Thread: We've run out of bubbles

We've run out of bubbles

Booms and busts are natural to capitalism, but for years now an irresponsible Fed has interfered with the down cycle. The only choice now may be to let nature take its course.

By Bill Fleckenstein
Are the bulls in hibernation?

I'll begin the new year with this comment: There are no bullish interpretations for the stock market's action thus far. This tells us that 2008 will be the year when reality finally overtakes the Goldilocks crowd.

Of course, we should expect the bulls to regale us with stories about a proverbial second-half rebound -- the possibility of which is approximately zero, in my opinion. We should also expect believers in that hypothesis to spark a rally from time to time, based on hopes of surprise interest-rate cuts and on actual cuts.

But their efforts will become progressively less effective. (Anyone seeking a road map to how that might evolve can look at the market's responses to the rate cuts from 2000 through 2002.)

Irresponsible liquidity originally emanating from the Federal Reserve and then-chief Alan Greenspan (a subject I cover thoroughly in my soon-to-be-published book), coupled with reckless acts of deregulation, have created the problem we now face. The country has gone "all in" via the credit-bubble-inspired housing bubble, which is now unwinding.

I do not believe there is a potential bubble left that could bail us out, nor do I believe a bailout should be attempted. Likewise, I do not believe any quick fix exists.

What I do see as the real solution is to let the creative destruction of capitalism finally run its course, after having been held back for a couple of decades.

I know I've said it before, but it bears repeating: Capitalism involves booms and busts. There is a phenomenon known as the business cycle that loosely revolves around those booms and busts. The policies of Greenspan and the Fed suppressed those busts, and "risk" was more or less struck from the lexicon of the English language (while linguists have pronounced "subprime" their word of the year).

If we stop attempting to bypass the creative destruction of capitalism, we will finally be able to bring about a recovery built on a solid foundation instead of the quicksand underlying the 2003-07 "recovery" that was built on the housing mania. Though I would like to think the politicians and the Fed get the message and will let the process play out, I am not going to hold my breath.

Memo to those who would meddle
Indeed, as Stephen Roach wrote in last week's Financial Times (read "America's inflated asset prices must fall"): "The U.S. body politic is . . . underwriting massive liquidity injections that produce another asset bubble and proposing fiscal pump-priming that would depress domestic saving even further. Such actions can only compound the problems that got America into this mess in the first place."

Noting how those actions had suppressed the savings process in this country, Roach commented: "America's aversion toward saving did not appear out of thin air. Waves of asset appreciation -- first equities and, more recently, residential property -- convinced citizens that a new era was at hand. Reinforced by a monstrous bubble of cheap credit, there was little perceived need to save the old-fashioned way -- out of income. Assets became the preferred vehicle of choice. With one bubble begetting another, America's imbalances rose to epic proportions.

"Despite generally sub-par income generation, private consumption soared to a record 72% of real gross domestic product in 2007. Household debt hit a record 133% of disposable personal income. And income-based measures of personal saving moved back into negative territory in late 2007. None of these trends is sustainable."

I could not agree more with Roach's view of what lies ahead: "It's going to be a very painful process to break the addiction to asset-led behavior. No one wants recessions, asset deflation and rising unemployment. But this has always been the potential endgame of a bubble prone U.S. economy."

We have experienced a wild, drunken binge, and we are going to have a hangover. But the best policy for the country would be to accept the hangover, head to the gym, start working out, and get stronger and healthier for the next go-round.

Yellow dog takes a bowwow
Now, a look at gold, an asset I have been bullish on for many years:

On Jan. 7, gold was the subject of a rather remarkable Financial Times editorial titled "Gold is the new global currency." "In today's uncertain world," it notes, "the yellow metal is back in fashion."

I might point out that gold has always been a store of value, aka money, though gold hasn't always been recognized as such.

That the editorial writers agree is the takeaway from this quote: "A better way to think of gold may be as central bankers used to before America dropped the gold standard: not as a commodity, but as another currency."

Back to the editorial, which makes a fine point: "As long as the dollar stays weak, gold's bull run will last. . . . The U.S. Federal Reserve's aggressive rate-cutting response to the credit squeeze has created a risk of a sharp rise in American inflation. That in turn creates the risk of a precipitous fall in the dollar and so makes gold more attractive as a hedge."

Why gold is going higher
Additionally, notes the editorial, "the arguments for further gains in gold are compelling. It looks cheap, despite climbing from a low of $250 a troy ounce in 1999, when central banks were selling reserves."

As for the United Kingdom's recent decision to sell 60% of its gold holdings, the editorial describes the move as "particularly poor." I would certainly agree.

Finally, a word to contrarians who feel they need to fade this gold-as-currency movement due to the belief that the trade has become too crowded:

Staying with a bull market is often a hard problem to finesse, especially with something like gold, which has so few tangible fundamentals. (It's understandably unnerving to see lots of people picking a top, as though gold at $880 is radically different from gold at $850 -- or $900, for that matter.)

Perhaps gold will see a correction. But it's also worth noting that folks who don't like company often leave the train far too soon. In fact, for a bull market to blossom, the asset class in question has to become more popular. As for the public, thus far it seems not to be involved -- though I expect that before this is through, that will change in a meaningful way.

I have no idea how high gold will go, and I'm sure the ride will continue to be bumpy. But I think that if the Financial Times is declaring that gold should once again take its rightful place as the currency it always has been, the price of gold is headed much higher.

http://articles.moneycentral.msn.com/In ... bbles.aspx

2008 will be the year when reality finally overtakes the Goldilocks crowd

Nice artical thanks for posting it