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Paper Money Wears Prada

Tags The FedGlobal EconomyMonetary Theory

06/28/2011Doug French

Anyone who doubts the world's central banks' ability to send excess liquidity sloshing around the globe only has to look at the recent boom in the area of art and luxury goods.

It's always the case that cheap money flows to malinvestment.

While the monetary authorities look to create jobs on Main Street, the money inevitably flows to the latest speculative fashion, whatever it happens to be. No two Austrian business cycles are exactly the same. Like lightning, bubbles rarely strike the same sector twice.

Prada SpA, the maker of high-end accessories every girl wants to wear or carry, floated an initial public offering in Hong Kong priced at about 23 times estimated full-year earnings according to Bloomberg.

Although selling at the lower end of what some analysts believed the company would go for, the Milan-based maker of Miu Miu handbags still raised $2.1 billion for a mere 16.5 percent of the company to grow its brand. Sex and the City may be relegated to running sanitized episodes in syndication, but company president and head designer Miuccia Prada figures there's a boom somewhere and there are plenty of women needing expensive bags. "It's where the future is," she told the Wall Street Journal.

At the start of the year, Prada had 319 stores open for business, with another 80 on the way this year. The company prospectus points to China as the promised land for growth. "We are positive that the Greater China region is going to be one of the most interesting markets for the future of the luxury industry," Patrizio Bertelli, Prada's chief executive, said Friday at a ceremony to celebrate the company's stock-market debut.

Prada isn't an isolated case. Roman jeweler Bulgari was picked up for a 60 percent premium by LVMH Moët Hennessy Louis Vuitton SA in March, reports Grant's Interest Rate Observer. Two months later TowerBrook Capital tripled its money, selling Jimmy Choo to Labelux.

LVMH Moët Hennessy Louis Vuitton, the biggest luxury group in the world, is also following the money to China. The New York Times reports that last year, the company generated about 6.9 billion euros ($9.7 billion) in revenue in Asia, from its more than 800 stores. That compares with 4.6 billion euros in revenue, and 570 stores, in the United States.

The well-to-do are not just buying fashion. "The speed of the art market's recovery is astonishing, but it's a differently revived market," Michael Plummer, a principal of Artvest told the WSJ. "The lesson of the crash was to do your homework. Collectors feel wiser for the experience."

Vikram Mansharamani, in his book Boombustology, provides an interesting sidebar with a chart of auctioneer Sotheby's common stock going back to mid-1988, just before the final run-up of the Japanese stock market. The Yale lecturer and global equity investor tracks the ups and downs of Sotheby's common stock as a proxy for booms and busts in the art market.

The stock price for the auction house peaked as the Nikkei was peaking at the end of 1989. It ran to higher highs as the Internet bubble was cresting. Sotheby's ran to an all-time high of $61.40 with US house prices in 2007. The shares have run up again since the '08 crash busted the stock down to $6.05 with the China boom and the Federal Reserve's QEs 1 and 2. Earning $2.34 a share in 2010, the stock traded smartly in the $50 range in April, but it has since slumped to $40. "Even the most optimistic among us would not have predicted such results just one year ago," Sotheby's chairman Michael Sovern told Grant's.

Back in April, Kelly Crow reported in a piece for the Wall Street Journal, "The Art Market Snaps Back," that the market would be tested as $1 billion of Impressionist, modern, and contemporary works go to auction next week.

Crow wrote that some buyers are shy this time, having been burned just a couple of years ago.

But plenty more, flush and giddy, are just now joining in and paying little attention to prices. As a result, the art market's current state, while off from peak levels, still feels slightly breathless. Record prices are being paid for individual favorites like Pablo Picasso, whose "Nude, Green Leaves and Bust" sold at Christie's last May for $106.5 million, the most ever paid at auction for a work of art.

Art sales peaked in 2007, when Sotheby's and its main competitor, Christie's, sold a combined $11.3 billion worth. Two years later, in the wake of the financial crash, total sales plunged to $4.8 billion. "Yet, with a speed surprising both collectors and dealers, the market regained much of its momentum last year, with the two houses combining for sales of $9.8 billion," Crow reports.

Reporting on the spring auction season, the New York Times' Carol Vogel wrote, "Chinese and Russian could be heard in the Sotheby's salesroom. … But in spite of the presence of Prada-clad international collectors, it was a tepid start."

But at the end of the day, "while 'bidding was not euphoric,'" Simon Shaw, head of Sotheby's Impressionist and modern sale in New York, told the NYT "in most cases there was solid activity."

A week latter, Vogel reported, "A mix of overly optimistic sellers and price-conscious buyers made for a bumpy evening at Sotheby's sale of contemporary art on Tuesday night."

That evening Warhol's "Sixteen Jackies" went for only $20.2 million with Sotheby's fees, below the $30 million that was hoped for.

But while zero interest rates have only pushed the art market to ho-hum levels in the Big Apple, in Hong Kong, buyers can't get enough. So far in 2011, Sotheby's has moved $548.3 million worth during their Hong Kong auctions, more than double the $271.3 sold in the first half of last year.

And Chinese money prefers Chinese paintings and ceramics to Warhols. "They've now become among the top categories in the world," Sotheby's Bruno Vinciguerra tells Grant's, "and they're growing so fast that it's likely they will become the single-biggest category in the world." After sales in these categories doubled last year, they're doubling again this year, says Vinciguerra.

Moneyed Chinese have been working hard to trade their renminbi for anything from Vancouver condos to beachfront villas in Vietnam for good reason. The money supply has been growing at a rate north of 15 percent. In May the price of pork — the meat preferred by most Chinese — increased by over 40 percent from last year. And while the Chinese government says prices are up 5.5 percent, the price of all food was up 11.7 percent in May from 2010.

While the view exists that the Chinese economic mousetrap is a better one, Carl Walter and Fraser Howie don't see it that way. "We do not believe in Chinese exceptionalism," write Walter and Howie in Red Capitalism: The Fragile Financial Foundation of China's Extraordinary Rise. "If there are such things as economic laws, they work just as well in China and for Chinese businesses as they do in other markets."

The authors cast a skeptical eye toward China's government-controlled and propped-up banking system. Chinese bankers worry more about pushing the money out the door than the prospects of getting it back. As Jim Grant writes, "In China, the big banks don't formally go broke. Rather, every 10 years or so, the state recapitalizes them." Bad loans are shifted from bad bank balance sheets to worse bank balance sheets, Grant explains. The Ministry of Finance provides its guarantee to the bad loans at par, banking life goes on, and the economic miracle remains alive, backstopped by the lender of last resort, the People's Bank of China, levered at 1,233 to 1.

Economic miracles based on cheap and plentiful money are as old as John Law's system and the Mississippi Bubble. Easy money shortens people's memories and dulls their (good) sense. This one will end like all the rest, with the buyers of expensive art and luxury stocks wondering once again, "what were we thinking?"


Doug French

Douglas French is President Emeritus of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply, and author of Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master's degree in economics from UNLV, studying under both Professor Murray Rothbard and Professor Hans-Hermann Hoppe.

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