ever-expanding appetite for raw materials. Moreover, in 2008 China launched a huge $586 billion economic stimulus plan, leading to higher demand for commodities and, therefore, rising prices. But prices weren’t reflecting real growth, either. They were inflated as fake demand was created on the construction of excessively extravagant government buildings and uninhabited “ghost cities” in China.
The Bubble Gets Bigger
During the housing bubble, everyone was making money. Banks were making interest money from their loans. House owners saw the value of their assets rise and everyone was pouring money into the housing market. Everything was built on hopes that housing couldn’t crash.
Similarly, everyone was making money as commodity prices rose. Huge infrastructure was built around the world to produce those commodities. Banks were making money on interest as producers took debt to build this new capacity. China was achieving its fake percentage growth rate and billions of dollars of capital investment were poured into commodities markets as an effective way to bet on China’s economic development. Everything was built on hopes that China would continue growing at that pace forever.
Prices Start Falling
House prices peaked in April 2006. Over the next couple of years, people believed that the decline in home prices was only a setback. That housing in the US was strong and prices could only continue to go higher. It wasn’t until 2008 until the market really acknowledged that both the home industry and banks were in big trouble. Read more