Sunday, April 11, 2010

Bubble 3.0

I see more and more indications that we are into our third bubble in the past 12 years. I will call this new economic event: "Bubble 3.0" until someone thinks of a more appropriate name. It will be named once we figure out what sector of the economy overheats. In 1998 the first bubble was called the Tech Bubble. In 2004 the second bubble was called the Housing Bubble. Maybe this third bubble will be called the Bond Bubble. But of course we won't know until the recession of 2012 rears it's ugly head.

Our nation's current economic environment is somewhat unprecedented. There are only two comparisons to what we are going though now. But neither is an exact match.

The first comparison would be with Japan of the 1990's. I will call this the Economic Model.

In the 1980's Japan's private sector borrowed much more money than it could pay back as it inflated real estate and stock prices. Presently Japan's private sector is desperately saving money as their government is desperately borrowing money. Total debt for the country is increasing because the government is a lot more efficient at borrowing money than the private sector is at saving.

The Wall Street economists that didn't see a problem with Japan's private sector debt in the 1980's, presently don't see a problem with the massive debt that the Japanese government is creating now. These same economists are emphatically saying that we must use the same Japanese style solution in our economy. But of course we are Americans. We have to do it bigger and better.

The second comparison to what we are going through now is the Accounting Model. This was the method suggested by the bankers at the outset of the Great Depression. This method involved the private sector repairing their balance sheets through debt destruction instead of the government taking over the debt. Our country incurred a lot more pain but we came out of the 10 year World Depression in 1940 as the strongest country that has ever existed. That's why I have such an affinity towards the Great Depression.

I kind of like the idea of going through a little hardship and having a reward at the end.

Anyway, there is no need to worry about that. We are a nation of financial weaklings and have chosen the Economic Method to solve our debt problem. So we are in uncharted waters. The only example that we have is Japan and that scenario hasn't played out yet.

How the decision was made to use the Japanese Economic Model instead of the Accounting Model is interesting.

This actually happened one night when Ben Bernanke went to sleep thinking that our economy was in fantastic shape. He must have had a nightmare because the next morning he woke up as a maniac, running around yelling that the sky was falling and that the only way to prevent the end of the world was to funnel as much money as humanly possible to our financial sector so that they don't have deal with their bad decisions of the previous few years.

Investors currently think that Bernanke and the Federal Reserve will keep borrowing money from China and The Middle East in the taxpayer's name and flooding it into the financial sector for "an extended period", or basically forever.

So investors have extrapolated that for the next period of "forever" our government will put taxpayer's into indentured servitude to hostile foreign nations and give the money borrowed to the financial sector. Presently the financial sector is so bloated with cash that they don't know what to do with it all. This money along with the hope that we are different than Japan is driving our current bubble.

Our government has showered money on the financial sector hoping that our insolvent banks will lend money to our insolvent households. There are two big problems with this plan and both of them involve insolvency. Japan could be the perfect example of what not to do. They tried to use debt to get themselves out of insolvency for 15 years. They are still dealing with the original problem of insolvency, or to much total debt.

We have cemented the Japanese chain of economic events into our future. So far our government is borrowing $5 for every $1 that is paid off in the private sector so we can plan on a faster outcome than Japan. We might even get "there" before Japan does. Where ever "there" is.

The only events in the future that we can predict with accuracy is that within 3 years Ben Bernanke will get a Nobel Prize for using extreme measures to save the economy. And then 3 years after receiving these accolades he will start being demonized in the same way that Alan Greenspan is being demonized now for keeping the Fed Funds rate to low for to long.

So in essense all we know that our nation has a very, very short attention span as we are attempting to borrow our way out of to much borrowing.

So what is an investor to do?

I have thought about this moment a lot since Bernanke's nightmare. How do you invest when the Federal Reserve and the government are pouring massive amounts of money into the economy and creating an investment market full of drunken speculators? Is it wise to take risk and ride the bubble close to it's peak and then sell off? I told myself at the time that a ride on the bubble sounded like a good plan.

But now that it is happening I am a little nervous. I have rode the stock market up to overvaluation but presently I am totally out of the market. I have learned something about myself. I just don't have the guts to be a speculator.

I have made the decision to watch from the sidelines.

Sometimes I have delusions of grandeur and fantasize about placing a large short position at the peak of Bubble 3.0 just like I did with the stock market in 2008. But of course this is just folly. There are an elite few that have the intestinal fortitude to make money shorting a monumentally dysfunctional investment market like today. This market will create a lot of collateral damage. Shorts are already getting brutalized and it could get much, much worse. This could be the first market in history that has capitulation at a price peak instead of a price bottom.

For now my money will stay under the mattress, so to speak. I will buy as I always do, at good value. Probably in the declining market of 2012.

Today is not even a market for George Soros. He plays the odds. This will be a onetime bet for future Joe Kennedy's and John Paulson's that could potentially create investment dynasties. Or lose everything trying.

Presently any gain in this market from here to the peak is not worth the risk. From this point forward we will see a gun battle between the shorts and the longs. It will be like a winner take all, wild west shoot out on the muddy streets of Dawson during the gold rush of 1898. A pull of the trigger will determine who's standin' and who's lyin'.

All I can say is Yee Haw!

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