He warns that it is a mistake to assume that because things have always been a certain way means they always will be. Experts assumed housing prices would always rise. But when Wiedemer saw an unusually sharp rise in housing prices, that was a clue that something wasn’t right. Turns out that, as it often does, the bubble happened because of interference with the market. Mortgage standards were forced lower, with the goal of putting more people into their own homes (particularly those previously identified as not financially ready to take on a mortgage). More buyers meant more demand, which meant higher prices, which meant attracting more builders to the booming market, which meant oversupply—and combine that with much higher default rates causing insecurity in a previously safe investment, and housing prices suddenly plummeted. The bubble popped.
When the government sees a bubble that threatens to pop, its tendency is to avoid (postpone) failure by propping up the industry—purposely allotting greater resources where there capital has obviously been ineffectually used. This is what they did with the bailout of GM and various other entities back in 2009. A better way would be to pop a bubble quickly, when it’s still small. Then the capital becomes available for more promising purposes.
Serious trouble lurks on the horizon when the economy is a series of interwoven bubbles, so that the outcome is likely to be a domino effect once they start to pop.
Wiedemer’s group identifies the bubbles, and, when possible, predicts when they will pop. He says the current bubbles are government debt and the dollar. We’ve seen the charts. Debt slowly creeps up over the previous century, and then spikes during Bush’s term, followed by approaching the asymptote as soon as Obama takes over.
When there is debt, one way government deals with it is printing money to pay for it. (This is something counterfeiters do too, but when government does it, we don’t jail them. Maybe that’s the problem.) Sometimes money isn’t actually printed, just electronically produced by selling treasury bonds, where numbers change on computers, but no actual money gets hefted from place to place. But this “printed” money doesn’t represent wealth (surplus representing work completed that society is willing to pay for). It’s like monopoly money. Well, technically monopoly money has the value of functioning in a certain way for the purpose of playing the game, which is something people are willing to pay for. But, anyway, this printed money isn’t “real,” in the sense we regular mortals think of real wealth.
The usefulness of printing money to pay your debts is that it doesn’t take as much of that tedious work and wealth building to pay things off. Instead, you use the wealth you’ve already created and call it double that amount (or whatever increase). Your creditor might not be happy about receiving $1Trillion that represents only the work of $500 Billion or so. They will feel cheated. Not as cheated as if they get stiffed for the whole amount, but at some point they’re going to say, “You’re not worth lending to.” When they say things like that, it translates as, “Your Triple-A rating is being downgraded,” which happened last month. And that means, as a higher risk, we don’t get the lowest interest rates when we turn over the debt, but we pay something higher that is still adequate to persuade creditors to take the risk. And then we go ahead and pay with even-lower-value dollars, so they downgrade further and eventually refuse to lend to us at all. At which point any current debt isn’t payable—unless we drastically increase our dollar printing to pay off the debts with paper that doesn’t represent actual wealth.
So, what happens when government presses its luck and prints so much that the value of each dollar shrinks to something infinitesimally small? Hyperinflation. What are the signs that this could be on the horizon? Other countries don’t want to use the dollar as their base currency anymore—they don’t trust its value. (Although, so many countries have inflated their currencies that there isn’t an obvious replacement—which has been propping up the dollar for a while already.)
Another signal is the price of gold. When we were on the gold standard, in theory you could go to your local bank and turn in your dollars (bank notes) in exchange for that value in gold. When that got too limiting for government experts (back in the 1960s), we left the gold standard, and the dollars are just backed by the federal government’s promise that the dollar has worth. So when we know the dollar represents a lower value, it buys less. So prices rise. Inflation.
Gold is more stable. If you look at the amount of gold it takes to purchase a home, for example, it would stay relatively stable. But the dollars you would exchange for gold change as trust in the dollar changes. So, right now, while the value of the dollar is drastically shrinking, gold prices are drastically rising.
He didn’t say this, but I think gold is a bubble. If you’re trying to protect the value of your savings, doing it with gold is a good way. If you started doing that at $300 an ounce, instead of now, even better. It looks like you’ve made huge profits. But actually the profits are in less valuable dollars. At some point you’ll need a wheelbarrow full of dollars in exchange for an ounce of gold. This “bubble” will continue as long as distrust of the dollar continues.
But even gold has its limits. There is the following exchange about the value of gold in Terry Pratchett’s Making Money (I talked about it here). Moist von Lipwig is talking with journalist Sacharissa Cripslock.
Moist: “What are we, magpies? Is it all about the gleam? Good heavens, potatoes are worth more than gold!”
Sacharissa: “Surely not!”
Moist: "If you were shipwrecked on a desert island, what would you prefer, a bag of potatoes or a bag of gold?”
Sacharissa: “Yes, but a desert island isn’t Ankh-Morpork!”
Moist: "And that proves gold is only valuable because we agree it is, right? It’s just a dream. But a potato is always worth a potato, anywhere. Add a knob of butter and a pinch of salt and you’ve got a meal, anywhere. Bury gold in the ground and you’ll be worrying about thieves forever. Bury a potato and in due season you could be looking at a dividend of a thousand percent.” (p. 108)
In other words, even gold’s value is limited to either its usefulness or to whatever we decide to call its value. You can’t eat it. So in famine, when food is scarce, it will take more gold to buy a sack of flour. But it’s traditionally the best we’ve got for being a stable money base value. Certainly better than a piece of paper (or digital message) that the government no longer even claims to represent a given amount of work.
What is going to happen? I don’t know. I’m just beginning to read the book. Maybe before it’s too late we will elect an administration that will stop the insane rise in debt and government spending. Then maybe trust will continue so that getting out of the bubble will be less painful than if it continues to grow before popping. Maybe we can keep enough trust in the dollar that hyperinflation and collapse won’t be the inevitable only way to stop the current practice.
One thing in our favor is that we are used to being a free, hard-working, inventive and entrepreneurial people. Our behavior has always created real wealth. The system of exchanging that wealth is the problem—and it’s a big problem. But it’s not as big a problem as many countries face: a growing entitlement mentality. OK, we have that problem too. But maybe it’s not too late to pop that bubble quickly and move along with a better allocation of resources.