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The Trouble With Bubbles


A look at our debt-driven economy, and the trouble with bubbles.

I hope readers don't mind, but I'm diverging a bit from my usual today because a) I spent way too much time on this article and b) I'm actually running out of ways to say the same thing over and over regarding the intermediate outlook. The market outlook remains essentially unchanged on an intermediate basis; it's still watch and wait at the pivotal 1600 +/- zone. So today, I'm going to embark on a more overarching economic commentary.

The US government made big headlines recently by announcing that it will pay down a portion ($35 billion) of the national debt this quarter, the first such paydown in six years. $35 billion sounds like a lot, until you consider the fact that the national debt has been increasing by an average of $3.83 billion every single day since September 2007. I guess we're making progress by reversing about nine days of the past 2,000+ days of debt, but that means we're still left with... let's see, carry the zero... 2,000+ days of debt to go! If Uncle Sam can maintain this strict level of discipline, we'll be completely paid off by the 23rd century.

I maintain that our policymakers are creating a massive debt-driven bubble, and in this article, I'm going to outline why I feel this is a mistake by analogizing some of the unintended consequences in depth (in "debt-th"?).

Briefly, the historical chart below is from the always-interesting, and shows the current ratio of mutual funds and ETF assets to money market assets. The chart suggests equities are approaching the upper range of the Bubble Zone. We can see the current ratio of 3.31 has only been reached once before, in 2006-2007; we can also see in that instance, equities continued to rise for a while afterwards -- so these types of signals can take time to work. But they're hard to ignore. As Edmund Burke said, "Those who don't know history are destined to repeat it."

The x-factor impacting all of our lives and driving the equities bubble has been the Fed's printing press and quantitative easing. The majority of Americans don't even know what QE is, much less care -- but I believe there are genuine consequences awaiting the Fed's current policy, which will ultimately impact the lives of virtually all Americans. (The fact that you're even reading this suggests you're probably more informed than the average American, and already know what QE is -- but in case you don't, here's the Wiki explanation.) The Fed's stated goal with QE-Infinity is to improve the labor market -- and yesterday, new jobless claims came in at a five-year low, which undoubtedly has the Fed governors secretly high-fiving each other in the restroom. As I see it, though, there's a problem here (beyond hygiene): They are attempting to grow our economy through debt-driven consumption.

My contention is that there can be no lasting growth though this type of debt expansion. It will seem to work for a while because the Fed's printing press is creating a liquidity boom, and that excess liquidity is driving an increase in certain asset prices. This is not unlike the way they created the housing bubble. Excess central bank liquidity sends false signals to the market -- essentially, the market sees all the extra cash floating around and incorrectly concludes that the economy is better than it actually is.

To illustrate the impact of these false signals on the future economy, I'm going to draw an analogical story about a poor man who's suddenly (and erroneously) granted a big line of credit, which he begins using immediately and irresponsibly. Purely for sake of illustration in this story, let's give our hypothetical big spender a name: We'll call him "Benny B" ("B" stands for "Big spender"! I have no idea who you're thinking of here.) Benny B has no job and no assets, but he's mistakenly granted a humongous line of credit by our hypothetical credit card bank, which we'll call simply, "The US government."

For a while, Benny B can use his line of credit to run around town, spending like crazy. People see him cruising in his limo, dressed in his new Armani suit, and eating at the finest restaurants every night. The community naturally assumes he's rich, and in short order, Benny B gains a good reputation. Eventually, Benny B's favorite fancy restaurant even decides to extend a very large monthly tab to him.
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