Bubbles – Part III

November 7, 2014

In the previous article, I provided a brief outline of the South Sea Bubble of 1711-1720.  A bubble’s anatomy consists of three parts:  creation, collapse, and aftermath.


·        A favorable public psychology - confidence.

·        A herding instinct.

·        The means to speculate with money or credit.


·        An investor (just one) willing to sell at a lower price.

·        Loan defaults and evaporation of new credit.

·        Discovery of fraud.


·        Collapsing prices.

·        Recriminations of “guilty” parties.

·        Government attempts to restore public confidence.

I use 1981-1982 as a starting point for the greatest credit expansion in the history of the world. Bubbles are greatly facilitated through money/credit expansion. Public confidence increased during the 1990s while investors piled into stocks and real estate not wanting to miss the next sure thing (herding instinct).  Rather than label this a stock or real estate bubble, we can really just say it is a financial asset bubble.

Prices in the stock and real estate market started their cascade down when some investors sold at lower prices.  When these markets broke, officials said the credit markets “seized up” (loan defaults/evaporation of new credit).  The FBI uncovered dozens of high-profile Ponzi schemes (fraud), the Bernard Madoff scheme being the largest. 

The aftermath included a collapse of prices.  A severe public backlash erupted against leaders of banks, hedge funds, and former market wizards (recriminations of guilty parties).  The US government embarked on a spending spree of mythical proportions.  Congress took legislative measures to combat future bubbles. The Federal Reserve added trillions to their balance sheet.  The euphemism, Quantitative Easing, became part of our financial lexicon. All of these measures satisfy the criteria of government attempts to restore public confidence. [Note: the Fed would not qualify as "government" though their intent of restoring confidence applies]

The sheer magnitude of the financial asset bubble is difficult to comprehend.  This bubble is a product of unabated confidence that is still fostered by the financial Wizards in government and central banks.  It is always difficult for the public to recognize the effects of this bubble since credit tends to flow rather freely. 

What we have today is a re-inflation of the previous financial asset bubble or the creation of a new one.  Governments have coordinated their efforts to employ Keynesian economic stimulus and central bank tinkering to keep the bubble alive.  While many individuals and businesses recognized what happened in 2008 and made economic adjustments, the financial Wizards had other ideas.  The market never had a chance to experience the catharsis necessary to cleanse the financial system of its previous excesses.  This is the main reason why the collapse of the current bubble will be more painful than that of 2008.

1 cubic foot of silver weighs approx 655 pounds whereas 1 cubic foot of gold weighs more than half a ton.

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