Sunday, May 24, 2009

The Mother of All Bubbles

Back in the heady days of the 1990’s dot-com bubble there was a TV clip, on Nation Public Broadcasting I believe, that profiled a couple who were what I’d describe as extreme, or more appropriately mindless, investors. They had gambled their entire stash on a company they knew only by its stock market code. They had no idea what it actually did. That was four or five years before the crash, so they might well have cleaned up.

This was also about the time a true economic idiot made a bundle of money writing a book called DOW 36,000 that argued the market was actually way underpriced and was bound to triple in value even when in reality it was already seriously overpriced. It’s a new paradigm! Now the market only goes up! The boom and bust cycle is finished! Most depressing for the state of the world and the state of the American media is that that fellow, who’s name I can’t bother to remember, is still seen on TV doing his punditry thing, in spite of making one of the worst predictions of all time.

That was also about the time Greenspan made his too-smart-for-himself irrational exuberance comment. Too smart because after properly identifying a grave danger to the economy he did nothing to counteract or mitigate the certain crash to come.

You can be exuberantly irrational for limited periods of time but it defies logic, reason and common sense that you could carry on irrational behavior for very long before it results in a very rational smackdown.

I kept predicting the crash year after year; a good friend kept responding by saying, You’ve been saying that for years and it’s still going up. Well, no matter how much one might wish it otherwise, there’s no defying gravity. It’s in the nature of bubbles to burst, that’s what they do at their anointed time.

One bubble per decade seems to be America’s current pattern or need so it was important to create a housing bubble for the double oughts. In the great fear that the economy wouldn’t barrel ahead after 9-11, interest rates - for the bankers, that is - were taken down to near nothing. It’s worth pointing out that low interest rates are not good for everyone. For the savers, the people and their lifestyle that under normal circumstances - thinking of a rational world, that is - you want to encourage, low interest rates are a disaster.

In the midst of the housing insanity I pointed out to the same friend that in a market like Southern California it cost twice as much per month to own a house than it did to rent an equivalent one. An average $500,000 house might cost $5000 per month to own, but only $2500 to rent: in other words paying a $30,000 per year premium to own it. She then pointed out that property values were rising at 15% per year so that half million dollar house added $75,000 to its value and you’d still be way out ahead.

But rising values that were way out of line with reality were pricing people out of the market so mortgages had to be invented for people who couldn’t afford to pay them. NINJA loans – no income, no job, no assets – became the rage. It didn’t matter since the borrowers could always draw equity out of their houses’ rising value… until values stopped rising.

The enabler, I would argue, of both bubbles was/is the excessive wealth held by the powerful of society and the corollary belief that prosperity for the greatest number would be facilitated by placing the least restraints on those wealthy controllers. In reality, whenever they have too much money on their hands the certain result will be dangerous, and eventually destabilizing, speculation and asset bubbles.

Now, in the desperate, frantic, but also wistful and futile attempt to revive the old economy, or even a semblance of it, America is creating another bubble: this time it’s the dollar’s turn to bubbleize. It’s akin to a Reno loser story I once heard. When a gambler’s losses reach too high they feel they have to try anything to win the money back. After they max out the cash limits on their credit cards they go to a furniture store, buy a TV – the cards are still good for purchases – then turn around and hock it at the nearest pawn shop, getting probably 25 cents on the dollar.

America has already sold the farm – trillions of dollars are owed to foreign governments (China is the biggest creditor… If that doesn’t put a chill down your back, it should) – now it’s selling the furniture in the rented farmhouse; all to revive an unsustainable economy that should have been retired long ago.

Eleven trillion dollar national debt, 1.9 trillion dollar budget deficit for this year, 600 or 700 billion dollar trade deficits on an annual basis for years, one trillion dollars of personal credit card debt and now thirteen trillion dollars gambled on the big banks in the form of giveaways, loans and guarantees.

America’s the only country that could run massive trade deficits because the dollar is the world’s currency – people around the globe use dollars for things totally unrelated to the US. Eighty percent of transactions in Cambodia where I live, for instance, are in dollars. Every other country that tried to run those kinds of deficits would have been brought short pretty quickly and paid a heavy economic and social price for their spendthrift ways. Not America. At least not yet.

You know what they say; something that can’t go on indefinitely, won’t. Let me add my own postscript to that; the longer you wait to correct the imbalance the greater the impact when judgment day comes. For America comeuppance will bring catastrophe.

While all the aforementioned mentioned debts and liabilities will contribute to the crash of the dollar, the one most important factor has to be the attempt to save failed too-big-to-fail banks. Even after 13 trillion dollars of support, the Fed’s stress tests showed about half the nation’s 19 big banks will need another 70 billion dollars in new capital.

Moreover when you look at how unstressful the tests were, that 70 billion is a joke. The banks got to decide for themselves how healthy they were – doing their own pricing of their toxic assets, for instance - and their supposed solvency was based on extremely rosy economic predictions for the near future.

America’s on a years-long binge, challenging the gods, as it were, to bring it low. It’s ok to go into debt if it’s for something that has lasting value. It’s also good to go into debt if it’s used for something that brings in revenue and pays itself off. That’s sort of the thinking behind bailing out the banks: healthy banks = healthy economy = high tax revenues = debt no problem. But it’s a tremendous gamble on the order of the sad cases in Reno whose addictions result in them losing everything.

The big problem with going so deeply into debt so nonchalantly is that it has to eventually be paid back. At some point the joy ride must end and the price paid. Under any but the most benign circumstances, retiring debt is painful. It means taking from today’s advancement to pay for yesterday’s indulgence.

The only alternative to paying off the debt, which would require steep tax rises and social sacrifice – impossible to imagine in spoiled-child America - is running the money printing presses full speed ahead and hoping that doesn’t result in worst case scenarios.

There remains an immense reservoir of wealth in America in spite of the current hard times and great respect and trust in America’s strength around the world so I wouldn’t look for this dollar crash to happen tomorrow, but it’s as inevitable as the last two bursted bubbles were.

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