Not even close
I hate to break it to you, but chances are you’re just not prepared for what’s coming. Not even close.
Don’t take it personally. I’m simply playing the odds.
After spending more than a decade warning people all over the world about the futility of pursuing infinite exponential economic growth on a finite planet, I can tell you this: very few are even aware of the nature of our predicament.
An even smaller subset is either physically or financially ready for the sort of future barreling down on us. Even fewer are mentally prepared for it.
And make no mistake: it’s the mental and emotional preparation that matters the most. If you can’t cope with adversity and uncertainty, you’re going to be toast in the coming years.
Those of us intending to persevere need to start by looking unflinchingly at the data, and then allowing time to let it sink in. Change is coming – which isn’t a problem in and of itself. But it’s pace is likely to be. Rapid change is difficult for humans to process.
Those frightened by today’s over-inflated asset prices fear how quickly the current bubbles throughout our financial markets will deflate/implode. Who knows when they’ll pop? What will the eventual trigger(s) be? All we know for sure is that every bubble in history inevitably found its pin.
These bubbles – blown by central bankers serially addicted to creating them (and then riding to the rescue to fix them) – are the largest in all of history. That means they’re going to be the most destructive in history when they finally let go.
Millions of households will lose trillions of dollars in net worth. Jobs will evaporate, causing the tens of millions of families living paycheck to paycheck serious harm.
These are the kind of painful consequences central bank follies result in. They’re particularly regrettable because they could have been completely avoided if only we’d taken our medicine during the last crisis back in 2008. But we didn’t. We let the Federal Reserve –the instiution largely responsible for creating the Great Financial Crisis — conspire with its brethern central banks to ‘paper over’ our problems.
So now we are at the apex of the most incredible nest of financial bubbles in all of human history.
One of my favorite charts is below, which shows that even the smartest minds among us (Sir Isaac Newton, in this case) can succumb to the mania of a bubble:
It’s enormously difficult to resist the social pressure to become involved.
But all bubbles burst — painfully of course. That’s their very nature.
Mathematically, it’s impossible for half or more of a bubble’s participants to close out their positions for a gain. But in reality, it’s even worse. Being generous, maybe 10% manage to get out in time.
That means the remaining 90% don’t. For these bagholders, the losses will range from ‘painful’ to ‘financially fatal’.
Which brings us to the conclusion that a similar proportion of people will be emotionally unprepared for the bursting of these bubbles. Again, playing the odds, I’m talking about you.
How Exponentials Work Against You
Bubbles are destructive in the same manner as ocean waves. Their force is not linear, but exponential.
That means that a wave’s energy increases as the square of its height. A 4-foot wave has 16 times the force of a 1-foot wave; something any surfer knows from experience. A 1-foot wave will nudge you. A 4-foot wave will smash you, filling your bathing suit and various body orifices with sand and shells. A 10-foot wave has 100 times more destructive power. It can kill you if it manages to pin you against something solid.
A small, localized bubble — such as one only affecting tulip investors in Holland, or a relatively small number of speculators caught up in buying swampland in Florida — will have a small impact. Consider those 1-foot waves.
A larger bubble inflating an entire nation’s real estate market will be far more destructive. Like the US in 2007. Or like Australia and Canada today. Those bubbles were (or will be when they burst) 4-foot waves.
The current nest of global bubbles in nearly every financial asset (stocks, bonds, real estate, fine art, collectibles, etc) is entirely without precedent. How big are these in wave terms? Are they a series of 8-foot waves? Or more like 12-footers?
At this magnitude level, it doesn’t really matter. They’re going to be very, very destructive when they break.
Our focus now needs to be figuring out how to avoid getting pinned to the coral reef below when they do.
Understanding ‘Real’ Wealth
In order to fully understand this story, we have to start right at the beginning and ask “What is wealth?”
Most would answer this by saying “money”, and then maybe add “stocks and bonds”. But those aren’t actually wealth.
All financial assets are just claims on real wealth, not actually wealth itself. A pile of money has use and utility because you can buy stuff with it. But real wealth is the “stuff” — food, clothes, land, oil, and so forth. If you couldn’t buy anything with your money/stocks/bonds, their worth would revert to the value of the paper they’re printed on (if you’re lucky enough to hold an actual certificate). It’s that simple.
Which means that keeping a tight relationship between ‘real wealth’ and the claims on it should be job #1 of any central bank. But not the Fed, apparently. It’s has increased the number of claims by a mind-boggling amount over the past several years. Same with the BoJ, the ECB, and the other major central banks around the world. They’ve embarked on a very different course, one that has disrupted the long-standing relationship between the markers of wealth and real wealth itself.
They are aided and abetted by both the media and our educational institutions, which reinforce the idea that the claims on wealth are the same as real wealth itself. It’s a handy system, of course, as long as everyone believes it. It has proved a great system for keeping the poor people poor and the rich people rich.
But trouble begins when the system gets seriously out of whack. People begin to question why their money has any value at all if the central banks can just print up as much as they want. Any time they want. And hand it out for free in unlimited quantities to the banks. Who have their own mechanism (i.e., fractional reserve banking) for creating even more money out of thin air.
Pretty slick, right? Convince everyone that something you literally make in unlimited quantities out of thin air has value. So much so that, if you lack it, you end up living under a bridge, starving.
Let’s express this visually.
“GDP” is a measure of the amount of goods and services available and financial asset prices represent the claims (it’s not a very accurate measure of real wealth, but it’s the best one we’ve got, so we’ll use it). Look at how divergent asset prices get from GDP as bubbles develop:
What we see in the above chart is that the claims on the economy should, quite intuitively, track the economy itself. Bubbles occurred whenever the claims on the economy, the so-called financial assets (stocks, bonds and derivatives), get too far ahead of the economy itself…