Why I’m Afraid Of Bubbles
What an incredible time to be alive. I can’t help thinking that hundreds of years from now people will be studying the emergence of the coronavirus, and wondering what it was like to live through it, much like we wonder what it might have been like living through, say, the Black Plague or Spanish Flu.
Except of course, what we are currently facing is nothing like a plague nor a flu epidemic.
But don’t let the truth get in the way of hype. May the Lord protect anyone who needs toilet paper or bottled water in a hurry right now – the stores are sold out because of sudden panic buying.
Okay, I can sort of understand stocking up for essentials in case of an enforced 14-day self-quarantine period… but bottled water? This isn’t a cyclone where we need to be concerned that our water (renowned as being amongst the cleanest in the world) might get contaminated.
Sure, it’s wise to be informed and to take precautions. And if this virus mutates into something nastier, then it will truly be something to get worried about. But do we all need to rush out and buy a year’s supply of toilet paper? Surely not.
Now, while I’m concerned about the coronavirus, I am actually afraid of bubbles.
No, not the bath variety, but rather the asset and debt varieties.
Have you noticed the recent huge fluctuations on financial markets? The astounding rises, and falls, on world stockmarkets as people lurch from fear to greed and back again? This volatility scares me because if people act irrationally and stockpile toilet paper, how might they react when it comes to their financial nest eggs?
Recall the wisdom shared in the movie Men In Black (seriously!):
A person is smart. People are dumb, panicky dangerous animals and you know it.
Without wanting to be a false financial Cassandra, my ‘spider sense’ is tingling.
Did you know that US consumers are in more debt now than they were in the GFC? It’s true. They currently owe about US$14 trillion. That’s US$14,000,000,000,000 (see: https://www.debt.org/faqs/americans-in-debt/)
And corporates owe nearly as much again. Quoting from Forbes (emphasis added):
U.S. non-financial corporate debt of large companies now stands at about $10 trillion dollars, 48% of GDP. This represents a rise of 52% from its last peak the third quarter of 2008, when corporate debt was at $6.6 trillion, about 44% of 2008 GDP.
And the US government? The highest it has ever been. US$22trillion increasing day by day.
Perhaps you think things will be different here Australia. No. Here in the land of Oz we’re price takers, and so what happens on world markets will most certainly happen here.
So when you read that the solution to firing up the economy is to reduce interest rates to encourage people to borrow more and spend, you should be afraid. Very afraid. Not so much about the coronavirus, but about the crippling debt bubble that is inflating before our eyes that must certainly, eventually, pop. And when it does, the economic pain and associated social upheaval will be much, much worse than anything in living memory – even the GFC.
What should be our response? Well, so long as interest rates remain low it’s likely that asset values will continue to rise as cheap and easy money looks for opportunities to multiply (see my commentary on the latest property data here). As it does, the value proposition of assets will begin to look absurd, but people will invent excuses as reasons to justify why things are they way they are, and why prices must continue to rise.
Think tulips, or Internet stocks, or commercial real estate where right now average grade commercial property in Australia is selling at 6% returns. High grade on long leases is 4% to 5%. Junk is 8%. This is just way too low (truly, historic lows not ever seen before) for the risk involved, but cheap interest rates make the returns enticing nonetheless, especially when you compare to residential where the leverage returns are mostly negative.
Honestly, it’s not fun being the only sober one at a party… until the following morning when everyone except you has a horrible hangover and a humongous headache. Think about it… how much lower can interest rates and unemployment go? Sooner or later the benefit from both must be fully realised, so without increases in income (not likely as wage growth is low), what will drive prices higher? Possibly innovation in debt products (think Afterpay for property), but aside from that, I’m not sure.
That’s tomorrow though. Viva La Vida! Let’s tap open another debt keg – or two, turn the music up louder and start dancing on the tables. Bottoms up!
To wrap up then… Friends, sober won’t necessarily make you popular when everyone else is acting irrationally. But it will keep you safe, and it will help you make smart and sound financial decisions (and especially help you not to make stupid choices that drunk people make so willingly but regret so readily later). Sober right now means having a realistic strategy, and following it, without getting caught up in the hype.
If you want to hoard anything right now, cash is surely a better option than toilet paper. One can buy the other, and can also be used to purchase assets that may become available if values slip irrationally lower should panic selling set in. The other can only be used one way, and then flushed forever.
What do you think? Share your thoughts below.