Abaco

Do you think Wall Street is in another bubble?

61 posts in this topic

If anything the internet bubble shows the beneficial learning effects of a real, unregulated bubble: nobody these days invests in a company unable to produce earnings. Until 2007, some VCs did, but these days, even VCs focus on deals that already have shown client potential, as opposed to smart teams with an unfocused business plan.

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Hey rtg24 - I recently acquired some knowledge of fibonacci analysis. Being an engineer, of course I'm drawn to it. I imagine a little knowledge of it would be useful if one wanted to throw away money, also. Are you familiar with it and have you used it? The few examples I've seen using it really cracked me up. I was shocked at how well they timed reversals.

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Hey rtg24 - I recently acquired some knowledge of fibonacci analysis. Being an engineer, of course I'm drawn to it. I imagine a little knowledge of it would be useful if one wanted to throw away money, also. Are you familiar with it and have you used it? The few examples I've seen using it really cracked me up. I was shocked at how well they timed reversals.

Personally, I don't touch this stuff. Most traders I know consider most of "pure" technical analysis - that is, spotting patterns with no grounds in reality, like head and shoulders, trees, fibonacci, etc. - not to be a useful strategy.

But I'm all about fundamentals and investing in what is proven to work - great management, good business fundamentals, a valuation catalyst, interesting situations, etc. :D

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High interest rates mean lending to people who need to be productive with the money, and reducing the amount of leverage that people can take on. It naturally forces investors to be wiser with their cash. Can't lever up 30x on NINA loans at 2% pa. I would say high interest rates are more productive in the long run and definitely less inflationary. Remember money is "printed" when the Fed lends - most of the printing is electronic and consists of expanding the credit base.

I disagree and this is part of the total problem, that being a lack of understanding of what interest rates are. Interest rates reflect time preference, low interest rates reflect a long-term perspective and a higher premium is put on the future. High interest rates reflect a short-term perspective and hence why people need to make money "now" as their money will be worth less in the near future which is caused by government intervention from mulitple avenues.

The price or value of money is it's purchasing power, increase the amount without productivity to back it and you have inflation and a lowering of it's value. When the government increases the amount of money they automatically lower it's value and hence why the smarter creditors raise their rates as they need to make a profit before the value of their money drops. It is the monetarist that thinks that an excess of money spills over into the stocks causing their prices to artifically rise and this is incorrect. So, I disagree that "booms" lead to "bubbles" or "bust" as properity does not leat to empoverishment.

I offer that you rethink your premise and that you might start with the works of Richard Salsman.

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I disagree and this is part of the total problem, that being a lack of understanding of what interest rates are. Interest rates reflect time preference, low interest rates reflect a long-term perspective and a higher premium is put on the future. High interest rates reflect a short-term perspective and hence why people need to make money "now" as their money will be worth less in the near future which is caused by government intervention from mulitple avenues.

The price or value of money is it's purchasing power, increase the amount without productivity to back it and you have inflation and a lowering of it's value. When the government increases the amount of money they automatically lower it's value and hence why the smarter creditors raise their rates as they need to make a profit before the value of their money drops. It is the monetarist that thinks that an excess of money spills over into the stocks causing their prices to artifically rise and this is incorrect. So, I disagree that "booms" lead to "bubbles" or "bust" as properity does not leat to empoverishment.

I offer that you rethink your premise and that you might start with the works of Richard Salsman.

Interesting argument. Personally, I always think of rates as related to risk (sometimes not so well). Treasuries are "low risk" (ahem) and therefore low return. Private equity investments high risk, and therefore a much higher rate of return is required. Venture capital is the riskiest, with 1/10 bets actually moving up, therefore it requires IRRs upwards of 60% (roughly 10x return in 5 years).

As far as the money supply is concerned, interest rates are a price, the price of money. This is why I believe they should be left for the market to determine, rather than set by a central authority causing shortages and oversupply. None of this is a problem with gold-backed money.

I do agree that true booms are not bubbles. Bubbles are the allocation of assets from productive to unproductive uses. For example, industrials lost a lot of capital and found capital much more expensive to obtain during the duration of the tech boom of the late 90s. Booms, such as the industrial revolution in England or the better parts of the technology industry in Silicon Valley (post-bubble, e.g. Google, Apple, Amazon, etc.) do create wealth.

On the subject of interest rates, I will quote Lewis. I am sure he won't mind, as this will hopefully help sell more copies of his excellent book. Hunter Lewis, Where Keynes Went Wrong, p. 89:

1a. Keynes: Interest rates are too high. The rate of interest is not self-adjusting at a level best suited to the social advantage but constantly tends to rise too high...

1b. Comment: this is a frontal assault on the entire price system.

Keynes does not define any of his terms. He does not say what the "social advantage" is. He does not tell us how we will know when interest rates have fallen far enough. Nevertheless, he has told us something important - that the price system cannot be trusted.

It is important to keep in mind that interest rates are a price, the price of borrowed money. They are not only a price; they are one of the most important prices in an economy. All prices are interconnected, but this price in particular affects all other prices.

Businesses depend on prices to give them the information with which to run the economy. If the price system for interest rates is broken, no part of the price system is unaffected. If the price system is hobbled, it is a very serious matter because attempts to replace market prices with government-imposed prices have not generally been successful. As Oysten Dahle, a Norwegian oil executive, said about the Soviet Union, "[it] collapsed because it did not allow [market] prices to tell the economic truth."

As a rule, we should be extremely wary of any argument that begins by throwing the market price system out of the window, but for the moment we will withhold further judgement and see where Keynes is going.

[...]

4a. Keynes: The way to bring interest rates down is to create more money.

Government can and should bring interest rates down to a more reasonable level by increasing the "quantity" of lendable funds. This is done by creating new money that is made available to banks to lend.

4b. Comment: Keynes's policy of creating new money to reduce interest rates ultimately backfires. Why? We will explore the reasons step by step.

i. The new money is inflationary.

Keynes is correct that pouring new money into the banking syustem should, at least initially, bring down interest rates. Theere is, however, a hitch. AS soon as the new money has been borrowed, it will move out into the economy. Once there, it will tend to raise other prices. In other words, it will tend to create inflation.

[skipping explanation of inflation because I assume Forum members know already]

This was somewhat ironic, because Keynes had begun his career as an articulate foe of inflationary policies.

ii. Inflation leads to higher, not lower, interest rates.

There is a further hitch. What wil happen to interest rates when other prices start to rise? Lenders will of course notice that the money coming back to them at the end of the loan wil not buy as much as it once did. This will cause them to stop lending or lend less, which would tend to raise interest rates. Rates may even rise before inflation appears if lenders look into the future and take steps to protect themselves.

This is especially ironic, an example of what economists call an "unintended consequence". The quest to lower interest rates by injecting new money into the economy tends to lead, sooner or later, to higher rates. Swedish economist Knut Wicksell initially developed this point. No one, including Keynes, has ever refuted it.

iii. THe 1970s illustrate how inflationism leads to higher interest rates.

In the UNited States and elsewhere, printing money throughout the 60s and 70s led to very high inflation, which in turn led to very high long-term interest rates. Only decisive action by the chairman of the US Federal Reserve, Paul Volcker, finally broke the inflationary spiral. Volcker stopped pringin money, stopped holding short interest rates down, deliberately let the economy plunge into severe ecession, suffered intense criticism from national politicians, but was vindicated as inflation receded and the economy bounced back. By the early 1980s, Keynes appeared to be a false prophet, one whose recommendations had led the world to the bring of economic ruin.

iv. The deceptive 1990s

Did the next decade contradict our arguments and vindicate Keynesian ideas? No. IN this case Keynesianism led to bubbles and crashes. But events were genuinely confusing.

After the deep recession of the early 1980s, governments went back to printing money. Consumer prices rose (doubled in the quarter century after Volcker's recession), but the rise seemed moderate enough by the standards of teh 1970s. Interest rates did not rise as the pace of government money printing picked up in the 1990s and beyond; on the contrary, they fell. Without the drag of higher interest rates or a recession, the economy boomed.

Many people thought that this proved Keynes right. Contrary to the evidence of the 1970s, it was possible to inject new money into the economy and reduce interest rates without triggering inflation and then higher interest rates. To see why this is incorrect, we must look into the 1990s.

[summarizing argument:]

a. Masked inflation

[if prices should fall 3% but rise 3% the government is printing money at 6%]

b. Underreported inflation

[under Reagan, benefits were linked to the calculation of consumer inflation. Clinton developed new procedures which resulted in a lower inflation rate. Both methods excluded house price changes.]

c. Asset inflation

[New created money flows not just into hard assets but also stocks - your argument, Ray, being that it doesn't, please do expand if you have time - and housing as in the 1990s and 2000s]

d. Bubbles

Masked inflation, underreported inflation, and asset inflation all work together to create a bubble. What looks like moderate CPI helps keep interest rates down. This in turn makes it easier to borrow greater and greater sums of money to invest into assets such as stock or real estate. As the prices of these assets rise because of all the borrowed money being funneled into them, lenders are all the more willing to lend against the assets, and borrowers are all the more willing to borrow to buy more of them. Before long, all the new money channeled into investment assets has created a full-scale bubble.

e. The dot-com and housing bubbles

[in 1990s, corps borrowed the money for share buy-backs. This made share prices rise, causing the public to dive into the market. Greenspan called it a new era, bubble grew until CPI caught up, interest rates rose a bit and the bubble popped.]

The Fed responded along Keynesian lines by driving interest rates down to 1%. It held them there for a year and below the rate of reported consumer inflation for three years. This was tantamount to giving money away. It led inexorably to the housing bubble and then the collapse of the housing bubble starting in 2007. Towards the end of the housing bubble, interest rates finally began to rise.

v. the Bottom Line: government efforts to reduce interest rates create conditions that lead to crashes.

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Rtg24,

You missed my point as I am totally agianst interest rates being defined as "the price of money" as they are not. Interest rates are tied to the risk of the investment or loan to another while the lender is also paid for the time preference they are willing to wait to use their wealth which is their stored or extra produce.

Money is a representational tool of one's productivity, the more productive the more money or weatlh one produces and accumulates. But money cannot work in accordance to it's nature (as a tool of exhange) unless there are unconsumed goods to back it up. When a wealthy person or company chooses to lend, loan or invest in another person or company they are lending their unconsumed goods/productivity/wealth to another so that they can produce more wealth and also pay the lender in the form of interest for the risk taken and for the time that the lender waited to use or consume their own wealth. As the new startup person or company has not produced any goods it is the rich person's investment into the future that allows the startup to have funds before the production. When the startup takes the investment and turns it into new goods and hence a profit, new wealth is created and hence a larger money supply to represent the new products is needed. So, new or more money is needed to back the newly created wealth which is created by newly created products which is created by the producer who had a large enough amount of wealth that they could invest in the upstart. This type of increase in money is needed and rational and is not the cause of inflation. Infaltion is defined as an undue expansion or increase of the curreny of a country, by the issueing of paper money not redeemable in specie. Inflation is not caused by growth of the money supply alone, it is caused by a fraudelent exapansion of a country's currency without the products/goods to back it. (Even money lenders that lend for the so called non-productive items such as trips is still counting on the future productivity of the person being lent the money.) And it is only the government that has the power to create this problem not private citizens. Once again, prosperity does not lead to impoverishment, or in other words, economic growth does not lead to poverty.

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If I may go back to the title of this thread. As I stated earlier in somewhat different terms, as long as the government keeps intervening in the stock market they will keep creating the "bubbles" that are an essential aspect/effect of statist governments and their policies. But in a Capitalist economy, fully free and unregulated, stock prices would reflect the value that people put in the company for a share of the profits and not the companies output. In other words a rational investor is not investing on a whim nor for a share of a company's output/produce, but instaead they are rationaly investing their wealth in the company for a share of the profits. And as long as a company keeps producing profits and there is not an increase in stocks the simple law of "supply and demand" is applicable, even to stocks.

For those that have a desire to learn more about the items I have been mentioning I recommend Richard Salsman once again and specifically his lecture "The Cause and Consequence of the Great Depression."

http://www.aynrandbookstore2.com/prodinfo.asp?number=DS72M

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I do agree that true booms are not bubbles. Bubbles are the allocation of assets from productive to unproductive uses. For example, industrials lost a lot of capital and found capital much more expensive to obtain during the duration of the tech boom of the late 90s. Booms, such as the industrial revolution in England or the better parts of the technology industry in Silicon Valley (post-bubble, e.g. Google, Apple, Amazon, etc.) do create wealth.

That seems like a very useful definition. This is a very stressful time for anyone wanting to protect their wealth, and it goes back to a related thread. There is no way for the average person to save money without taking risks. You can't just sit on your money, because of inflation. Since the government is holding interest rates artificially low, you're losing the value of your money in a savings account as well. This means everyone who doesn't live on their pay check has to be an investor or lose money, encouraging ignorant decisions by necessity since people lack the means to become experts overnight. Doesn't this environment in itself create bubbles, since the markets end up reflecting the decisions of desperation and ignorance rather than the true value of companies? I remember reading the ancient article by Alan Greenspan that the cause of the collapse leading to the Great Depression was ultimately low interest rates, and the government is doing it again. That's why you can't just avoid the expressly regulated industries, because the whole economy is affected.

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I remember reading the ancient article by Alan Greenspan that the cause of the collapse leading to the Great Depression was ultimately low interest rates, and the government is doing it again. That's why you can't just avoid the expressly regulated industries, because the whole economy is affected.

I would offer that Alan Greenspan was wrong then and he is still wrong today along with almost everyone. I would also offer that you read or reread Richard Salsman's reply which can be found here.

http://forums.4aynrandfans.com/index.php?showtopic=3177

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(Ray, just so you know, I have acknowledged your counterargument. I currently do not have the time to read Mr Salsman's and so will refrain from commenting further on your line of thinking until I have read it, understood it, and am in a position to argue with or against it.)

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That seems like a very useful definition. This is a very stressful time for anyone wanting to protect their wealth, and it goes back to a related thread. There is no way for the average person to save money without taking risks. You can't just sit on your money, because of inflation. Since the government is holding interest rates artificially low, you're losing the value of your money in a savings account as well. This means everyone who doesn't live on their pay check has to be an investor or lose money, encouraging ignorant decisions by necessity since people lack the means to become experts overnight. Doesn't this environment in itself create bubbles, since the markets end up reflecting the decisions of desperation and ignorance rather than the true value of companies? I remember reading the ancient article by Alan Greenspan that the cause of the collapse leading to the Great Depression was ultimately low interest rates, and the government is doing it again. That's why you can't just avoid the expressly regulated industries, because the whole economy is affected.

I would very much like to be in a position to be able to care about this.

However, if that helps, all I can say is that those of my friends who are in such a position due to the very large sums of money they bring in tend to put it in physical gold in Zurich and London banks (I would very much like to discuss why physical but cannot do so on a public forum). Perhaps worth thinking about.

Also check out John Mauldin's latest letter. It talks about what retired folks - who will die in the next 10-30 years - should do, since they obviously cannot wait out the crisis, to preserve their wealth. It might be of interest just because of the practical advice it offers.

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Rtg24, I appreciate you taking the time to let me know your intentions and look forward to further discussions on this extremely important and unfortunately misunderstood field, even by most Objectivist. I offer that if you read or listen and attempt to integrate Richard Salsman's ideas you will have to redefine some of the terms that most economist use today and that you will possibly come to disagree with most other Objectivist, Austrian schools of thought, Monetarist theory and the Mercantilist theory which is where the fallacy of "interest rates are the price of money" originally began. Fundamentally you will have to redefine what interest rates really are (which I already gave you a glimpse of) and discard the Neo-Marxist ideas of John Maynard Keynes which has lead to the fundamental misunderstanding of what caused America's Great Depression and what has caused the consequences we are seeing duplicated now. Until then I would like to remind you (and others) that Capitalism leads to prosperity not poverty and any "boom and bust" cycle we see is not caused from capitalist policies, but from the statist policies that are interjected and cause those contradictions.

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Just based on the above, 2 further thoughts: 1. I agree that Keynes is dangerous and 2. interestingly, some of my friends are working on a critique of Friedman and the monetarists... should be interesting to watch this thread develop.

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I heard today on French radio a - technically - right-wing politician arguing for doubling the number of people who should have access to zero-interest mortgages (taxpayer-backed). She said it was an outrage that 30% of the population couldn't afford a home. History is condemned to repeat itself.

Who was that, if I may? Christine Lagarde has been lambasting Germany for having healthy finances and an export-based economy.

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I heard today on French radio a - technically - right-wing politician arguing for doubling the number of people who should have access to zero-interest mortgages (taxpayer-backed). She said it was an outrage that 30% of the population couldn't afford a home. History is condemned to repeat itself.

Who was that, if I may? Christine Lagarde has been lambasting Germany for having healthy finances and an export-based economy.

Can't remember, was driving past Geneva airport at the time and we had just switched to French radio...

She has to do with either culture or cooperation. Not a big minister like Lagarde.

Anyway, Peter Mandelson has outdone any French efforts by attacking Bob Diamond for being the only British banker to have made money this year.

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I heard today on French radio a - technically - right-wing politician arguing for doubling the number of people who should have access to zero-interest mortgages (taxpayer-backed). She said it was an outrage that 30% of the population couldn't afford a home. History is condemned to repeat itself.

Who was that, if I may? Christine Lagarde has been lambasting Germany for having healthy finances and an export-based economy.

And come on, Merkel is pasty white and fat, and Lagarde is tanned and thing... she obviously knows better :D

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...

However, if that helps, all I can say is that those of my friends who are in such a position due to the very large sums of money they bring in tend to put it in physical gold in Zurich and London banks (I would very much like to discuss why physical but cannot do so on a public forum). Perhaps worth thinking about.

Also check out John Mauldin's latest letter. It talks about what retired folks - who will die in the next 10-30 years - should do, since they obviously cannot wait out the crisis, to preserve their wealth. It might be of interest just because of the practical advice it offers.

rtg24 - I appreciate your earlier comments in this thread.

I started integrating physical gold into my investment strategy a while back and found that doing so created a nice sense of inner peace.

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I started integrating physical gold into my investment strategy a while back and found that doing so created a nice sense of inner peace.

Why?

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However, if that helps, all I can say is that those of my friends who are in such a position due to the very large sums of money they bring in tend to put it in physical gold in Zurich and London banks

That's what many wealthy German Jews did in the 1930's. They put their gold into foreign banks -- and stayed in Germany.

Bad move.

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I started integrating physical gold into my investment strategy a while back and found that doing so created a nice sense of inner peace.

Why?

I'm not sure. It's like that feeling I get when I drink a big, round glass of cabernet. It's a feeling that defies explanation. But, I'll try. It hasn't hurt that gold has generally gone up in value. However, I'm in gold as a long-term investment. I look at it as a pseudo savings account...one with interest that doesn't show up on my tax records. :)

Control. I like the control that physical gold affords one vs. paper saying that you own gold, as in the ever-so-popular ETFs.

I got the idea while reading Sustainable Wealth by Axel Merk. He has been buying physical gold for his children's college fund. It's been very good to him.

But, in a nutshell...think of a big, red, Paso Robles cabernet. I think that explains it best.

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Abaco, have you read any of the links to Richard Salsman's books or other works such as the one below? If you have and do not agree with his analysis then just discard my offers as I do not think they will change your mind on this subject.

http://forums.4aynrandfans.com/index.php?showtopic=321

Actually, I appreciate that info RayK. You know, to some degree it's a matter of persepctive. For somebody like me who wants to spend a little bit of their investment funds on physical gold as a means of diversification in a long-term strategy...well, the information you reference makes sense, for the most part. Mr. Salsman uses the term "gold bugs" and that made me chuckle. It qualified what he was saying and clarified it. It didn't necessarily change my mind, in part, because I agree with much of it. I just choose not to have as much faith in the gold ETF that tells me I own a pile of gold that's stored in the other hemisphere. I'll be the first to admit that my take on it is unusual. And, thanks for the info.

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Abaco, I am glad that you found the information useful and enjoyful even if only to a certain degree.

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Whilst Richard Salman's forecast on the gold price did prove somewhat flawed in the medium term (admittedly, in 2005 >$400 seemed high!) he does have a point about market timing and relative prices. Gold is very high historically. One of two things could be true: 1. the market, full of Keynesian-trained traders (from the leftie economics departments all across the Western world), is not sufficiently discounting the risk of high inflation from bad government policies. This could be especially true due to the relatively comfortable years we've had, since markets have very short memories (or rather, the individuals within them have mostly very short careers); 2. the gold price is overdiscounting, and once facts clarify, gold will sink back down somewhat. Most of the big guys, including John Paulson (a smart global macro guy if there ever was one, very good at spotting trends!) think gold has still some way up to go. I don't particularly disagree with them considering the socialists controlling most of the world's important countries, the US especially. But gold could go back down, and not so long ago it was down to $200. The question you must ask yourself is, if another bubble arises somehow (after all there was one a decade, usually breaking neatly before the next decade starts - 1987, junk bonds, 2000, tech, 2008, mortgages) will you have the courage to hold on to your $1000+/oz gold for the 3-6 years that it will remain at $200-400/oz? Or will you feel so physically sick in the stomach (you must have been a long term investor to understand this feeling) from having made that bad trade that you will sell at a loss, wiping out some of your wealth?

Gold was a very attractive trade at the middle and height of the bubble. Many argue it is still an attractive trade, but too uncertain for me. Philosophically however, there is no more liquid, universally accepted currency and as a wealth preserver, it is definitely attractive. Just think about the potential downside and make sure you are comfortable with it before you enter the trade.

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Also bear in mind the cost of a Swiss numbered account, which currently stands at $300/annum if I remember well. I prefer to think of it as an insurance premium :)

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