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Here Comes Another Bubble, and a Crash That Will Dwarf the Last One, Unless . . .

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Headlined to H1 2/14/11

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Eric Janszen recently provided some very useful historical perspective in Harper's Magazine.   He begins by explaining exactly what a financial bubble is:   "A huge spike in asset prices that results from a perverse self-reinforcing belief system, a fog that clouds the judgment of all but the most aware participants in the market."  

Asset hyperinflation starts at a certain stage of market development under just the right conditions.  

The bubble is the result of that financial madness, accurately seen only when the fog of current events rolls away.   It is a market aberration manufactured by government, finance, and industry -- a shared speculative hallucination and then a crash, followed by depression.  

Bubbles were once very rare, says Janszen -- one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences.   After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid "raising or pretending to raise a transferable stock."   For a century this law did much to prevent the formation of new speculative swellings, i.e. bubbles.

Nowadays, however, we barely pause between such bouts of insanity.   The dot-com crash of the early 2000s should have been followed by decades of soul-searching;   instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being.   Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives (a kind of insurance policy that transfers risk to someone other than the bank or other institution that extended the credit) and debt securitization, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.

That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning.   There will and must be many more such booms, for without them the economy of the United States can no longer function.   In America, the bubble cycle has replaced the business cycle.

Such transformations do not take place overnight.   After World War I, Wall Street wrote checks to finance new companies that were trying to turn wartime inventions, such as refrigeration and radio, into consumer products.   The consumers of the rising middle class were ready to buy, but lacked funds -- so the banking system accommodated them with new forms of credit, notably the installment plan.   Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation.   Too far below.   Borrowing was rampant.  People began borrowing heavily in order to buy stocks.  Pundits hailed a "new era" of prosperity -- until Black Tuesday, October 29, 1929.

The crash, the Great Depression, and World War II were a brutal education for government, academia, corporate America, Wall Street, and the press.  

For the next sixty years, says Janszen, that chastened generation managed to keep the fog of false hopes and bad credit at bay.   Economist John Maynard Keynes emerged as the pied piper of a new school of economics that promised continuous economic growth without end.   Keynes's doctrine was that when a business cycle peaks and starts its downward slide, one must increase federal spending, cut taxes, and lower short-term interest rates to increase the money supply and expand credit.   The demand stimulated by this deficit spending and cheap money will thereby prevent a recession.   In 1932 this set of economic gambits was dubbed "reflation," i.e. re-inflation.

In 1933, President Franklin D. Roosevelt called in gold and re-priced it, making it worth more, thereby hoping to test Keynes's theory that monetary inflation would stimulate demand.   The economy did begin to expand.   But it was World War II that brought real recovery, through an unprecedented, highly effective, demand-generating, deficit-and-debt-financed works project for the United States -- of a size that FDR could not muster prior to the war.   In other words, World War II did what FDR's flawed and inadequate application of Keynes's theories could not:   It put to work everyone who needed and wanted a job, and paid them relatively well.   For the first time, women and blacks had job offers aplenty.   (What kind of Republican members of Congress would allow that kind of spending and job creation -- except in the event of war?!   The answer:   None.   And so it was that millions had to die in WWII.   -- consider that Germany, too, could have employed Keynesian spending and investment to create millions of new jobs building things that benefited people and society, rather than spend it on the instruments of war.)

 

And now, our newest bubbles

As economist Danny Schecter recently pointed out, the bubblenomics game is back on.   Two years of essentially zero interest rates, limitless guarantees, and a $2 trillion I.V. drip-feed from the Fed, has lifted Wall Street up off its back and put the greed-head speculators back in the center of things.   It's a miracle:   Who would have thought that Bernanke could engineer another bubble this fast after the disaster the last one led to?   But he pulled it off!   Mergers and Acquisitions (M&A) are increasing, LBO's (Leveraged BuyOuts) are on the rise, revolving credit ("plastic") is expanding, and wild eyed investors are scarfing up low-yield junk bonds wherever they can find them.

Don't believe it?   Take a look at this from Businessweek:

   "Home loans that inflated the U.S. housing bubble...are fueling the fastest gains in the mortgage-bond market....Prices for senior bonds tied to option adjustable-rate mortgages (ARMs), called "toxic" by a government commission, typically jumped from 6 cents to 64 cents on the dollar in the past month, according to Barclays Capital.

    Rising values show Federal Reserve efforts to stimulate the economy by purchasing an additional $600 billion of Treasuries and holding interest rates near zero percent are driving investors into ever-riskier securities.....

    The worst housing slump since the Great Depression is deepening.   ("'Toxic' Mortgages Rally as Resets Accelerate: Credit Markets"   -- Businessweek)

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Several years after receiving my M.A. in social science (interdisciplinary studies) I was an instructor at S.F. State University for a year, but then went back to designing automated machinery, and then tech writing, in Silicon Valley. I've (more...)
 

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 Click here to watch a five-minute video clip... by Richard Clark on Monday, Feb 14, 2011 at 4:46:47 PM
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Maybe this time we'll learn to ditch this broken e... by M_Hudson on Tuesday, Feb 15, 2011 at 7:33:43 AM
Richard, while you correctly describe several addi... by Alan MacDonald on Tuesday, Feb 15, 2011 at 4:20:02 PM
Could someone please put the following explanation... by Richard Clark on Tuesday, Feb 15, 2011 at 5:10:08 PM
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give it one more shot: break it down into words t... by Richard Clark on Wednesday, Feb 16, 2011 at 9:37:48 AM
Instead of balancing budgets on the backs of worki... by Richard Clark on Wednesday, Feb 16, 2011 at 8:02:49 PM
Propose a flat tax - on assets - and then watch t... by Jack Flanders on Wednesday, Feb 16, 2011 at 9:47:11 PM
Instead of balancing budgets on the backs of worki... by Richard Clark on Wednesday, Feb 16, 2011 at 8:03:07 PM
In the last month, three states have introduced bi... by Richard Clark on Friday, Feb 18, 2011 at 2:21:29 AM