Wednesday, May 28, 2008

We Know About The Housing Bubble, But What About The Other Bubbles?

Boy popping bubbleTalk of the housing bubble can be heard at dinner parties across the nation and read about in just about every newspaper and magazine, but if you think the housing bubble was the only bubble around, you are sadly mistaken.

“The same factors that were behind the housing bubble were also at work, to varying degrees, in the auto bubble, the commercial real estate bubble, the travel bubble, the college tuition bubble, the retail bubble, the Web 2.0 bubble and most recently the commodities bubble. Unlike housing, which began losing steam two years ago, these other sectors have just begun the painful process of repricing and finding a new balance between supply and demand,” Steven Pearlstein said in a Washington Post article.

It seems everything that is bought and sold nowadays can be turned into a bubble. Remember Beanie Babies several years back? Now kids are revisiting the same thing, only this time with the internet version of Beanie Babies: Webkinz. I recently went to buy one of these Webkinz online for a little girl's birthday present and was taken back by prices being asked for some of the “limited edition” or discontinued little animals. One retailer was asking more than $100 for a little stuffed unicorn. I thought to myself, "Who in their right mind would pay that kind of money for a little stuffed unicorn?" only to find one of the little girls at the birthday party bragging about having one. Go figure.

The point of is, markets will at times act irrationally. We have a tendency to get caught up in the hype and pay too much when the hype is positive, which creates a bubble. Then, when the bubble finally bursts, we tend to oversell the item; it's simple investor psychology. When you add investor psychology to fundamental changes, these bubbles can become severely overinflated before they finally pop and we end up with bubble gum all over our faces.

Pearlstein does a great job in his article of explaining that there is no easy fix for the problem we now find ourselves in. The only way things are going to get better is for the market to take its course. There is a reason things are getting repriced (bubbles popping): They were priced too high to begin with. Or, in certain cases, not priced high enough.

The hardest thing with all of this is that in the end, Americans are going to have to realize that we have been living on borrowed money.

“The decline is the result of years of large and growing U.S. trade deficits that should have caused the exchange rate to adjust years ago but didn't because so many of our trading partners in Asia and the Middle East were intent on linking their currencies to the dollar. In the process of maintaining those dollar pegs and reinvesting those surpluses in Treasury bonds and Fannie Mae and Freddie Mac securities, they created a surfeit of cheap credit that spawned all those bubbles,” Pearlstein wrote.

The ride was sure good, but it can’t and won’t last forever. We need to realize that things are going to have to change, and in many cases it is going to be for the worse. We have to have the wherewithal to see that the tracks end up in the distance, and either we get off now or we risk falling to our doom (Ok, maybe that's a bit dramatic, but hopefully you get the point: The sooner we take action, the better). I will leave you now with the ending paragraph of Pearlstein’s article, which I think is fitting:

“Is all this the end of the world? For the richest country on the planet, certainly not. But it does represent the end of a decade or more during which Americans were permitted and even encouraged by the rest of the world -- and by their own leaders -- to live way beyond their means. As a result, the United States has gone from being the largest creditor nation to the world's largest debtor. For the first time since the early 1980s, Americans will have to endure several years of uncomfortably slow growth and uncomfortably high inflation as the U.S. economy regains its balance and creates a foundation for more solid and sustainable growth.”

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