Bubble Trouble

Will Oswald Spengler be Proven Right in the End?

The world is awash with money. Well, maybe a bit less now that we have had a few billion sub-prime mortgages, CDO's, and other exotic debt instruments written off. But endless talk of a credit crunch is just that—talk. It ain't so.

A quick check with the latest edition of The Economist shows that M3—the broadest measure of a nation's money supply (aka, credit, in most of its forms)—shows that it is increasing on an annual basis at a healthy clip in most of the larger economies of the world: United Kingdom (11.2%); Euro-zone (9.5%); Australia (17.9%); Canada (14%). Money supply growth is a bit less in the United States, yet hardly contracting at 6.3% per annum. Couple this with the petro-dollars flowing to oil producers, and one is left with the conviction that a serious global credit crunch is a figment of febrile imaginations.

The credit crunch has not been global at all. It has hit particular sectors—primarily and particularly the housing markets of the US, UK, Europe, Australia and New Zealand—that is, the West. Residential housing prices had been in speculative territory for four or five years. Everyone knew that the bubble had to burst eventually. It has, particularly in the US and the UK.

The old adage was that if you were investing in the share market, and the shoe shine boy starting giving you stock tips, or telling you how much he made in the market last week, it was time to get out. The bursting of the bubble was nigh. These days, the adage translates perfectly to taxi drivers. When they start regaling you with share market triumphs or insider whispers, pack up your kit bag and quietly head for the hills, rifle in hand and deer in sights.

There is an equivalent in the residential housing market. When you go to Whitcoulls and browse the Finance and Investing section only to find most of the books on offer are promising untold wealth through residential property investment, commence an orderly exit from the market. A bubble is building. Or, when you find numerous home grown television programmes in prime time slots with aging personalities attempting a new career launch through shows promoting wealth through residential property it's time to move on.

When the world is awash with money there will be an repeating cycle of bubbles, booms and busts until the monetary splurge dries up. Under these conditions, when one bubble bursts, another will form. In 2000, we had the tech wreck. This hugely speculative investment bubble in technology companies, which had been building for six or seven years, burst. But the growing surfeit of money simply moved on to the next bubble—residential housing. This bubble took about five or six years to expand and expand, until finally it also burst.

Now, where is the money going? What will be the next bubble? For a while commodities had the nod. But these are underpinned by sustained growth in large emerging economies such as China, India, Russia and Brazil. Demand for commodities will continue to put pressure upon supply. It is less likely that a truly speculative bubble will develop in commodities, although a series of mini-bubbles are on the cards.

The serious bubbles start when the “bigger fool” effect comes in to play. This is easy to understand. Sustainable investment earnings come from the production and profitable sale of goods and services. Speculative investment earnings come from investors thinking that they will be able to on sell their investment to a more desperate buyer in the future. Speculative investment gains rely on a bigger fool coming in after to pay even higher prices for your uneconomic assets. Bubbles emerge when bigger fool speculative gains start occurring. Surfeits of money only make bigger fool conditions more likely.

So, we have a surfeit of money sloshing around the globe. We have a burst housing bubble. These days some analysts are suggesting that the next great bubble might be a green one. Consider the following from The Economist:

Some are calling it a clean energy rush. The value of new investment in sustainable energy reached $148.4 billion in 2007, an increase of 60% from the year before. Investments have grown at around the same rate or higher since 2004, according to a study from the United Nations and New Energy Finance, a research firm. Those sums include investments by private-equity and venture-capital firms, money raised through stock offerings, corporate and government money for research and development, and investments in small-scale projects or companies building new renewable energy capacity. Wind-energy projects proved most popular with new investment of over $50 billion in 2007, followed by solar and biofuel.

When governments get behind something—when it becomes part of an almost universal policy consensus in the West (as indeed has occurred in this case)—a bubble is certain to develop. Couple government support and largesse with easy credit, and with a global economy that has lots of money sloshing around, and a bubble becomes inevitable. Investment mania will follow. A huge bubble will inflate—to be followed eventually by the inevitable crash.

Bear in mind that the clean energy rush is to this point investing in energy sources and technologies that are not economic. They are too costly; they are too energy inefficient. They can only survive with government subsidies or bigger fools. So in fact the clean energy rush is really a way to make money from governments and bigger fools.

Another interesting aspect is that this bubble is likely to be an almost exclusively Western phenomenon. The Euro and Anglo blocs are the ones who will be seriously involved; these are the economies that will face the damage when the bubble bursts—in precisely the same way that these blocs are the ones that have suffered the most damage from the collapse of the housing market. Emerging economies are simply not interested in the global warming, environmental, green mania.

If you want to speculate in this sector, our advice would be “get in quick; get out quick”. Be very aware of the risks you are taking. Make sure that you have a bigger fool lined up. It's not likely to last. It is unsustainable.

The longer term global effect will be a sustained, secular transfer of wealth from the northern to the southern hemispheres. Even as some of the world's largest financial institutions are now significantly owned by middle eastern and southern hemisphere sovereign wealth funds (that is, by politically controlled capital) as a result of the most recent bubble bursting, so when the green bubble bursts, southern hemisphere nations will end up owning more northern hemisphere businesses. The Greater East Asia Co-Prosperity Sphere is going global. The West is now in a long term (and probably irreversible) decline.

We await a new Oswald Spengler to arise and write The Decline of the West, Part II.