Where did all the money go? The New Bubble Arising

Are you asking the same question? As a student of economics I am plagued by this question. I am haunted by it. And I think about it all the time. Here are the conclusions I have reached as clear as I can make them.

1. The money is still there. As John Reed stated in his article about the Financial Meltdown, most of the money in real estate is in the hands of those who sold their houses in between 2005 and 2007. It is also in the hands of real estate agents and loan officers who made a killing during the boom era. This money was paid out by the mortgage companies who in turn figured the new owners could pay up. When many owners couldn’t pay and started to foreclose, the bank was left with the need to use their real assets (cash) to back up their fake assets (mortgages). This stopped money from flowing to other areas that are needed to sustain growth (business investment, infrastructure, etc.) Where did the money go in the tech boom and bust? Mostly to the employees of the failed companies and to their suppliers.

2. The Fundamentals remain the same. There is a law going into effect right now called Gresham’s Law. This law states that bad money drives out good. In others words, the mixing of good money and bad money causes good money to go into hiding. The good money is the “real” money. Real money being cash, commodities, and other physical assets. The bad money is the “fake” money. Fake money being debt, asset backed securities, mortgages, IOU’s, etc. The bad money is gobbling up the good money. People and banks alike are holding tight to their cash right now. This one fundamental will always be true: Cash is king. (Sidenote: If you want to learn how to be a fundamental investor one way to do it is to start looking at blue chip companies that pay out dividends.)

3. Exchange of Money is Built on Trust. The reason banks are not loaning money to each other is that they can not trust other banks to repay them. It is much easier to buy a bank and have control, than it is to loan to them right now. First banks can’t trust consumers to pay them, and now they can’t trust each other to pay them.  What needs to happen? Trust needs to be rebuilt one day at a time.

4. Our Government is Failing Us. The Fed just announced another interest rate cut which dropped the prime rate to 1%. Our government is failing us because they are encouraging the same sort of actions that got us into this mess in the first place. Yes, our debt economy has helped create a lot of growth and a lot of jobs in the past few years, but a lot of it wasn’t sustainable. What is sad is that because the flow of money has more or less slowed to a trickle many cities are having trouble financing their projects. I recently heard a story on NPR about how a city couldn’t fund a greenlighted project that could potentially employ hundreds of people and improve their infrastructure because no one would buy their municipal bonds. There are so many little things adding up like that. What the government should be doing is using the $700 billion dollars in bailout money to invest in job creation, infrastructure improvements, education, and technology. Instead they are trying to falsely motivate banks into lending to each other again. So the banks can then invest in businesses, and infrastructure, and everything else. It is kind of pointless if you ask me. They should just bypass the banks and save themselves and the American public the headache. Let the banks fend for themselves. If you ask me, the banks and the government are too much in bed with one another.

5. Value Creation, not Money Creation, is the Answer. The money is out there. What is needed is not more money, but more value. Money is worthless without something of value behind it. It is simply the medium we use for trade. It has no intrinsic value of its own and the sooner we realize that the better. We all need to really focus on value creation. When we do, all of our needs will be satisified.

I heard another excellent idea on the radio today about a new bubble that is coming. It promises to be much worse than the tech bubble and the real estate bubble combined. It is the coming government bubble. In the next few years we are going to see a lot of money flooding into the government. Namely, in the form of companies that the government is taking vested interest in and the taxes we pay. Don’t be surprised if we start seeing the government buying even more companies and assets. With freshly printed money and higher taxes to boot…

I think the government is too big already and it should be downsized. However, there are no such promises in the near future. If anything, there are too many interest groups lobbying to keep government big and powerful. They have a vested interest in having the government retain more control rather than less because that is where they derive their power from. The politicians are bought and paid for by them. A government will not on any normal basis volunteer to make itself smaller. With our current demographics we will only see the government expand as the need for social security and medicare expands. Our government will not break its promise lightly. The problem is that it will probably fail in its mission before it accomplishes much good.

In the next four years, we will see this housing and credit mess resolved, but our next issue will be an inflated government. We have seen the last three recessions hit approximately in 1981, 1991, and 2001. This may seem a bit absurd, but it looks like we are off track. Shouldn’t the next recession be in 2011? 😉 No one really knows the future. However, with something like this that effects everyone so much, it is worth it to pay attention to the trends.

Here is some humorous reading @ The Onion about Bubbles that is worth the read. Recession-Plagued Nation Demands New Bubble To Invest In.

Check back next week for an article that discusses what we should be doing when we find ourselves in economic rough waters like we do today.

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