What a fun system we have - all we do is go through bubble and busts courtesy of punch bowls provided by the wise chiefs at our central bank. We speculated that perhaps 'cleantech' could be the next bubble but really the possibilities are endless as I don't see the Federal Reserve lifting a finger on the fed funds rate for all of 2010. As I said in 2008 and earlier this year, as a student of the Great Depression, Ben B wakes up with chills at night thinking he could push us into a double dip if he takes away the kerosene too early. [Sep 12: Federal Reserve's Kohn: We Plan to Keep Throwing Kerosene on the Fire] That was considered the great error of the 1930s.
So instead? Much like a dam bursting (see 2007/2008) we'll go down that path instead. Build up excess, talk about the brilliance of the new Maestro and then watch it all come washing over the sea walls ... again. I can see right now just how addicted to nearly free money that what used to be normalized terms (i.e. people having to pay for their own cars, mortgage rates at 6.25%) now will cause carnage to our economy. [Jun 3, 2009: A Country that Cannot Function Without Easy Money]
So let's see how this happens...
- The next financial bubble could come sooner than you think. A year after the collapse of home values triggered the financial crisis and Great Recession, another rapid and irrational rise in the price of assets -- whether stocks, home values, oil or something else -- would seem unlikely. After all, major bubbles through history have been spaced decades, if not centuries, apart. (those were the good ole days, now we have the new paradigm)
- Today, though, amid the wreckage of the last bubble, the ingredients for the next are still with us. One reason is that there's a sharp rise in the amount of capital sloshing around the world in search of the best returns. Investors are still fixated on short-term gains over long-term performance. (so are investors' computers) And information now travels instantly, fueling a herd mentality and feeding the optimism wired into our brains. (I apparently was born in the wrong species, since realism is wired into my brain)
- Bubbles feel good when they're inflating, but even that upside isn't a replacement for slow-and-steady growth -- the type of economy the U.S. mostly had for decades. (again, we're down with the good ole days - we now have a central bank on meth) The problem comes when the music stops and the wreckage spreads far beyond the assets that were inflated.
- It's not a matter of could it happen again; it's a matter of when, says Kenneth Rogoff, an economics professor at Harvard University and co-author of a new book on bubbles called This Time Is Different: Eight Centuries of Financial Folly.
- Reckless day traders and unqualified home buyers got blamed for the Internet stock bubble at the beginning of this decade and the still-deflating housing bubble. But they're just bit players in the story. The surge of global capital seeking the quickest and most profitable investments played a larger role.
- Over the last 30 years, the value of financial assets -- such as stocks, bonds and bank deposits -- grew to be four times larger than annual global gross domestic product.
- Mckinsey Global Institute estimates this measure of wealth peaked at $194 trillion in 2007. And while it fell back to $178 trillion at the end of last year, it is still dramatically larger than the $43 trillion in 1990 or the $94 trillion in 2000.
One has to wonder where all this wealth came from? It appears the sky. Or printing presses. A doubling of wealth from 1990 to 2000 and then another doubling in under 7 years? Hmm...
- Today, record-low rates for short-term loans in the U.S. -- tied to the Federal Reserve cutting its target rate for overnight bank loans close to zero -- are also now playing a role. And there's more incentive for money managers around the globe to use dollar-denominated short-term loans to buy stocks, commodities and other investments that typically deliver higher returns.
- .... as money managers shift funds around the globe in search of the highest returns, they often end up piling into the same asset classes so they can show clients they're wise to the next hot investment. This is the kind of herd mentality that leads to asset prices inflating beyond their fundamental value. (which is why when these things end - and they always end ... it is so ugly on the other side)
- Harvard professor Rogoff and others say that's why tougher rules on risk-taking, Wall Street compensation and borrowing are needed. Good policy changes could put off the next (bubble) by 50 to 75 years, instead of five or 10, he says. (that sounds like socialism Mr Rogoff - I assume you must of been interviewed at a cute cafe in Paris for this story? We cannot restrict bubbles, in fact our central bankers have told us they cannot even see them. Only the Indians can see them - perhaps we need to outsource our central banking position to New Dehli) [Dec 28, 2008: NTY - How India Avoided the Crisis]
- Harrison Hong, an economist at Princeton University who researches bubbles, says the same short-term mindset that prods investors to pile into the next boom also allows them to forget the previous bust.
- After the bursting of the tech bubble in 2000, it only took a few years before the same investors who lost money on Internet stocks turned their attention to real estate as home prices rose rapidly. Memories are fairly short, Hong says. My sense is that we're going to be in for a repeat of this stuff somewhere down the line.
Hold on Mr. Hong - down the line won't be too long... you can see the waves hitting the sea walls as we speak.