Blowing Bubbles

Blowing Bubbles

This morning on Yahoo! Finance, I came across this line in an article entitled "Stocks set to continue to slide on economic worries": "There has been growing concern throughout the month that the economic recovery is slowing to the point where the country could fall back into recession."

The article goes on to list the some of the woeful statistics from the world's markets:

  • The Dow dropped 4.4 percent in August
  • Japanese stocks are at a 16-month low
  • Consumer confidence is low due to high unemployment
  • Housing prices are flat
  • US manufacturing indexes like The Chicago Purchasing Managers Index are dropping

By now, almost all talk of an economic recovery, which was so strong just a few months ago, is over. Now, people are bracing for yet another recession—a double dip.

Bank Bubbles

Despite the bad economic news, The Wall Street Journal reports this morning that "Bargains on Failed U.S. Banks Are Over." According to the article, despite the fact that more bank failures are projected to occur in 2010 than in 2009, some investors are pulling out of deals to buy failed banks from the FDIC because the prices are getting too high. In comparing 2010 to 2009, the average discount on failed bank assets is 9.5 percent versus 14 percent, the average buyer purchase gain as a percentage of assets is 2.5 percent versus 4.5 percent, and the cost to the FDIC of loss sharing pacts as a percentage of assets is 22 percent versus 27 percent.

By all accounts, though the market is worse and more banks are failing, some investors are paying more and driving up the price of failed banks.

Gold Bubbles

Also in the news this morning is an article at, "Gold Rallying to $1,500 as Soros's Bubble Inflates," stating that gold futures for December are now trading at $1,500, which is 18 percent higher than the record gold price of $1,266.50 recorded in on June 21st. According to the article, one of the biggest purchasers of gold is George Soros, who called gold the ultimate asset bubble at the Davos World Economic Forum in January. Apparently, he thinks that despite gold's record pricing over the summer, we're just at the beginning of the gold asset bubble.

This makes sense because in times of economic distress, people have historically always moved into gold, the one true money, as a hedge. I've been buying gold since it was at $400 an ounce. That it may climb higher is good news. Today, I'd much rather have gold than US dollars.

Yen Bubble

And in Japan, the yen is rising to an all-time high against the US dollar, which is bad news for an economy that relies heavily on export growth. The higher yen makes Japanese goods more expensive and harder to export. The yen is now at a 15-year high and not expected to slow. Japan is doing all it can to try and devalue the yen, including printing more, but investors spooked by the fragile world economy are moving into the yen as a safe-haven investment. This is bad news for Japan, whose economy recently slipped into third place worldwide behind China.

More Bubbles to Come

These are just three examples of bubbles forming around the world. There are plenty more—and plenty more to come. The world economy is in a precarious state, and the US economic problems are at the heart of the world's fears. And at the center of the US economic problems is a weakening dollar. As The Wall Street Journal reports in an article entitled "Betting Your Bottom Dollar on Export-Lead Growth": "The dollar is caught up in the type of competition that countries don't want to win: a global race to the bottom."

Because the US economy is so weak, it's pushing for export-lead growth, hoping to double exports over the next five years. In order to accomplish this, the dollar must be weaker not stronger. This will cause inflation at home as it will take more dollars to purchase the same goods but will be a boon for manufacturers selling goods to other countries since their currency will have more purchasing power and lower the cost of US goods abroad.

In the short-term, this may seem like a good thing for the US economy. But a weak dollar is bad for the long-term and many investors are scared. As a result, we're seeing more and more bubbles appear. As I wrote in Conspiracy of the Rich: The 8 New Rules of Money, Nixon took the dollar off the gold standard in 1971. Since then, the US dollar has been a currency capable of wild swings and easily manipulated. Before 1971, it made sense to save dollars and it didn't take much financial intelligence to become wealthy. After 1971, it took a much higher financial IQ to become wealthy because the dollar became just another asset class.

In my book, Rich Dad's Prophecy, I wrote about another change in the rules to money—the change in the rules of retirement with the passage of the Employee Retirement Income Security Act (ERISA) in 1974. This change in the rules moved retirement from defined benefit accounts, accounts provided by employers to employees for life, to defined contribution plans like the 401(k). This pushed millions of middle-class baby boomers into the stock and bond markets. Again, it became more important to have a high financial IQ to become wealthy since employees were now responsible for their own retirement investments.

As I wrote in Rich Dad's Prophecy, there is a flaw in the ERISA law that requires individuals to take forced distributions from their retirement plans when they reach the age of 70.5. Beginning in 2012, the first of the baby boomers, the largest age group in US history, will begin turning 70.5. Basically, this law is in place to capture the deferred tax income. Unfortunately, this means that money will be flowing out of the stock markets and looking for places to go. The result will be a major crash in the stock market and asset bubbles forming again and again.

Don't Get Popped

While I don't have a crystal ball, I feel strongly that the coming years will be exceptionally hard ones economically. Those with a low financial IQ, who cling to the old rules of money of go to school, get a job, buy a house, save, and invest in a diversified portfolio of stocks, bonds, and mutual funds, will suffer the most.

I encourage you to continue increasing your financial education, and to understand the history of money, in order to better see what may be coming. In an economy full of bubbles, you can do very well—if you know how to see the trends and how to profit from them. I can assure you that in times of economic trouble your financial intelligence will be your most valuable asset. As we say at Rich Dad, Financial Education is The Way Out of the Crisis.

Original publish date: August 31, 2010