First paragraph (Teaser):

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.

Rest of the text:

GLOBAL DEPRESSION 2006---?

Gavin R. Putland
(http://grputland.com)
December 4, 2005

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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