Rondaben
April 21st, 2008, 10:06 AM
As a backgrounder, I would highly, highly recommend this article:
The Next Bubble: Priming for Tomorrows Big Crash (http://www.harpers.org/archive/2008/02/0081908)
This discusses, to some degree, Keynesian economic policy. Keynes believed that we could avoid recessions in economies (i.e. the value of things always goes in one direction--up) by "reflating" asset bubbles. The article discusses how economic bubbles should be a rare event--and that the fallout from the bubbles used to actually have ramifications for elected officials.
The Tech boom in the late 90's was created by venture capitalists throwing money at every internet-related stock that came down the pike. These companies, when they went public, enjoyed a MASSIVE spike in price as people put thier savings into into the stock speculating that it was the "next big thing" and reading articles about how 20-somethings were making thier first 100 million overnight. Greed was abundant. The venture capitalists made billions--trillions even--from the initial public offerings of these companies stock. Proceeds were then cycled back into new startup companies and the wheel of asset price inflation was began. Stocks like Yahoo, Google, and the like saw stocks soar.
At its peak the market had inflated in value to over 7 Trillion dollars. People then began to look expectantly at the companies to produce revenue commiserate with there stock price (P:E was astronomical). Unfortunately most of these companies couldn't produce income that was anywhere near "the next big thing". Paper millionaires were everywhere. Stocks began to decrease in value.
Investors had a very important date on April 15th. They had tens of thousands of dollars in tax liability from the paper increase in value. They began to sell even more. The rush to the exit had begun and almost 7 trillion in value began to evaporate.
The Federal reserve, as it is now, lowered interest rates dramatically. It pumped in cash to "reflate" the imploding economy. This is the first of Keynes requirements to avoiding recession--free action of the government to fiscally intervene with monetary policy--i.e. print money as needed. Cash flooded into the markets. Interest rates declined across the boards. The next bubble began to take shape as government policy turned from promoting the internet and technology through tax abatement and legislative support to pimping out the all-American dream of Homeownership.
The next bubble had begun to take the place of the one that was popping.
Over the next 5 years housing exploded. House prices typically rise in value close to the rate of inflation (~3%). Because of the availablilty of loans, low interest rate and soaring demand (houses were actually cheaper than renting) the value of property was bid up significantly. At the height of the housing market people with $30k incomes were getting $500k mortgages or more. There was no expectation of paying it back--the price of the house would continue to go up and would cover any default by the owner. After all, the subprime only represented a very small part of the overall market, right? The housing bubble had grown to 12 Trillion dollars.
The people in the excessive mortgages, in excessive credit card debt, with no savings began to default. High gasoline prices, inflation in food and other necessary items squeezed homeowners to the breaking point. Defaults began to rise, as did foreclosures. Banks began to feel the squeeze to thier bottom lines as the stream of income from the mortgages began to die out. They were hemorrhaging reserves--money loaned out on credit cards, to financial brokerages for big multi-billion dollar leveraged buyouts yet their income was being cut off. lending practices tightened. Interest rates went up. ARMs began to reset at the higher rates and homeowners couldn't afford. All of the foreclosures around them drove down the price of thier house and they couldn't refinance. They defaulted and spun the wheel of deflation even faster. We are currently in the throes of this now. Those of you who believe that we are almost through to the other side should look at the historical value of homes to where they currently are. We have another 20-30 percent fall in home prices before we reach the bottom of the bubble. There is much more pain coming.
And yet, like a schizophrenic, the Fed begins to dramatically lower interest rates again. They use measures to reflate the economy again but this time they have very little gunpowder to do so. The power of the Government must intervene once again--cut taxes, put money back in the hand of the consumer so that they can spend their way out of this recession! enter tax breaks (will be coming, i'm sure), "rebate checks" that are simply a direct cash transfusion into the terminal patient (the economy). Meanwhile, the value of the dollar plummets. Energy and food inflation are reaching unbearable levels (food inflation is nearing 70% per year..believe it or not). Consumers are caught between the tax stone and the inflation hammer. It is obvious that the government's only solution is to print it's way out of the mess.
Enter hyperinflation.
Currently the market is at a intermediate rally point. They are ecstatic not at good financial data, but rather that it's not as bad as they feared. P:E ratios on the market are near 50:1. This is 4-5 times what they are normally in the market historically. Earnings aren't likely to increase--were it not for the weak dollar, earnings would be negative almost across the board. Companies are making large dollar profits by selling products overseas for stronger Euros and Yen, then converting them to dollars to "boost" their earnings. Sales in the US are abysmal.
For the P:E to normalize the price of stocks would need to decline by a factor of 4. That means that the market should be trading at around 3,000 today. But it's not. Why?
I feel that it is likely inflation of the assets. they are being supported by massive cash infusions directly to banks and now, brokerages, to keep them afloat so that the whole house of cards doesn't implode. The Government has spent, injected, allocated over $1 Trillion dollars to fighting the "credit squeeze" we are in. They are trying to keep the deflation of assets such as houses from dragging down the entire financial sector. If banks default you will see a financial Armageddon not even considered since 1929. All bubbles will pop. All assets will depreciate to historical levels. They won't allow this to happen if at all possible.
The Europeans are in as bad fo a shape as we are. They are still fighting the urge to lower interest rates and turn on thier own presses. They protest how we have weakened our dollar by freely printing cash. In the end, they too will have to do the same. The dollar will find some short term stability but the economies of the west will be in severe recession or perhaps depression. Enter the Kings of the East.
China, and to a lesser extent Japan, control the vast majority of the cash reserves in the world. To simplify the expression, they are savers. They have large lakes of cash stored up. They have done this to fight inflation in thier own country from the hundreds of billions of dollars that have come across the oceans from America to purchase goods and establish a massive trade deficit. Those dollars are held in reserve and not circulated in the Chinese economy to any large extent. This is why thier currency is stablized even with a 10%+ rate of economic growth. Large reserves of currency. Depressed prices in the American economy. It is time for the great American Yard Sale.
China will see stability in the dollar paired with lower asset prices as the indicator to begin acquiring assets that it needs for its booming economy. Trillions of dollars will flood back from China and Japan as they purchase companies, properties, natural resources and commodities from the US with the dollars that we have been sending them for the cheap goods purchased at Wal-Mart. As those dollars come back ashore inflation will reach unprecedented rates---Trillions of dollars hitting the market at once. Prices will rise hundreds of percent. The great collapse will begin as the dollar freefalls in value. The bloated government will reinforce this fall by printing the money needed to perform it's operations. True value assets will now belong to the lendors who have provided funds to the US for the last 50 years.
The death of the American economy will be at hand.
The Next Bubble: Priming for Tomorrows Big Crash (http://www.harpers.org/archive/2008/02/0081908)
This discusses, to some degree, Keynesian economic policy. Keynes believed that we could avoid recessions in economies (i.e. the value of things always goes in one direction--up) by "reflating" asset bubbles. The article discusses how economic bubbles should be a rare event--and that the fallout from the bubbles used to actually have ramifications for elected officials.
The Tech boom in the late 90's was created by venture capitalists throwing money at every internet-related stock that came down the pike. These companies, when they went public, enjoyed a MASSIVE spike in price as people put thier savings into into the stock speculating that it was the "next big thing" and reading articles about how 20-somethings were making thier first 100 million overnight. Greed was abundant. The venture capitalists made billions--trillions even--from the initial public offerings of these companies stock. Proceeds were then cycled back into new startup companies and the wheel of asset price inflation was began. Stocks like Yahoo, Google, and the like saw stocks soar.
At its peak the market had inflated in value to over 7 Trillion dollars. People then began to look expectantly at the companies to produce revenue commiserate with there stock price (P:E was astronomical). Unfortunately most of these companies couldn't produce income that was anywhere near "the next big thing". Paper millionaires were everywhere. Stocks began to decrease in value.
Investors had a very important date on April 15th. They had tens of thousands of dollars in tax liability from the paper increase in value. They began to sell even more. The rush to the exit had begun and almost 7 trillion in value began to evaporate.
The Federal reserve, as it is now, lowered interest rates dramatically. It pumped in cash to "reflate" the imploding economy. This is the first of Keynes requirements to avoiding recession--free action of the government to fiscally intervene with monetary policy--i.e. print money as needed. Cash flooded into the markets. Interest rates declined across the boards. The next bubble began to take shape as government policy turned from promoting the internet and technology through tax abatement and legislative support to pimping out the all-American dream of Homeownership.
The next bubble had begun to take the place of the one that was popping.
Over the next 5 years housing exploded. House prices typically rise in value close to the rate of inflation (~3%). Because of the availablilty of loans, low interest rate and soaring demand (houses were actually cheaper than renting) the value of property was bid up significantly. At the height of the housing market people with $30k incomes were getting $500k mortgages or more. There was no expectation of paying it back--the price of the house would continue to go up and would cover any default by the owner. After all, the subprime only represented a very small part of the overall market, right? The housing bubble had grown to 12 Trillion dollars.
The people in the excessive mortgages, in excessive credit card debt, with no savings began to default. High gasoline prices, inflation in food and other necessary items squeezed homeowners to the breaking point. Defaults began to rise, as did foreclosures. Banks began to feel the squeeze to thier bottom lines as the stream of income from the mortgages began to die out. They were hemorrhaging reserves--money loaned out on credit cards, to financial brokerages for big multi-billion dollar leveraged buyouts yet their income was being cut off. lending practices tightened. Interest rates went up. ARMs began to reset at the higher rates and homeowners couldn't afford. All of the foreclosures around them drove down the price of thier house and they couldn't refinance. They defaulted and spun the wheel of deflation even faster. We are currently in the throes of this now. Those of you who believe that we are almost through to the other side should look at the historical value of homes to where they currently are. We have another 20-30 percent fall in home prices before we reach the bottom of the bubble. There is much more pain coming.
And yet, like a schizophrenic, the Fed begins to dramatically lower interest rates again. They use measures to reflate the economy again but this time they have very little gunpowder to do so. The power of the Government must intervene once again--cut taxes, put money back in the hand of the consumer so that they can spend their way out of this recession! enter tax breaks (will be coming, i'm sure), "rebate checks" that are simply a direct cash transfusion into the terminal patient (the economy). Meanwhile, the value of the dollar plummets. Energy and food inflation are reaching unbearable levels (food inflation is nearing 70% per year..believe it or not). Consumers are caught between the tax stone and the inflation hammer. It is obvious that the government's only solution is to print it's way out of the mess.
Enter hyperinflation.
Currently the market is at a intermediate rally point. They are ecstatic not at good financial data, but rather that it's not as bad as they feared. P:E ratios on the market are near 50:1. This is 4-5 times what they are normally in the market historically. Earnings aren't likely to increase--were it not for the weak dollar, earnings would be negative almost across the board. Companies are making large dollar profits by selling products overseas for stronger Euros and Yen, then converting them to dollars to "boost" their earnings. Sales in the US are abysmal.
For the P:E to normalize the price of stocks would need to decline by a factor of 4. That means that the market should be trading at around 3,000 today. But it's not. Why?
I feel that it is likely inflation of the assets. they are being supported by massive cash infusions directly to banks and now, brokerages, to keep them afloat so that the whole house of cards doesn't implode. The Government has spent, injected, allocated over $1 Trillion dollars to fighting the "credit squeeze" we are in. They are trying to keep the deflation of assets such as houses from dragging down the entire financial sector. If banks default you will see a financial Armageddon not even considered since 1929. All bubbles will pop. All assets will depreciate to historical levels. They won't allow this to happen if at all possible.
The Europeans are in as bad fo a shape as we are. They are still fighting the urge to lower interest rates and turn on thier own presses. They protest how we have weakened our dollar by freely printing cash. In the end, they too will have to do the same. The dollar will find some short term stability but the economies of the west will be in severe recession or perhaps depression. Enter the Kings of the East.
China, and to a lesser extent Japan, control the vast majority of the cash reserves in the world. To simplify the expression, they are savers. They have large lakes of cash stored up. They have done this to fight inflation in thier own country from the hundreds of billions of dollars that have come across the oceans from America to purchase goods and establish a massive trade deficit. Those dollars are held in reserve and not circulated in the Chinese economy to any large extent. This is why thier currency is stablized even with a 10%+ rate of economic growth. Large reserves of currency. Depressed prices in the American economy. It is time for the great American Yard Sale.
China will see stability in the dollar paired with lower asset prices as the indicator to begin acquiring assets that it needs for its booming economy. Trillions of dollars will flood back from China and Japan as they purchase companies, properties, natural resources and commodities from the US with the dollars that we have been sending them for the cheap goods purchased at Wal-Mart. As those dollars come back ashore inflation will reach unprecedented rates---Trillions of dollars hitting the market at once. Prices will rise hundreds of percent. The great collapse will begin as the dollar freefalls in value. The bloated government will reinforce this fall by printing the money needed to perform it's operations. True value assets will now belong to the lendors who have provided funds to the US for the last 50 years.
The death of the American economy will be at hand.