The Biggest Bubble in Human History?

What kind of liquor do they drink?

by Bill Bonner

Dow up 125 points yesterday, to a new all-time record.

Why? What's behind it? The economy is not so hot. Why the red-hot stock market?

China is back in the news. A new report from CBS's "60 Minutes" documents the extent of the ghost cities in China – miles and miles of empty highway, office towers, apartments and malls. Analysts are talking about the biggest real estate bubble in history!

Is China a bubble? We don't know.

Does it matter? Well... yes... maybe. If China melts down or blows up the demand for oil and other resources goes down. The Chinese have pumped vast sums of money into development projects. That money helped to keep people on the job... and also kept the ships full of stuff, going back and forth across the world's oceans.

Trouble in China is trouble everywhere – particularly in Australia (which has been selling itself by the ton to the Chinese) and in Europe (which sells its precious, high-touch products by the boatload). Drive around Beijing and you see German autos, Italian shoes, Swiss watches and French perfumes.

But why worry? The Chinese can print money too! When China does something, it tends to do it to excess. That's why there are so many empty buildings in the Middle Kingdom and why it might have created the biggest real estate bubble in history.

China overdoes it when it comes to central bank stimulus measures too. Arguably, no central bank has done more than the People's Bank of China when it comes to pumping up the economy.

M2 money supply in China is roughly twice GDP. In developed economies the ratio between M2 and GDP is usually below one. In emerging market countries, M2 is usually 1 to 1.5 times GPD.

That's why bad news for China... like bad news for the U.S. economy... could be good news for the stocks. The Chinese feds will pump more money. Stocks will go up!

The New York Times reports:

The Dow Jones industrial average, which measures the performance of 30 blue-chip companies, closed with a gain of more than 125 points Tuesday, surpassing its previous record close of 14,164.53, which it achieved nearly five and a half years ago, as well as its record intraday high, set around the same time, of 14,198.10.

Of course, a few things have happened since October 2007. The housing market collapsed, the financial system went into meltdown, the European Union started to fray and politicians dragged the United States through an on-off-on-again fiscal imbroglio.

But stocks managed to move beyond all that.

Since a low point in March 2009, the Dow Jones index has more than doubled, stunning even the most seasoned stock market watchers. It closed at 14,253.77 Tuesday.

"What's amazing about this bull market is that people still don't think it's real," said Richard Bernstein, chief executive of Richard Bernstein Advisors, a money management firm. "We think this could be the biggest bull market of our careers."

The Aristotelian Error

Yeah – you can count us among those who don't think it's real. We think it's what happens when all the world's central banks are evaporating yields on bonds and corralling investors into stocks.

If China goes into a serious correction, how will its leaders overreact? With even more funny money and EZ credit?

We don't know enough about the Chinese situation to make an educated guess. So we'll make an uneducated one. Whether they live in Beijing or Washington, economists tend to have the same dumb ideas.

They are heirs to the Aristotelian error: the belief that without them the whole world will fall to pieces. They believe they must set the price of the economy's most essential ingredient: credit. And if the economy fails to do their bidding, they will give it more money too.

All major central banks are in agreement about this. All believe they can see, in their mind's eye today, a picture of the world as it will be tomorrow. And they further believe that they can Photoshop it to make it better.

They improve the future by making credit cheaper or dearer, as the occasion requires.

But how is it possible, you might wonder, that these few homo sapiens can do something so remarkable?

How do they know precisely how much new money to create and how to price it? What kind of bread do they eat? What kind of liquor do they drink? Surely, they do not eat and drink the same things we do; for they must sup at the gods' table to be able to do such things.

In their naïve and simpleminded way, the planners believe that a slack economy calls for overtime work at the central bank. That which the private sector taketh away, they say, is what we will put back – and more!

So stocks go up. That's our best explanation.