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Where is the money going?

July 18th, 2008 · No Comments

That was the end of a previous entry on Thursday. Now, this actually turns out to be an important question in more than one aspect. The US economy might depend on it.

Paul Krugman (in the NYT this morning) note:

  • The Onion, as usual, hit the nail on the head with its recent headline: “Recession-plagued nation demands new bubble to invest in.”

He then goes on explaining (apart from being an influential columnist, he’s a world-class economist) two things:

  • In the aftermath of two previous recessions, there things only got going when there was a new asset class to invest in
  • There is no obvious new candidate for creating the next bubble.

The first is something of a pattern we previously noted as well. When we were talking about that ‘New Economy‘, the one that was supposed to end the business cycle, we noted that the business cycle seems to have been supplanted by something that could be called a ‘bubble cycle‘.

It goes a bit like this:

  • Low interest rates make borrowing cheap (essential since so many market players nowadays use incredible amounts of leverage), which makes a wall of money available to throw itself at the asset class flavour of the month
  • These asset prices inflate way beyond reasonable prices, but gravity can only be suspended for so long, at a certain time, the country (or world) runs out of ‘bigger fools’ to sell inflated assets to at even more inflated prices
  • The bubble pops, the leveraged financial system threatens to bring the whole economy down (or so is the official version anyway, the unofficial one might have just as much to do with the old-boys network running Wall Street)
  • The Fed comes to the rescue, bailing out the losers and making money once again ridiculously cheap so that the next bubble can inflate.

Now, if this pattern is going to repeat itself there must be some asset class which is both big enough to absorb all that new money, and interesting enough for it to happen in the first place.

If there isn’t, as Krugman suggests, the Fed can lower rates as it likes, but this will not really have much effect on the quantity of borrowing. It’s a situation that Keynes already described in the 1930s as a ‘liquidity trap‘.

In a liquidity trap, the power of monetary policy is greatly diminished, Keynes likened it to pushing on a string. If this is indeed the case, then that ‘bubble cycle’ is broken, and the economy will not come springing back out of its present funk anytime soon..

Indeed, we need a new bubble to invest in!

Our only candidate is alternative energy, and this is somewhat funny, as an investment wave would help get the economy going, which is, in our view, a crucial condition for getting oil prices going again, which will make alternative energy even more attractive. A self-inflating and self-reinforcing bubble.

And this might be a rather benign one, it will accelerate the US waning of oil, which will have wide ranging geo-political consequences (but we’re talking decades here). The Middle-East, instead of the explosive matchbox it is now, will become more of a garden variety area with conflicts that might not necessarily shake the whole world. And Uncle Sam might not be that interested anymore.

Tags: The Markets