The Impact of Bubbles – Week 5

Negative Force – Bubbles:

December of 2008 was a very scary economic time and The Fed correctly dropped interest rates down to almost zero that month. Reducing the cost of borrowing money is one of the key tools of The Fed when it is trying to encourage economic growth.

You may remember that by 2011, the American economy was experiencing good economic growth. However, The Fed failed to begin to normalize interest rates in 2011. There would have been a lot of benefits if The Fed had started raising rates in 2011 but they did not. Instead The Fed launched Quantitative Easing (QE).

Fast forward to 2018 and there are a multitude of bubbles in our economy. My favorite economist, Dr. Kindleburger, wrote a book titled “Manias, Panics, And Crashes” in which he chronicled and explained the various bubbles that have burst in economic history since Tulip Mania. In an interview, Dr. Kindleburger was asked “How do you identify when an asset is experiencing a bubble?”. His answer was “Any asset that doubles in value in less than 12 months is a bubble.” Bitcoin anyone?

The economic danger is not limited to the asset that has bubbled to an unsustainable value. The real danger is the ripple effects that occur after the bubbled asset burst. Not only do the investors in that asset experience real financial loss, but to cover debts they dump “good” assets to raise the cash they need. The result is an economic implosion.

Recently, I read that margin debt (the money stock brokers lend to customers so the customer can buy more stock) is at an historic high. Bitcoin isn’t the only bubble in our economy as a result of interest rates having been too low for too long heightened by Quantitative Easing. It is way past time for investors to start being cautious.

It is critical to remember that land is the source of all wealth. Every product that we humans consume originates with land. Not all tracts of land are equal in quality and portfolio management requires every investor to hold some cash for liquidity. But historically, long term the best investment is land.