On Monday, the Dow Jones Index of the stock market fell 1175 points, the largest one-day point drop in history. This was preceded by a spooky 666 point-drop in the previous trading day. Is the stock market about to totally crash? Fact is that nobody can predict what will happen in the next few days or weeks. However, there are systemic economic variables that point to an immense crisis in the near future. If the fundamentals are fake, all we get from casino capitalism is a house of cards.
Let’s start with the start market. Does this chart of S&P 500 index like a bubble? That’s 270% growth in just under nine years!
Not having learned the lesson from the housing bubble that crashed the global economy, the elites have created a sequel. Here’s the Case Schiller Index for various cities in the U.S. Do they seem frothy?
Around the world, there are massive real estate bubbles in Canada, Australia, U.K. etc. (Since the global economies are all linked, you should care). And Sweden tops them all:
Then there is a new asset bubble – auto loans, which is up 50%.
Another debt bubble that has reached insanity is the student loan, which now stands at $1.4 trillion (doubled since 2009). The student loan was a desperate scheme by the government to reduce the official unemployment rate after the economy tanked in 2008.
The U.S. non-financial corporate debt ($8.7 trillion) and household debt ($13 trillion) are also at record levels.
The federal government has more than doubled its debt since 2008 and the debt-to-GDP has gone from 68% to more than 106%:
Three types of bubbles: Bad, worse and ugly
Bubbles are always bad because they are illogical and, when they burst, cause a lot of pain. A bubble depends on the “greater fool theory,” whereby each person hopes that there will be a bigger idiot who will pay even more for an asset. Bubbles also appeal to the get-rich-quick fantasy.
There are three different types of bubbles.
Irrational bubble: This is the simplest one that’s caused by hype, herd mentality, greed and FOMO (Fear of Missing Out). Without any change in the fundamentals, the price of a product keeps going up. Whether it’s the Tulip Mania of the 17th century or the BitCoin bubble of the 21st century, the principle driving the irrational exuberance is the same: human psychology. (By the way, Bitcoin has fallen from $20,000 to $7000 in the last few weeks).
Debt-driven bubble: This is worse than a simple bubble, since people get into debts, hoping for a massive return. Mortgage, of course, is the biggest debt for most people. American middle class lost 40% of their wealth after the great financial crisis of 2008, but they forgot all about it a few years later. When the bubble bursts, everyone – families, corporations and governments – are left deeper in the hole (except for the few lucky ones and insiders who make it like bandits).
Bubble fueled by debt, money-printing and loose standards: This is akin to that bartender who seems to have a lot of energy. Then you find out that he had coffee at 9 pm, Redbull at 10 pm, Ecstasy pills at 11, cocaine at midnight and meth at 2 am. The current bubble is fueled by (a) money-printing by the central banks, (b) artificially low interest rates set by the central banks, (c) and loose standards for loans.
Since the 2008 crisis, the big central banks in the U.S., EU and Japan – Fed, ECB and BOJ respectively – have (digitally) printed more than $10 trillion out of thin air. Then the commercial banks turned them into $100 trillion or more, thanks to the fractional reserve system.
The Fed and other central banks also coordinated their actions and reduced the prime interest rates to virtually zero (“ZIRP” policy) and held it there for 8 years.
Easy money meant that big corporations spent trillions of dollars – including massive debts – to buy back their own shares. The ECB has spent billions buying corporate bonds and the BOJ has spent billions buying stocks. Of course, the stock market has tripled.
Financial engineering also created Housing Bubble 2.0 and other newer bubbles. Keep slashing the required down payments, incomes and credit scores, you will get more new buyers for more expensive homes and cars. Creating a bubble is not rocket science.
Wealth versus wealth-effect: Somewhere along the way, we collectively lost the notion of what true wealth is. Earning and saving have been replaced by borrowing, spending and speculating. In this environment, the entire nation has turned into Las Vegas, and Casino Capitalism has become the norm.
Disregard for fundamentals: Since 2008, the U.S. GDP grew by 35% while the stock market grew by 270%. Does that sound reasonable?
Tesla has lost more than $3 billion in the last five years, but its stock price went up 10-fold during the same time. If you invested money in Amazon shares, it will take 250 years to get your money back through its earnings. Australia’s housing market is 4 times its GDP. There’s no logic when the society is caught up in a frenzy.
What’s next?
This time is not different. All we have done since 2008 is rinse and repeat. We simply replaced the housing bubble with Everything Bubble and perpetuated the boom-bust cycle on a larger scale.
The bubbles will soon start popping all over the world (except for a few countries like Russia that has very low debt). The timing depends on how fast and how much the central banks will raise the interest rates. Even a 2-3% point rate hike is enough to pop the bubble, since bond markets, housing and stock buybacks are all very sensitive to interest rates. The yield on U.S. 10-year treasury has already jumped 80 basis points in the last few months, even without any help from the Fed. And the U.S. dollar has dropped 12% in value against other currencies in the last year.
The debt binge is coming to an end, as households and corporations are close to being maxed out. When there are no more new buyers, there will be a stampede towards the exit door. 2018 might very well turn out to be the year when the house of cards collapses again.
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