Return of the Bubble

One of the advantages of aging is that it gives you a perspective on life that’s very difficult to gain any other way. My 23 years of work life  gives me some idea of life and the industry you are associated with.

Here is one of the things that should amaze us. US is said to be in a severe recession. But, the unemployment percentage in US is hardly up by about 3 basis points from the peak of the boom. Unemployment in Jun 2007 was 4.6% and Jan 2009 is 7.6%. Ref:

Corollary of this is  – 92.4% of USA workforce is still employed as on Jan 2009, as versus 95.4% in Jun 2007.  Does this look very bad?? Why should there be massive slowdown in consumer purchases, when more than 92% of the people are still employed and are earning?

It has everything to do with the moods and cycles. There will be a boom leading to a bubble, which will burst leading to a gloom. The reason for the Boom-gloom cycle is easy to explain.

From a layman’s economic perspective, the amount of money that is available doesn’t change drastically between Boom and Gloom cycle. Govt’s across the world print the money according to a plan. So, in 2007, when the world economy peaked, world didn’t have much more printed money than today. So, why is there a liquidity crunch today and not in 2007?

It all has everything to do with the Spending cycles, rather than the amount of money available.
Here is how it goes:

  1. Companies consider the market opportunities and bring out products and services. As the products become more desirable to people, companies find more people wanting those products (Growth Opportunity/Potential market).
  2. Companies determine, through surveys and other statistical mechanisms, the kind of growth they can have for their products and services. On growth projections they get valued higher in the market. On the basis anticipated growth, they decide to employ more people.
  3. This is where the up-turn begins. More people get employed, more confidence they have on spending and they will go buy those products/services they always wanted to buy. This fulfills the growth projections made by most companies.
  4. Now, here is where the Bubble comes-in!  Companies start thinking they are doing something wonderful, so they will keep growing at the same phase. So, they make even higher projections of growth (and market data supports them too!). The stock-markets reward them with valuations that are heady. They go and hire even more folks. Everyone has employment, everyone has money to spend, a bubble gets created where all assets become expensive. Since everyone gets convinced of their future income, they go borrow the money to buy things that on cash they can’t buy.
  5. This goes on in a pattern of a Ponzi scheme, where people go on discounting their future income to buy things today. At somepoint, the pyramid breaks as someone in the chain sees through it. Typically, it is the government, which calls the economy overheated and increases the interest rate and making it difficult for people to borrow the money against their future income.
  6. All of a sudden the projections made by the companies don’t look real anymore. They refactor and decide they don’t need higher employees afterall. They stop hiring, and some start to lay-off.
  7. This is the begining of the Gloom cycle. The confidence of people about their future cashflow is dented, they buy less and hold on to the money. The projections of the companies on their sales, is hurt even further, they reduce expenses and let go of even more people. This cycle continues till a point is reached, where the business reflects the purchasing power with real-money (as versus purchasing power of the virtual money/assets built by discounting the future income).
  8. That is the point of equilibrium and ideally the world should stay there with moderate growth. But it won’t!! People still want to buy those things currently they can’t afford with the money on their hands. Even the guys who don’t have employment have needs/wants. This is where govt’s step in and do something. They reduce the interest rates, raise public debt (thru bonds) or even print money and spend a lot of it on infrastructure or bail-outs, in the name of ’stimulating’ the economy. Making it easy to borrow or get money. This is the oil that makes it possible for the economic machine keep going forward.
  9. Slowly, People who never lost jobs/income realize they are holding off on their purchases without any rational reason! They go out and slowly start buying things.
  10. All of a sudden we are at Step-1 all over again.

So, I believe even as we are reaching the end of the bust cycle, the next boom and bublle is just being created!! The world rarely remains static. While lot of economists debate about the stagflationt hat Japan experienced in 1990s, that’s just one country. The world on the whole can’t remain static.

So, I firmly believe that in about couple of quarters from now, the next bubble would be on its way.