There are more than a handful of notable economists and investors who believe that the current credit crisis is really just an extension of a much larger bust that was set in motion more than a decade ago. In essence, the 90’s created a mentality that everything was different. American net worth exploded and the world appeared to be permanently altered for the better. Specifically, assets to liabilities soared:
Then the Nasdaq bubble burst and the paper wealth went up in flames. Alan Greenspan’s approach was simple. If we could simply reflate the consumer balance sheet through asset reflation everything would be resolved. So, the consumer was encouraged to continue taking on excess debt without the underlying income to sustain this debt. In essence, Americans were trying to sustain the lifestyle that they had become accustomed to in the 90’s and the Federal Reserve and Treasury did everything in their power to maintain that lifestyle.
As the housing bubble grew Americans once again felt the invincibility of paper wealth. Of course, just like the Nasdaq bubble none of this was actually supported by the underlying fundamentals. And as the housing bubble wealth effect dissipated in 2005 so did the ability of the consumer to sustain its 25 year spending spree:
The surge in household wealth due to the double bubbles proved to be nothing more than paper gains that were not supported by the underlying fundamentals. Assets were higher than they otherwise should have been. It’s clear, in retrospect, that Americans never really recovered from the excesses of the 90’s. The government’s response to this bubble era has done little to help create the foundation for a sustained recovery.
This past weekend, Brian Sack admitted that the Fed’s recovery plan is largely dependent on propping up asset prices that would “otherwise be lower”. The U.S. government hopes they can reflate assets and sustain a supposedly capitalist market without having any losers. They just can’t come to grips with the fact that there are decades of excesses that have yet to be resolved and that perhaps we need lower asset prices in order to create the foundation for a sustained recovery. Propping up assets is not a recipe for economic recovery. This reflation plan didn’t work the first time around. I am not sure why anyone thinks this reflation recovery would ever work this time.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.