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David's Macro Blog

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Tag: bubble economy

The belief in a recovery from the global economic collapse in 2008 has gained strength as the unemployment rate has leveled off, the stock market has recovered about 70% and real estate prices have stopped falling.

However, do we really have an organically growing economy or something else?

A great description of our recent economic experience comes from Bloomberg’s Caroline Baum:

“What we had was a government-prescribed course of amphetamines (to keep it up), antibiotics (to prevent infection) and antidepressants (to make it feel better). It endured regular steroid injections from both monetary and fiscal authorities. And it still has no real muscle.”

Here’s a list of things we should expect in a true recovery:

  • Increasing bank lending
  • Growing credit use by consumers
  • Increasing labor participation rate
  • Increasing hours worked
  • Increasing interest rates
  • Decreasing unemployment (yes it is a lagging indicator)

Some far there is “no real muscle” because we don’t see any true signs of rebound in the economic and financial systems. Sure, the stimulus can temporarily bump up retail sales and the stock market, but long term it can’t.

Judge for yourself. Which do we have, an economy on life support or a real recovery?

In my opinion, we’ve been headed for a double dip recession ever since massive amount of stimulus was injected into the economy. Once that stimulus is removed, the double dip will commence. In reality we never left the first dip — we just momentarily suspended the decline.

Are you an expert if you make mistakes? 

Are you an expert if you make BIG mistakes?

Are you still an expert if you miss the biggest financial bubble in world history?

Let’s consider these questions while reviewing some quotes from the so-called “experts” just prior to the 2008 financial collapse and the start of the Great Recession.

“I believe that the general growth in large [financial] institutions have occurred in the context of an underlying structure of markets in which many of the larger risks are dramatically — I should say, fully — hedged.”

— Alan Greenspan, 2000

“Even though some down payments are borrowed, it would take a large, and historically most unusual, fall in home prices to wipe out a significant part of home equity. Many of those who purchased their residence more than a year ago have equity buffers in their homes adequate to withstand any price decline other than a very deep one.”

— Alan Greenspan, October 2004

Financial innovation means “shocks may be less likely to result in the type of trend amplifying, self-reinforcing dynamic for sustained periods of time that can threaten the stability of the financial system… but it is unlikely to have brought an end to the periodic tendency of markets to experience waves of mania and panic.”

“Improvements in lending practices driven by information technology have enabled lenders to reach out to households with previously unrecognized borrowing capacities.”

— Alan Greenspan, October 2004

“The use of a growing array of derivatives and the related application of more-sophisticated approaches to measuring and managing risk are key factors underpinning the greater resilience of our largest financial institutions …. Derivatives have permitted the unbundling of financial risks.”

— Alan Greenspan, May 2005

“We’ve never had a decline in house prices on a nationwide basis. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s gonna drive the economy too far from its full employment path, though.”

— Ben Bernanke, July 2005

“In the financial system we have today, with less risk concentrated in banks, the probability of systemic financial crises may be lower than in traditional bank-centered financial systems.”

“The Federal Reserve is not currently forecasting a recession.”

— Fed chairman, Ben Bernanke, January, 2007

“At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained.”

— Fed chairman, Ben Bernanke, Congressional Testimony, March, 2007

Final Questions:

  • Should an expert still be considered an expert AND be in a position of power and influence to repair the economy/financial systems after they didn’t even see it coming?
  • Why do professionals with significant academic training, industry experience, and extensive access to real-time data mis-interpret the fundamentals and say things that look foolish in retrospect?

Perhaps the best quote to summarize the situation:

“The economy depends about as much on economists as the weather does on weather forecasters.”

What do you think? Do you have a favorite expert quote not shown above? Comment below and let me know.

One of the most obvious signs of the market cycle being at its peak is when new people enter the market with no experience and DO WELL.

During the stock market bubble ending in 2007/2008, Lenny Dykstra, a baseball player known for tough play but limited intelligence had become a respected financial anaylst and investment guru (even endoursed by Jim Cramer).

Naturually there was no substance to Dykstra’s investment genius, just the tail wind of a massive credit bubble and rising stock prices.

Watch these 2 segments of the Daily Show below about Dykstra’s rise and fall as an “investment guru”.

 

Note the spots in the video where Dykstra says that he doesn’t read books because they hurt his head and where Cramer calls him “brilliant.”

It should come as little surprise that Dykstra has now filed for bankruptcy, is multiple millions of dollars in debt, and has dozens of lawsuits filed against him.

As a side note, Lenny Dykstra was endorsed and promoted by Jim Cramer who said Dykstra is “one of the great ones in this business.” That should have been a clue that there was probably no substance. Watch Cramer on video tape admitting to manipulating stock prices: Jim Cramer on The Daily Show.

Calculated Risk also posted about this story in this post – Daily Show: Financial Guru?

What do you think? Comment below and let me know.

Classical economics teaches that an economy, if properly managed, will remain in a state of equilibrium. This is because economists assume a perfect market place with rational actors who maximize their returns through their uniform access to all information.

As we know, the REAL world is much different from economic equations.

Instead, the real world economy moves through market cycles. These market cycles fluctuate between boom and bust as the market participants move through cycles of fear and greed and all sentiments in between.

The past 10 years have seen some amazing bubbles which were not sustainable because the asset prices got out of line with the underlying fundamentals supporting the market.

Let’s review the bubbles in our recent memory.

2000 Nasdaq index over 5000 – 9 years later the index is still off 60% from its peak.

2007 Real Estate Bubble – In just 2 years some markets are off 60% and the average is off 30%.

2008 Oil Price – The price per barrel peaked around $150 but then fell to under $40 in less than 2 years.

2009 US Treasuries??? If the future holds inflation then this may be just as large as the 2007 real estate bubble. However, if we continue with deflation, then maybe current yields are the new normal.

So, what bubble are we in now?

Please comment below and let me know what you think.

You might also like these posts on similar topics:

Is it possible that the great equity bubble of 2007 could fool the person best positioned to detect it?

Calculated Risk states in his post “A Comment on Fed Chairman Ben Bernanke” that Ben Bernanke misread the real estate bubble as Fed Governor, then as Chairman of the Presidential Council of Economic Advisers, and later as Federal Reserve Chairman.

How can Fed Chairman Ben Bernanke miss the biggest bubble in history?  Not only did he have the best education at Harvard, MIT, and Yale, but he also had access to all the data, experience, and team members that came with his powerful positions and titles.

In July 2005 Bernanke said:

“We’ve never had a decline in housing prices on a nationwide basis.  What I think is more likely is that house prices will slow, maybe stabilize … I don’t think it’s going to drive the economy too far from its full-employment path, though.”

From this one quote, made at the peak of the boom, we can see two things.  First, Ben did not believe that housing prices would fall much if any and that it was not conceivable that prices would fall across the country in all markets.  Secondly, any decline in housing prices would not slow the economy much to cause a significant increase in unemployment.

Now, just 4 years later we can see that we had the biggest housing boom (and bust) in history AND that the crash caused us to experience the unemployment unparalleled since the Great Depression.

In this case, a big trend (in asset prices and leverage) caused even the most well trained and experienced economic thinker, who has access to the best data, to get swept up and lose track of the fundamentals.

Why did this happen?  Share your opinion by commenting below.