The Skyscraper Indicator Strikes in Saudi Arabia
In the recently published book “Austrian School for Investors”, one chapter inter alia discusses Dr. Mark Thornton’s “Skyscraper Indicator” in great detail. To this it should be mentioned that at the time the original German version of the book was written, crude oil was still trading above the $100 mark.
The erection of skyscrapers, specifically the construction of the “tallest building in the world” (somewhere in the world, there almost always seems to be someone busy with putting up the tallest building ever lately) is of great interest both from the perspective of Austrian business cycle theory and Socionomics (a theory of mass psychology and how it influences trends in asset prices and economic fundamentals).
What the Jeddah Tower is going to look like from above
(provided those funding it can remain solvent long enough).
Image credit: Jeddah Economic Company / Adrian Smith and Gordon Gill Architecture
To briefly explain the difference in approaches: we regard Socionomics as a “theory of contingent circumstances” – this is to say, it is a psychological and thymological discipline rather than an economic theory. It would therefore not be sensible to compare it to economic theory or to assert that it represents a competing economic theory.
Similar to history, Socionomics involves what Mises called “understanding”. It is advantageous to use it in conjunction with sound economic theory, it should be clear though that its task is definitely not to reinvent economic laws. It is by the way no surprise that the people who have come up with it (Robert Prechter and his colleagues) are speculators and financial market observers – people who Mises referred to as being akin to “historians of the future”.
A recentweb site brings us an awestruck reminder of the major engineering feat currently underway in the land of moderate head-choppers, which is leading the “tallest building in the world” sweepstakes at the moment.
“Saudi Arabia is currently on the way to building the world’s tallest building which would rival Dubai’s Burj Khalifa, currently the tallest building in the world. It is to be called Jeddah Tower and is currently already under construction. Costing at least $1.23 billion, it will also be a part of a $120 billion proposed development known as Jeddah Economic City. Interestingly, it is being designed by Adrian Smith, the same American architect who designed Burj khalifa. It will also become the first structure to reach the 1 kilometer high mark.
The Jeddah tower which would resemble a desert plant shooting into the sky as a symbol of Saudi Arabia’s growth and fortune, has a triangular footprint and a sloped exterior design to reduce wind load. It also has a high surface area which would make it ideal for residential units. Though no official floor count has been given, the architect Adrian Smith stated in an interview that it would be about 50 floors more than Burj Khalifa. This leads us to believe that it would have more than 200 floors. The building would have a total of 59 elevators including double deck elevators and 12 escalators, it would also boast the world’s highest observation deck to which high speed elevator’s would travel up to 33 feet per second in both directions (slightly over 35km/hr). Jeddah tower would have 3 sky lobbies where elevator transfers can be made.
The Creator [sic, ed.] and leader of the project, Saudi Prince Al-Waleed bin Talal, intends for it to bring significant change in terms of development and tourism to the city of Jeddah. It is estimated that the construction will take five years and 3 months to complete. Although other experts believe it might take significantly longer considering the duration of the construction of Burj Khalifa.
Incidentally, Saudi Arabia is currently losing foreign exchange reserves at a pace of 5.7 Jeddah Towers per month – assuming the tower’s price tag remains close to the current estimate, which is just as heroic an assumption as the estimate of how long it will take to build it.
What it Means
Readers may have noticed that China has been a recent host of assorted “tallest building” efforts – and its economic miracle has begun to look decidedly wobbly of late. Before that, Malaysia was busy erecting the Petronas Towers shortly before the Asian crisis struck, and in the US construction of the Empire State building – then the tallest skyscraper in the world – was started shortly before the beginning of the Great Depression. The construction of Dubai’s Burj Khalifa almost had to be abandoned when the original developer was felled by the 2008 credit crisis.
Constructing the world’s tallest building clearly seems to invite bad luck, but is this a coincidence? Let us look at the phenomenon from an economic perspective in the context of business cycle theory.
First of all, we can state the following: the business cycle is a monetary phenomenon (in Human Action, Ludwig von Mises succinctly debunks a host of non-monetary business cycle doctrines – see pp. 578-583 of the Scholar’s Edition). As such, it is the result of suppressing gross market interest rates below the level of the natural interest rate by means of credit expansion.
Changes in interest rates exert a pronounced inter-temporal effect on the economy’s capital structure. The further an element of the production structure is temporally removed from the final consumption stage, the more strongly it will be affected. This is easy to understand: everybody is aware that the height of the time discount makes a huge difference to the net present value of a durable good, or a long-term economic project (take for instance the NPV calculations presented in the feasibility studies of mines – often the time discount is at least as important a factor as the price of the raw material to be mined).
While skyscrapers – similar to all developments involving land and real estate for residential purposes – are ultimately consumption goods, they can be regarded as akin to capital goods for analytical purposes. As J. H. de Soto notes in Money, Bank Credit and Economic Cycles:
“[D]urable consumer goods are ultimately comparable to capital goods maintained over a number of consecutive stages of production, while the durable consumer good’s capacity to provide services to its owner lasts.”
In light of the above it is clear that in boom periods, the relative prices of land and real estate will tend to increase significantly. This produces the economic incentive for actors in the economy to shift factors of production inter alia toward real estate development. This is why enormous developments like the many condominium projects dotting the Vancouver and Toronto landscapes and dreams of construction projects that represent astounding feats of engineering likely to set new records, have a tendency to “get out hand” as a credit expansion progresses.
Here is a description of the Toronto condominium building boom from 2013 – when the oil price boom was in full swing and it was still widely held that it would never end:
“Toronto is awash in real estate. There were 144 skyscrapers under construction in late February, more than in any other city in the world, according to SkyscraperPage.com. Proposals for new condos reached 253,768 units at the end of the fourth quarter, up 10 percent from a year earlier, Toronto-based research firm Urbanation Inc. says. Four luxury hotels, each featuring condos, have opened in the past two years.”
The projects keep coming. Frank Gehry, architect of the landmark Guggenheim Museum Bilbao in Spain, plans three towers. The highest, at 85 floors, would be North America’s tallest residential building.”
Construction of a residential community in West Dom Lands in Toronto, a former industrial zone, anno 2013.
Photo credit: Doug Dean
It is no coincidence that many of these projects are likely to be finished just as Canada enters an economic bust. Their location – and that of the Jeddah Tower for that matter – is of course no coincidence either. Major real estate developments require a lot of time. From the decision to make an investment, to the planning stage, to the complex permitting processes, to the often formidable engineering and logistic challenges, there is a vast array of obstacles that need to be overcome.
OPEC and the Skyscraper Curse
The above is especially relevant for the project that represents the current “tallest building in the world” effort. The challenge of undertaking such a project is so formidable that apart from an abundance of cheap credit, numerous ancillary conditions need to be fulfilled as well. Its realization as a rule therefore takes especially long. This is why the construction of the tallest building in particular often begins only close to the end of an economic boom – it is therefore both a timing indicator, as well as an indicator of the boom’s magnitude.
If one looks at the report on the Jeddah Tower further above, the major socionomic element of the process stands out quite clearly – we are paraphrasing:
“The Jeddah tower resembles a desert plant shooting into the sky as a symbol of Saudi Arabia’s growth and fortune.”
In other words, it is essentially the culmination of a mass psychosis that has engulfed the country and its rulers and leading financiers, a collective fit of megalomania. Nothing seemed impossible when Saudi Arabia was still raking in wagon-loads of moolah day in day out selling overpriced crude. Unfortunately for the developers, the price of crude oil these days looks like an inverted version of their skyscraper:
WTIC crude, daily, over the past two years. Just as the skyscraper was supposed to soar to the heavens, crude oil’s price plunged to the depths of Zool (a place largely inhabited by evil ninja gremlins) – click to enlarge.
If it were possible to put on a paired trade involving both assets, we’d go long crude and short the Jeddah Tower (a potential alternative is a “long crude, short the Saudi riyal” trade. The riyal’s peg to the US dollar is easily the most shaky such arrangement on the planet right now).
Needless to say, in the wake of the oil stepping on a major oil slick, “growth and fortune” have suddenly become increasingly elusive commodities in Saudi Arabia (contrary to crude oil itself, which has become somewhat overabundant). What has caused this development? In our economically highly interdependent world, the causes are actually well outside the ambit of Saudi Arabia’s control.
Contrary to frequent assertions that the oil price collapse is either the result of a Saudi conspiracy to bring US frackers to their knees or a joint US-Saudi conspiracy designed to punish Vladimir Putin by damaging Russia’s economy, the culprits are actually found elsewhere. The main ones are probably the decisive slowdown in China’s money supply growth and the tightening of the Federal Reserve’s monetary policy that has begun with the “tapering” of QE3.
The former has occurred in conjunction with China’s attempt to become less dependent on exports and pyramid-building. This change in the country’s economic central planning efforts was by no means voluntary. It has been forced on its political ruling caste by the fact that consumer balance sheets in the US and Europe have been utterly devastated by the Fed and ECB policy-induced credit bubbles that have blown up so spectacularly in 2008.
The Fed’s halfhearted tightening meanwhile seems reflective of the confusion and desperation of Western monetary planners. Contrary to the “all is well” and “back to business as usual” assertions lobbed at an increasingly incredulous audience by assorted politburo officials, its aim is actually not really to tighten financial conditions. Rather, it aims to create “room to maneuver” to enable them to counter the inevitable bursting of the vast Bernanke-Draghi echo bubble.
China, M1 and M2, year-on-year growth rate. Although money supply growth has recently re-accelerated quite a bit, the lagged effects of the collapse in M1 growth from almost 40% to nearly 0% continue to play out and will do so for a while yet – click to enlarge.
The Saudis are just impotent spectators in this game, not the wily strategists as which they are sometimes portrayed. As an aside to this, it is quite funny that although there is really nothing good about one’s currency’s external value collapsing, the weakness of the ruble has in a sense enabled Russia to turn the tables on the Saudis (there is little love lost between Messrs. Putin and Lavrov and their counterparts in Wahabbistan).
Russia has found that it can actually live with $35 oil and is simply pumping more of the stuff – to the chagrin of the collapsing OPEC Cartel. In fact, OPEC has become a complete joke – it has been one since the early 1980s already, but these days it is more obvious than ever. Its “control” over global oil markets is precisely zero.
This leads us to a further aside: the entire mainstream theory of monopoly, which is regularly waved at us as a major justification for state intervention in the economy, is hopelessly flawed (readers are strongly advised to check out Murray Rothbard’s revolutionary take on the topic in chapter X of Man, Economy and State).
Putin and Lavrov meet the dishdash-clad Saudi defense minister Mohammed bin Salman, the number one son of the current king, who is working intensely on his personal mission of becoming caliph after the caliph.
Photo credit: Aleksey Nikolskyi / RIA Novosti/ AFP
The decision to build the Jeddah Tower was a major warning signal: as soon as it was made, it became just a matter of watching when construction would begin. Once that happened, the boom in crude oil prices was likely to be close to expiring. Meanwhile, it seems likely that the collapse in commodity prices and the associated recent collapse in junk bond prices represents merely the initial phase of a major synchronized global economic bust.
To understand why this is so, one has to keep the heterogeneity of capital in mind, and the temporal sequence of events in a boom-bust cycle. Many economists assert that since wealth is merely going to be redistributed between commodity producers and consumers, nothing untoward should happen overall. It is true that such a redistribution effect is occurring, but this simple narrative overlooks a major problem.
Let us not forget, the boom that began in the early 2000ds after the technology bust had played out was characterized by sharply rising commodity prices and the major capital malinvestment they engendered – which went well beyond the mere construction of mines and oil wells. Before the benefit consumers are gaining from the plight of producers has a chance to appreciably boost the economy, a different effect is going to play out: namely the liquidation of the above mentioned malinvested capital.
Financial markets won’t be immune to the bust. There are inter alia quite direct consequences. Many commodity producing countries have e.g. built up vast sovereign wealth funds, which are now transitioning from major purchasers to forced sellers of securities. The consumption-happy and saving-averse populations of Western countries seem unlikely to provide a sufficient offset. Without continuously accelerating monetary inflation, the air for the remaining asset price bubbles will become ever thinner.
The construction of the Jeddah Tower may be far more meaningful than meets the eye at a first glance. Its symbolic importance actually transcends Saudi Arabia and the oil-producing regions of Chaostan. Rather, it may well represent a warning sign for the whole world.
Charts by: Real Estate Board of Greater Vancouver, StockCharts, St. Louis Federal Reserve Research
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