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Sunday, November 22, 2009

Prepping For Bubbles - Part 2

 Yesterday, in Part 1, I talked about some of the influences now in play in our economy - namely recessionary cycles, unemployment, inflation and government intervention.  A growing group of people are voicing concern of a potential economic bubble being ready to burst.

So what is an economic "bubble"? Wikipedia describes it as -
An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, or a speculative mania) is “trade in high volumes at prices that are considerably at variance with intrinsic values”. (Another way to describe it is: trade in products or assets with inflated values.)
As more and more people attempt to buy the same type of asset or product, the price rises even more, causing a sort of "feeding frenzy".  Speculators start buying the assets - even at inflated prices - in anticipation of even higher prices in the future, NOT because they think the asset is undervalued based upon its expected performance or function.

During this decade alone, we've had 2 significant economic bubbles - the "Dot Bomb" Internet bubble and the housing bubble.  Both touched virtually all Americans.  The Internet bubble caused a lot of damage to the stock market in general - thus retirement funds and 401k investments - with the "evaporation" of over $5 trillion in wealth.

The housing bubble still persists, but with a double-wammy on people.  Trillions in value have evaporated from the primary asset of most individuals - their homes - even if they weren't acting in the role of an investor.  We're all being hit by the increased taxes and government debt associated with the various bailouts Washington has thrust upon us.

The Internet bubble fed the Housing bubble.  Investors and others who got out before their stocks crashed, needed a place to put their money.  In the early 2000's, much of that money went into real estate.  When coupled with horrific government policies encouraging people to buy homes they could not afford, we ended up with the mess we're in today.

Just like with the Internet bubble, there are people today with large amounts of money and they've been looking for some place to put it.  With increasing frequency, they've been putting it into the stock market.  As noted yesterday, this is despite the fact that business in general is horrible. The business fundamentals don't support the current stock values.

The presumption is that the bubble will burst, and stock prices will come crashing down.  I personally agree with this presumption.

So what? you may say.  You may have all of your money (what's left of it) somewhere other than the stock market.  If it crashes, big deal.  Let the rich guys take another bath, right?

The reason everyone should care is explained in Japan.  If we want to see the result of our current market conditions, real estate conditions and government policy impacts, we only need to look across the Pacific.

Any of this sound familiar?
The big question is: why the Japanese economy remains so weak so many years after the bubble burst? Economists are still debating this.
(1) One explanation is purely cyclical. Since the bubble period created large overcapacity, it will take time to reduce capital stock and inventory. But if so, stock adjustment is taking a bit too long.(2) Another explanation blames the banks' non-performing loans. Since banks failed to get rid of bad debt (and the government did not encourage this effectively), financial intermediation was impaired, which in turn hurt the real economy. This vicious circle will continue until a bold measure to clean up the banks' balance sheets is taken (the government is claiming that it is being done, but maybe it is not enough...)
(3) Another popular explanation is that Japan's economic system has become obsolete. Japan's relational systems (lifetime employment, seniority system, keiretsu groups, subcontracting, and so on) may have worked well during the 1950s and 60s, but they are no longer efficient in the age of globalization. Some argue that Japan is facing the third major transformation (the first was in Meiji, the second was post-WW2 reforms). But others caution that Japan should not adopt the American system uncritically since some Japanese systems are still useful. Recall the argument about the origin of the Japanese system in lecture 9.
(4) Still another explanation points to the long-term changes of the Japanese society. Japan has a rapidly aging population and snowballing government debt. The Japanese people are uncertain about their future, especially concerning the rising tax burden, availability of jobs, medical care, and the sustainability of pension schemes. This pessimism slows down consumer spending and business investment.
(5) More recently, the lost competitiveness and the "hollowing-out" phenomenon (as firms invest abroad, jobs will disappear at home) of the Japanese manufacturing base are cited as a great threat. The recent rise of China as the factory of the world is raising concern [but China's growth may slow down; China itself has many economic, social and political problems in the age of WTO].

That was written in 2004 - over 10 years into their recession...

And that's really the most likely impact of a bubble burst - a long, grinding recession.  Just like Japan, it started with real estate and progressed to the stock market.  Our government is increasing debt and taxes attempting to fix the problem.  Instead, it merely prolongs the pain.

People need to understand that this is unlikely to be a quick-and-dirty affair.  Are you prepared to take that on?

Accept The Challenge

The likelihood of the state and federal governments cutting back their tax and spend policies is almost non-existent.  In fact, the opposite is more likely.  We all need to assume this recession will either worsen or at best, be a long "U" shaped event.

Because of increased printing of money, the dollar will most likely continue to fall in value.  Your precious dollars will buy less. 

Investments, in the traditional sense of the word, are likely to take a beating, and those that appreciate will likely do so at rates that barely keep up with inflation.  Buy tangible assets you can use - Food, equipment, ammunition, precious metals, homesteads.  Buy them now before sales taxes are increased. 

I will be shocked if we don't get some sort of a Federal VAT in the next couple of years, especially if Cap and Trade goes down in flames.

Prepare NOW while you have resources available.  If we come out of this by some miracle, what harm has been done?
Copyright 2009 Bison Risk Management Associates. All rights reserved. You are encouraged to repost this information so long as it is credited to Bison Risk Management Associates.


Andrea said...

I told a friend last year that I was putting my money in Mason jars...he thought I meant hiding the money in jars LOL. Over the past year, all our extra money has gone toward good tangible investments: larger sized kids clothes, canning jars, seeds, food stores. We still have a 401k, but it's taken a beating. Mine will be the generation that will have to fund their own retirement through (gasp) saving money and working long past retirement age.

Chief Instructor said...

The New York Times - not an organization often critical of Obama - had a quite sobering article yesterday on the coming crushing effects of the debt facing the government.... which means facing all of us.

I'm not sure a traditional retirement will ever be around for most people. Finding safe investments with returns high enough to combat inflation are nearly impossible to find.

Tangible goods and real estate, not fluff.