The new bubble: China

In the wake of the dotcom bubble of 1995-2000, and the real-estate-bubble catastrophe of 2003-2008, economists and policymakers are looking around anxiously, trying to predict the next bubble to burst.  In all their casting about, they are quietly ignoring the dead moose lying right there on the coffee table in the middle of the room:  China.

Consider the dotcom bubble for a minute.  The bubble was caused by a bunch of entrepreneurs who jumped on the make-money-fast-on-the-Internet bandwagon (the ".com" suffix, pronounced "dot-com," became a new word and a label for the whole fiasco), and all the investors who fed them money.  Greed fueled the dotcom bubble.  Even people who should have known better, smart and educated Wall Street professionals, bought into the boom.  Some college professors and very conservative investment advisors warned that both the entrepreneurs and the speculators were ignoring the basic principles of investing, but others said that the dotcom boom had rewritten the rules.  I actually heard several "experts" on public radio saying, "This time it's different."

Well, that time, it was no different.  Most of the dotcom businesses  went bankrupt in a few years.  The entrepreneurs and the investors lost everything.  The money simply disappeared, along with everything built on that money.

When you get right down to it, the cause of the dotcom bubble was pure and simple greed:  people wanted to get rich quick.

The real estate bubble was the same way:  Before the bubble began, mortgage lending was governed by strict rules.  A potential homebuyer had to have a large enough down payment to indicate a serious intent to keep the property, and a demonstrated ability to make the required monthly payments.  Potential lenders did serious evaluations of buyers' ability to pay:  the credit appraisal.  Millions of homebuyers have experienced the anxious waiting period while their credit appraisal was being completed, wondering what kind of credit risk the lender would assess them at, and what mortgage terms they would be offered as a result.

Suddenly, almost overnight, the lending rules changed.  The required down payment dropped from 20 percent, to 10 percent, then five percent, and finally zero percent.  No down payment was required to get into a house.  At the same time, credit terms were relaxed.  There was no longer any need to demonstrate that a buyer could sustain a mortgage payment - not for one month, let alone for 30 years.  And finally, an insidious form of mortgage which had been quietly gaining in popularity for 30 years seemed to take over the market.  This was the negative-amortization loan, which allowed a buyer to make smaller payments than the minimum required by the traditional formulas, with the accrued interest being added to the principal, so that the buyer owed more and more money as time went on.  Some of these negative-amortization loans had a a schedule of gradually increasing payments as the years went on.  Some only had a term of three to five years, with a huge "balloon" payment at the end, with the unwritten (but oft-spoken) mutual expectation that the buyer would arrange new and better financing before the loan expired.

Two things happened as a result of this relaxation of the rules.  First, people who should never have been buying houses started buying houses.  Second, everybody - well, almost everybody - started buying houses bigger than they could afford.  Then sellers started realizing that they could get a lot more money for their property than they were expecting, and so they started jacking up the prices of their homes.  Home prices had been rising steadily for decades anyway, but suddenly the prices accelerated their upward trend.

Everybody was getting rich.  Buyers were getting bigger houses than they could afford.  Sellers were making lots of money.  Lenders were getting lots of mortgages - meaning that they owned lots of homes.  Then the sellers, mostly banks, started bundling the mortgages together (think of the physical metaphor, all of those paper mortgage agreements, stacked up and held together with rubber bands) and selling them to each other as investment instruments.  Heck, if all those buyers actually made their payments for 30 years, those mortgages represented a lot of income for the lenders!

(We haven't even talked about China yet.  Stay tuned.)

So buyers, sellers, lenders, and stockholders saw the chance to get really rich, really quick, and they jumped on it.  Once again, as with the dotcom bubble, people ignored the safe and sensible rules of investing, caught up in the chance to make money off the rapid rise in property values.  Builders built, banks lended, flippers flipped, and real estate agents (and their friends, the mortgage brokers) paid cash for fancy new cars and stuff.  As before, greed ruled the day.

This entire house of cards was built on a foundation of borrowers - home buyers - who couldn't afford to pay back the money they had borrowed.  When these people eventually ran out of money and defaulted on their loans, the lenders exercised the terms of the mortgage, kicked them out of their homes, and took over their property.  But foreclosed property doesn't make the banks any money.  They try to get rid of it as quickly as they can.  But the banks had acquired so many homes that they couldn't sell them all - not quickly, not slowly, and not for anywhere near their appraised value.  That's because the home values had been horrendously inflated in the price runup that was the bubble.

Now the banks had the properties, but not the cash flow that the properties were supposed to generate.  Without money coming in, the banks couldn't take care of their own financial obligations.  So the banks started failing, or at least were in danger of failing.  The only way they could generate money in a hurry was by selling some of their investments.  And the vast majority of investments were those bundles of mortgages - "mortgage-backed securities," they were called - and since those mortgages were in default, they were worthless pieces of paper.  Nobody wanted to buy them.

So the homeowners lost their homes, the banks lost their money, and the investors lost their money.  Banks couldn't afford to pay their bills or their employees.  All the money that went into the real estate market disappeared and was gone forever.  The ripple effects from this disaster led to failures in other, tightly connected industries, such as investment broker Merrill Lynch, insurance company AIG, and automaker General Motors. That's when all the banks, the investment companies, the insurance companies, and the automakers ran crying to the government, saying "we're too big to fail."

In case you haven't figured it out yet, I'll say it again.  The entire dotcom bubble and bust was caused by greed.  The entire real estate bubble and bust was caused by greed.

And that brings us to China.  I speak of China here as one monolithic entity, encompassing its government, its financial institutions,  and its industries.  Some of you may object if I include Taiwan and Hong Kong in the monolith, but for now that's what I'm doing.  I may lump the Chinese people in here as well, because the individuals are what make up the aforementioned institutions.

China is the next big bubble, and when it busts, the results will be a worldwide catastrophe.  And as with the dotcom and real estate bubbles, the driving force behind it all is greed.

China has systematically undercut prices for manufactured goods all over the world.  Because of the low prices offered by Chinese manufacturers, many American companies have moved all their manufacturing from North America to China.  It saves the American companies lots of money, which shows up in their  corporate profits.  Besides, it lets them sell their goods to American consumers more cheaply, and American consumers like "cheap."  Most American consumers prefer "cheap" over "quality," but I don't think we'll get into that here.

As a result, most, if not all, of the American companies who make their goods in China are trapped.  For example, all of Apple's iPads and iPhones are made in China.  They could not stay in that business segment if they were suddenly forced to make them here.  Even if they could set up an assembly line, they couldn't run it without the components - the display, the batteries, and so on - because the components are also made in China.

(There was a great article in Forbes recently, called "Why Amazon Can't Make a Kindle in the USA.")

Much of today's high-tech gadgetry, including the cheapest cellular phone on the market, depends on some exotic minerals known as rare earth elements to operate.  Those rare earths used to be mined in Africa, Russia, and North and South America.  Several years ago, China started mining them and selling them at drastically reduced prices.  The other mines could not compete and shut down, leaving China as the sole source for these rare earths.  Recently, China has been talking about jacking up the price or restricting the supply of these minerals.  Guess what would happen to Nokia and other (non-Chinese) cellphone manufacturers if rare earths became too expensive to buy, or simply unavailable?  That's right!

Recently, I wanted to buy my wife a new kitchen mixer.  I went to three department stores here in the western U.S.  Every single mixer I looked at was made in China.  The venerable domestic brands like Sunbeam, and the classy European brands like, um, Braun (I think) all had "Made in China" stamped on the box somewhere.  And they were all made in China because it's cheaper.

Our first vacuum cleaner was a Hoover.  It was made in America (or Canada, I think) and it was mostly made of metal.  Our second vacuum cleaner was also a Hoover.  It was mostly made of plastic, but it was still made in America.  Together, those two vacuum cleaners lasted over 30 years.  They were sturdy machines, and we used them A LOT.  Now we're shopping for our third vacuum cleaner.  We looked at the offerings from Hoover.  They're made mostly of plastic.  They're made in China.  They have a terrible reputation for workmanship, reliability, and vacuum-ability.  Why should we buy Hoover again?  We won't.

Hoover's not the worst, nor is it the cheapest.  There are cheaper vacuum cleaners.  They don't work very well, either.  And guess where every single one of them is made?

It gets worse.  Shall we look at automobiles?  The concept of a "made in America" automobile, even a manly American pickup truck, is laughable.  All of the electronics are made in China, or assembled in the U.S. (or Mexico or another country) from components made in China.  The bumpers and fenders may be made in the U.S. (or Mexico or Ohio), but the raw materials for those metal bumpers and plastic fenders were shipped to the U.S. from overseas - mostly from China!  Even the fabric or vinyl upholstery for the seats comes from China.  The light bulbs!  The floor mats!  Detroit has outsourced all of it, in an effort to make a buck.

(John Deere, in Iowa, still makes a lot of their own components.  But Chinese electronics are starting to make inroads there, even.)

How did the U.S. government finance the bailout of the companies that got caught in the 2008 financial crisis following the bust of the real estate bubble (especially the "too big to fail" companies that should have been allowed to fail, or else cut up into smaller pieces that were no longer "too big to fail")?  They sold government-backed securities to other countries.  And which country bought the lion's share of those securities?  Which country was so flush with cash (or the promise thereof - remember how the real estate bubble worked!) that it could step in and buy billions of dollars of U.S. treasury bonds without flinching?  Well, China, of course!

And guess where China got all that money from?  From America, of course!  They sell us their stuff, they collect our money, and then they buy our country and our future.

But it's all a house of cards, just like the dotcoms and the housing boom.  China has looked into their future and they're forecasting massive growth - so massive that they've gone out into the countryside and carved out entire cities from nothing.  Street lights, apartment buildings, government buildings and shopping centers have risen out of the pastures and are waiting for people to move into them.  These "ghost cities" can be seen on Google Maps, and they're eerily empty.  The Chinese are mining coal and burning it at a furious rate, to literally fuel their growth.  They are damming rivers and gouging out strip mines to supply their hungry industries with raw materials.

And they are engaging in a centuries-long tradition of imitation and deception.  They take products made in the West, try to figure out what makes them work, and then try to come up with a copy that looks the same - right down to the trademarks, the colors and the textures.  Some of the patented and trademarked cable that my own employer makes has appeared in counterfeit form in Asia - made in China.

In the ultimate irony, they duplicate not only Apple's computers and handheld products (and remember, the legitimate ones are also made in China), but they sell them in 22 imitation Apple stores.  The stores are not affiliated with Apple Computer in any way, but their layout, decor, and even employee uniforms and name badges are exact duplicates of what you will find in real Apple stores.  The deception is so complete that some of the store employees think they are really working for Apple Computer.

I have already written about the sham (and the scam) that was the 2008 Beijing Olympics.  It was a plastic imitation of the real thing, a shameless ripoff of other people's hard work, enabled by the duplicity of the Chinese government and the gullibility of the rest of the world.  In the same way, the duplicity of monolithic China and the willingness of the rest of the world to be led around by the nose (or other body parts) has contributed to the growth of the house of cards that is the Chinese bubble.

Actually, that's not completely accurate.  At the core of everything, it is the greed of monolithic China and the greed of the rest of the world that have contributed to the Chinese bubble.

One day, the U.S. government or another government will not be able to make good on the financial instruments that China holds.  China will find out that it is holding on to worthless pieces of paper, and that China does not have enough real money to keep operating.  With no money to pay its own obligations, power plants and mines will shut down.  Trains will stop operating.  With no way to get raw materials, factories will shut down and send their workers home.  With no jobs and no money to spend, Chinese people will stop buying their own goods.  With nothing to ship, ships will stop crossing the ocean, and Americans will no longer be able to buy Hoover vacuum cleaners, Sunbeam mixers, or Apple iPhones.  Without the raw materials and components from China, American automakers (and Japanese and German ones, too) will no longer be able to build cars.

Printing presses, computers, traffic lights, tables, chairs, dishes, cutlery, light bulbs, furniture, clothing:  all of it will come to a stop until alternative sources can be found or tooled up.  Those alternative mines and factories will spring up all over the world, but they won't start producing overnight.  They will take years.  And the wealth, or commerce, or economic prosperity - the money - that was lost forever will take even more years to replace.

It may take a decade for the bubble to burst.  Some people will argue with me and say it will never happen.  But it ony took 15 years for the gigantic Japanese economic machine, which was also supposed to take over the world, to come crashing down.  It surely did, and the Chinese one will come crashing down just as surely.  And when it does, it will take years for the world to recover.

From its own greed.

Tesla Motors and Lightning Hybrids: Two New Car Companies Worth Keeping an Eye on

In 2006, a three-year-old startup called Tesla Motors (http://www.teslamotors.com/) introduced the world to the Tesla Roadster, an all-electric, two-seat sports car that could go 0-to-60 in under 4 seconds, had a range of 200 miles, and was powered by about a zillion lithium-ion batteries just like the ones in your digital video camera. The Tesla Roadster only costs $101,000, and they sell so fast you can't even find one on a showroom floor.

Tesla recently announced its second model, the Model S, a sedan with a 0-to-60 time of 5.9 seconds, still a breathtaking time, especially for a family car that seats 7. The Tesla Model S sells for about $50,000, half the cost of the Roadster. I wouldn't turn down either one of them.

Tesla Motors is unique in that it's not located anywhere near Detroit, St. Louis, or any of the other traditional automotive manufacturing locations in the U.S. Its headquarters is in San Carlos, California, in the northern borders of Silicon Valley. Tesla Motors is an American company, but its components come from Germany, Norway, and the UK, as well as the USA. If you see any similiarities between the Tesla Roadster and the Lotus Elise, that's intentional: Lotus won a competition to design and build the Roadster's chassis, among some other parts.

Tesla Motors has been around long enough that it has gone through its share of intrigues, shakeups, and lawsuits. The founders have been kicked out of the company and the current CEO is Elon Musk, the South African genius behind PayPal. Dealerships are popping up in big cities nationwide, in preparation for the release of the Model S.

We wish Tesla well, and we wish we owned a Tesla with its carbon fiber body, kick-a$ acceleration and all-electric drive train. Maybe one day. In the meantime, there's another new player in the game.

In January 2009, an "automotive research and manufacturing company" based in Loveland, Colorado, calling themselves Lightning Hybrids (http://lightninghybrids.com/), quietly announced that they were developing a hydraulic hybrid automobile. They showed their concept car at the Denver Auto Show in April 2009, and had their prototype driving around the streets of Loveland in June 2009.

Lightning Hybrids hosted an open house on Friday, June 26. It was an invitation-only event, but everyone was invited, and you had to RSVP in order to find out the location. Several hundred interested guests crowded into their "garage" in downtown Loveland, to get a look at the prototype and the facilities, and to listen to the founders and employees of Lightning Hybrids talk with excitement about their creation.

The prototype is a model called the LH4, the "4" meaning "four wheels." A second model, called the LH3, is already in prototyping as well. The LH3 is a unique design in that it only has one back wheel. It's a tricycle that runs backwards. (I assume that the front wheels will be for both steering and propulsion, as research at Stanford and MIT has shown that a configuration like this with rear-wheel steering is inherently unstable.) Both the LH3 and LH4 will be 4-seaters.

The hydraulic hybrid propulsion system is analogous to the more well-known (think "Toyota Prius") electric hybrid propulsion system, with a hydraulic motor/pump and 5000-psi reservoir taking the place of the electric motor/generator and battery bank. The hydro hybrid system is 50 percent more efficient than the Prius' electric hybrid system, and it delivers enough horsepower to give the car the same kick-a$$ acceleration as the Tesla vehicles have been posting.

The LH designers have been fanatical about keeping the gross vehicle weight below 1000 pounds -- that's right, only 1000 pounds. (Or was it 1800 pounds? Help!) Like the Teslas, the LH cars have carbon-fiber bodies. The LH designers went the extra mile (sorry) to tweak the aerodynamics of their cars. The LH4 has only three body parts: the hood, the canopy, and the pan. The carbon-fiber pan gives the car a smooth undercarriage to reduce turbulence and drag in the boundary layer between the car and the road. The hood is the entire front half of the car -- no fenders, and no seams. The clamshell canopy opens and closes on hydraulic lifts, like an aircraft canopy or some of the futuristic concept cars from Ford and GM in the 1960s, so there are no doors, doorknobs, or door seams. Digital cameras take the place of side-view mirrors, and windshield wipers and radio antenna are recessed, retractable, or molded-in.

The result is a very slippery car that gets 100 miles per gallon in both city and highway. In the city, the hydraulic motor does most of the work, with the German-made Audi biodiesel engine only turning on to assist with heavy acceleration. On the highway, the high mileage is thanks to the super-efficient Audi engine, the lightweight construction, and the low-drag design.

LH plans to keep manufacturing costs low by buying off-the-shelf parts wherever possible. In a dark corner of the garage is the shell of a Mazda Miata resting on four jack stands, looking like something that was abandoned on a New York City street and stripped by, um, entrepreneurs for anything of value. Its dashboard, airbags and climate control system are now part of the LH4, as are key components of its suspension and steering.

Every component of the hydraulic system came out of somebody's online catalog. The (bio)diesel engine, as I mentioned, is a crate engine from Audi. Other key automotive components will be stock parts, purchased from other automakers or their suppliers. The only full-custom parts may very well be the body panels, window glass, and headlamp/taillight lenses.

In 2010, LH will expand into a manufacturing facility in Loveland, Colorado, large enough to employ 300 people and turn out 10,000 vehicles in the first year.

But at $39,000 and $59,000 respectively, the LH3 and LH4 may end up being LH's loss leaders. The company may end up making their real money on a couple of other product lines. First, they will sell an LH hydraulic hybrid retrofit kit for existing fossil-fuel-only vehicles. It wasn't clear to me if they will sell directly to manufacturers or to aftermarket garages (like Shelby, for instance). Second, they have applied for a $74 million economic stimulus grant to commercialize a plug-in hybrid electric (PHEV) drivetrain developed at Colorado State University. Even though their market niche is hydro hybrids, they have the expertise to do PHEVs as well, and it's too good an opportunity -- a local university, partnering with a local company -- to pass up.

When the Big Three were the Big Three and gas was cheap, independent automakers didn't do very well. Nobody remembers the Bricklin anymore, and the DeLorean only lives on as a time machine driven by Michael J. Fox. But the world has changed. Today, the Big Three are the Struggling Two and a Half. Gasoline is no longer cheap and plentiful. Maybe the market is finally ready for something different.

Sign me up. I'll take one of each, please.