Economic advance is not the same as human progress.
~ John Clapham
We've heard a lot about bubbles in the economic world over the past decade – so much, in fact, that it seems like we might be facing a bubble of bubbles. But what does that mean to the average person? We'll take a look at some of the issues and implications of our bubblicious culture this week and try to figure out how to handle it all.
What's a Bubble?
The term bubble has been tossed around pretty liberally of late, with just about every asset class having been labeled a bubble at one time or another. All the while some analysts keep insisting that some of these bubbles are just bugaboos – symbols of success rather than excess. But what is a bubble?
Here are two different definitions from my old dictionary:
bubble: n. 1, a thin film of liquid holding gas or air. 2, an unsound project or idea.
So it seems that bubbles are structurally tenuous entities with nothing of substance at their core. How does that strike you? Do you think that accurately describes any part of our economy, financial system, or cultural zeitgeist? It's been my contention that it very accurately describes all three. It seems to me that we've embarked on more than one “unsound project or idea” over the past few decades. As the opening quote hints, we can have long periods of economic advance that do not necessarily accompany any progress of substance for humanity.
The Bubble Roster – Part I
If our economy and our culture are essentially a bubble of bubbles, it seems like there should be a lot of them out there. Wednesday, we'll take a look at some of the social trends that have been become bubbly. Today, we focus on some financial factors that have been stamped with the bubble moniker over the past few years:
5 Economic & Financial Bubbles
1. Real Estate: This seems like an easy one, as it would be pretty hard to argue that the U.S. residential real estate market was not in a bubble over the first half of this decade, given that it has already popped. Questions remain, however, about whether or not the U.S. commercial real estate market is the next real estate bubble to pop – or maybe it will be the Canadian housing market, or, heaven forbid, China's.
2. Bonds: The bond market has been in a secular bull trend since the early 1980s, with U.S. Treasury prices rising and yields falling. At what point does a bull market become a bubble? Many have been calling for bond yields to rise for years now, and yet yields across various maturities continue to fall as worries about debt deflation mount.
Louise Yamada's analysis seems to make the most sense out of any that I've read so far. She explains that secular bond cycles tend to last about 30 years. While bottoms (like the one in 1981) tend to reverse very quickly, tops (like the one we're going through now?) tend to take 2 to 14 years to unfold. If that's the case, we could be looking at lower bond yields for quite a while longer. In fact, Ms. Yamada points out that bond market tops are often associated with economic depression.
3. Commodities: Commodity prices might have been called a bubble before they got whacked (along with everything else) in the credit crisis. Since then, oil, agricultural commodities, and especially gold, have rebounded sharply. The argument for higher commodity prices often centres around emerging market (especially Chinese) demand. While I can see how that might be a long term driver of commodity price inflation, I tend to worry more that the popping of some of the other bubbles mentioned here (especially debt) will swamp commodity prices.
4. Stocks: Some stock bubbles are pretty obvious – like the NASDAQ bubble in 2000. Others are less so. Most won't be identified as such until it's too late and they've already popped. Are stocks in a bubble right now? Most people would say that stocks are neither grossly overvalued nor undervalued right now based on current earnings estimates. But if those estimates are wrong, all bets are off. If the other bubbles mentioned here start to pop, whether one at a time or all at once, those estimates will become meaningless. This is a time for caution and capital preservation.
5. Debt: Debt, both at the consumer and sovereign level, is probably the biggest, and possibly most dangerous, bubble of them all. Back in December of 2009 I identified debt as “one of the biggest factors in determining how the economy and markets perform in 2010”. So far we have experienced tremors in the credit and stock markets due to sovereign debt excesses in many European countries as well as deteriorating economic fundamentals. Unemployment remains elevated, making it difficult for already over-leveraged consumers to spend more – as if that's always a good thing. U.S. sovereign debt levels are very close to hitting numbers that many consider dangerous.
Not only is debt a problem in and of itself, but it limits our options for fixing the structural problems we face. We have continued to dance to the Keynesian drumbeat, “solving” one crisis after another with ever-increasing doses of debt in a dangerous game of musical chairs. When will we find some leadership that's willing to acknowledge that the music needs to stop? Shoveling debt on top of debt is not working. We need to put plans in place for the inevitable scarcity of chairs as we change the rhythm to one that everyone can dance to.
The Trouble with Bubbles
The trouble with bubbles is that they can continue to grow larger for longer than anyone expects. When they pop (and they always do), it usually comes as a surprise, sometimes even to those who have been predicting it for awhile. Whenever a bubble pops, the collateral damage is usually directly proportional to the age and size of the bubble. Everyone always thinks they will get out before the bubble pops, the music stops, or whatever metaphor you prefer. Few actually do.
If we stick with our earlier definition of a bubble as a structurally tenuous entity with nothing of substance at its core, then I would have to say that debt is at the core of our current financial bubbles. Growth built on debt is not real, especially when that debt is used to support corporate entities that are already insolvent. Debt can only lead to progress when used in moderation to support the real growth of viable businesses.
Given the bubble of bubbles that seems to be floating around right now, it seems like a relatively cautious position is prudent. Bubbles can pop very quickly, and often unexpectedly. Preventive measures and contingency plans are best made while bubbles are forming, and not while they're popping. As I always tell my sons when they want to continue a potentially risky practice, just because it hasn't happened yet, doesn't mean it won't.
What do you think about the bubbles mentioned here? Can you think of any others? How are you planning your finances and investments in light of this bubble of bubbles?