Where the next bubbles are & how Colorado will know

(’76 Contributor) Alan Greenspan, an august recent chair of the Federal Reserve, articulated what is generally believed; economic bubbles are hard to identify and little can be done about it anyway. If you consult Wikipedia you will discover that since the creation of the Fed in 1913, we have had numerous depressions and recessions in a pattern not unlike before the Fed began tinkering with the economy. This means we are constantly playing catch–up after ma and pa’s pension is decimated, their home loses it value and everyone but trust fund babies and attractive women lose their jobs.

I believe the identification of bubbles are easily done if you use the economic concept of dead–weight loss. With rare exceptions bubbles emerge as a result of irrational exuberance tied to easy money. Clearly the dot–com bubble that burst in 2000 came not unlike the railroad bubble that burst in 1893—from an overinvestment in an industry that was not able to sustain growth and meet expectations. And, the Great Recession of 2008 was not only a real estate bubble, but tied to a chronic deficit in wealth–creating exports linked to the off–shoring of our manufacturing base. The failure of the American auto industry occurred because of the over–use of credit to purchase cars. Ford, GM, and GE are not manufacturers but finance companies.

When Americans are allowed to buy items using their house as an ATM, with no money down and an expectation of never–ending appreciation, only a fool would deny a bubble is being created, not only in the real estate market but, also, the consumer economy. Hyper–inflation in these sectors would never have occurred if the consumer had to earn the money and pay cash. Just like Professor Joel Waldfogel’s admonition about Christmas presents it is a hyper–reality that would not exist if old fashioned cash on the barrel–head were required. And, when the collateral securing the loan loses value, both borrower and lender are put at risk.

So, we sat back for two decades watching cars being sold at inflated prices with cheap lease programs and no interest loans. It suddenly ended and the industry crashed as consumers with marginal credit had to buy used cars from Rocky’s. And, the real estate industry did the same thing and crashed. Am I and the other bear contrarians I ride with ominiscient or are Alan Greenspan and his posse a confederacy of dunces? What is so hard about this that a trained, experienced economist and consummate money–changer couldn’t see? I think the really smart ones did see it coming, got out early, and are now using cash to vacuum up the buying opportunities.

You are probably saying: “Well, Fran, it’s easy enough to drive down the road looking out your rear–view mirror, but where are the next bubbles?”

There are some who believe it is gold, because gold is really a hedge against inflation and people may be investing now for the wrong reasons. But, I think long run prospects for inflation are strong enough and the gold market is small enough that it wouldn’t hurt anyone but a few goldbugs. Where my attention is focused is on three really big areas:

1—Health care—The role of insurance and public entitlement programs has created significant dead–weight loss in the industry. H/C is now at 17% of GNP and will hit 20% before long. There is no way that a ruthless, self–maximizing consumer would take money out from beneath the mattress and pay health providers what they are commanding through a credit driven situation. The precipitating event may be a pandemic or breakthroughs in genetics. Regardless, the situation is unsustainable and the unfunded liabilities are big enough to cause a day of reckoning at some point.

2—Education—Another area with enough dead–weight loss to fill the ocean is public education. It’s taxpayer financed system, fraught with incompetence, inefficiency and glut. Teacher unions, benefits and pensions are unsustainable. I think the bubble will burst when iPad, multi–media technology combined with our new–found knowledge of the mind and human learning converge to obsolete the current system. Maybe vouchers will speed it up, but the really big things looming cannot be stopped or even slowed down.

3—State and Local Government—It is clear that state and local government has benefited mightily by debt–fueled projects that fail on fundamentals. They are also dependent on taxes from fossil fuels. The social contract with employees for their pensions and benefits simply cannot be sustained so something must give eventually. What will likely bring down this house of cards is the mass migration of productive people to penturbia towns leaving suburban and urban cores with the permanent underclass. The State will not be able to save the day and legislatures will still have enough rural conservatives to put the kibosh on tax–payer funded bailout schemes. Many states will likely default and no one will be able to save them. Perhaps state boundaries will be redrawn.

4—Suburban real estate—The drying up of credit for the subprime market has not fully been felt by the McMansion crowd. The new demographics will not provide enough fools to buy their faux homes built of styro–foam stucco and cultured stone. As energy costs rise and people bail out of the current system it will continue to plague the housing and construction market for years to come. The market is still 50% too high and there is enough bad air in the bubble to deflate far more. A home is no longer a good investment. This will affect funding to government and result in more crises to come.

Those are my picks. I feel pretty certain about the long run probabilities but unsure about timing. It will be driven by the big events of the day; who can say when the earthquake will hit California or terrorism will take out the U.S. Capitol? Negative events throughout the rest of the county benefit Colorado and the Rocky Mountain region. We have plenty of room to grow and only lack water and landscape design. Given the amount of water on the planet it is a mal–distribution problem that can be solved by pipelines and technology at some cost.

What I see here in Douglas County is a two–tiered situation. There have been plenty of affluent grandees arriving to make D/C the 8th most affluent and educated county in the U.S. Whether they will stay in place as government picks at their income or move to lower tax states is yet to be determined. People tend to stay in place when their kids are in school and the housing markets sucks, so time will tell.

But, what I also see at the Walmart are thousands of people who have moved here hoping against all odds they can live on the cheap and maybe pick up a job. These are grapes of wrath folks who are on their last leg and inhabit the rabbit warren apartments around town. Cheaper than LA and they can still lead an anonymous life, unlike Wheatland, Wyoming where everyone would question their taking of federal transfer payments.

The demographics of Colorado will be shaped like an hour–glass. Cities like Aurora and Brighton will epitomize the places where ethnic minorities and immigrants can move. Hey, it’s way better than Somalia. And, places like Boulder and Douglas County will be the places where the landed–gentry use zoning codes, gates and all manner of defenses to protect their turf. I don’t see much room for the middle class. They are like penguins on an melting iceberg floating out to sea.

I, for one, intend on splitting my time between Montana, Hawaii and Colorado. There is no one perfect place and psychologically my identity lends itself more to being a nomad tethered to the Internet. Bon Voyage!!

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