In last week’s article, The Sentinel provided a brief outline of the South Sea Bubble of 1711-1720. In this article, we focus on the current bubble and its aftermath.


A bubble’s anatomy consists of three main areas: bubble creation, bubble collapse, and bubble aftermath.


The following conditions create the bubble:


1. A favorable public psychology (confidence)
2. A herding instinct
3. The means to speculate (money or credit)


The collapse of the bubble includes:


1. An investor (just one) willing to sell at a lower price
2. The default on loans and evaporation of new credit
3. Discovery of massive fraud


The aftermath of the bubble includes:


1. Collapsing prices
2. Recriminations of “guilty” parties
3. Government attempts to restore public confidence


Our current bubble began roughly in 1982, accelerated in the early 1990s, and culminated in a pop in 2007. Public confidence continually increased during this time. Investors systematically piled into stocks and real estate not wanting to miss the next sure thing (herding instinct). The means to speculate was made possible through the greatest credit binge in history by private investors and government entities. Rather than label this a stock or real estate bubble, The Sentinel calls it a credit bubble.


Prices in the stock and real estate market started their cascade down when some investors sold at lower prices. Commodity prices also collapsed. When these markets broke, we heard officials saying the credit markets “seized up” (aka, the evaporation of new credit). The FBI uncovered dozens of high-profile Ponzi schemes, the Bernard Madoff scheme being the largest. The Ponzi schemes satisfied the massive fraud criteria.


Our aftermath includes a continuing collapse of prices. A severe public backlash erupted against leaders of banks, hedge funds, and former market wizards (recriminations of guilty parties). The US Government embarked on a spending spree of mythical proportions. Our Congress, with Executive Branch prodding, is taking legislative measures to combat future bubbles. The last two satisfy the criteria of government attempts to restore public confidence.


The problem with our contemporary bubble is its sheer size. Our bubble is a product of unabated confidence (read credit expansion and debt accumulation). It was very difficult for the public to recognize the effects of this bubble since there was no pain felt in its creation. Our political leaders only exacerbated its effects through devastating increases in public debt. Using 1980 as a base year, the outstanding public debt of the United States in its previous 200-year history was $909 Billion. This included debt-creating events such as The Revolutionary War, The War of 1812, The Civil War, The Spanish-American War, World War I, World War II, the Korean War and the Vietnam War. Throw in government efforts to fight the Great Depression of the 1930s, and we have readily identifiable reasons for public debt increases.


After 1980, our public debt tripled to $2.6 Trillion by 1988. By 1992, this debt surged to $4 Trillion. It took 8 years to reach $5.6 Trillion in 2000. By 2007, the top of the bubble, the debt reached $8.7 Trillion. Our debt ceiling (our legally allowed debt) now is $12 Trillion. With our current actual debt in the $11+ Trillion range, this debt ceiling will vanish.


How have private individuals fared during this bubble? Regrettably, individuals swallowed large pieces of debt. At the bubble’s peak, the US commercial banking system alone held $2.6 Trillion in consumer revolving and non-revolving loans, $900 Billion in individual loans and nearly $4 Trillion in mortgage loans. For those scoring at home, that is a cool $7.5 Trillion. Personal savings on the other hand peaked in the early 1990s and actually went negative in the 2005 period. While debt increased exponentially, savings experienced a steady decline – a fatal combination.


In the last year, a shift occurred in the private sector with savings increasing at the greatest rate since the Federal Reserve Bank of St. Louis started tracking this data in the late 1950s. Consumer revolving/non-revolving debt has decreased in this same period. The reduction of credit and increase in savings are manifestations of initial deflationary conditions.


The anatomy of this bubble fits the prerequisites noted earlier. What is most disturbing is not that it meets all the characteristics of a bubble but the sheer magnitude will make the bubble pop feel more like the aftermath of a 10-megaton nuclear blast.


Rather than help the country, and in fact the world, confront the bubble’s explosion, governments have coordinated their efforts to employ Keynesian economic stimulus. Individuals and businesses, however, recognized the bubble pop and are in the early stages of austerity measures.


The beautiful thing about economies is the resilience of its participants. The Sentinel has postulated a series of Economic and Investment laws. One of the laws (Economic Law #4) says that markets allow people to satisfy themselves by satisfying others. The bursting of this bubble will be the most painful in our economic history. There will be little market satisfaction until we clear the economy of this malaise.


Government spending policies continue to obfuscate the large elephant in the room. The previous comment is entirely apolitical. Government is not above the market. It is a participant in the market consuming resources, borrowing money, and allocating capital. Government does not operate in an orbit around the earth sprinkling magic dust on economic problems. Until government makes this recognition, we worsen the crisis.


Jim Mosquera is the author of The Sentinel financial newsletter www.TheSentinel.biz. Mr. Mosquera’s email address is jim@TheSentinel.biz