Monday, March 29, 2010

What if it was all just a big bubble?


Not the bear market rally of the past 12 months.

Not the post tech-stock recovery of 2000-2008.


I'm talking about the whole of your investing life, the last 30-40 years of asset price inflation that started with Great Society spending in the 1960s, augmented by the baby boomer effect on consumption, the effect of technologies like cars and mass production and telecommunications, all strapped to a booster rocket of Nixon abandoning the gold standard in 1971.

When, in your life, has your government sustained a surplus? When has your currency increased in purchasing power?
These provocative questions were prompted by this provocative article is from a provocative blog by Tim Iacono called The Mess that Greenspan Made. Check it out.

What is considered an average return in the stock market took a jump up after money was decoupled from gold. Few people factor in the effect of inflation on stock indices. Look at the chart above, and eyeball an average for the period from 1880 to 1970. Then do the same from 1970 to now.

Real returns probably should be calculated in terms of something timeless, for example the Dow/Gold ratio. The Dow Jones Industrial Average has its weaknesses, but it is easily recognizable. Right now it takes about 10 ounces of gold to buy one unit of the DJIA.
The chart shows the craziness of the gold mania in the late 1970s, and the equal but opposite craziness of the tech bubble in 2000. Those who disparage gold point to its poor performance from its 1979 peak through the subsequent two decades. Those who admire gold simply pick a different time period.

The message of Tim Iacono's article is that the housing bubble and accompanying credit bubble that goosed the financial system from 2000 to 2008 was just the most recent example. Who knows...maybe gold is the next bubble, just as it was in the late 1970s. You will know a bubble is happening when TV shows feature ordinary people buying gold or taking Grandma's old jewelry and flipping it for a huge profit, like the home reno shows that were everywhere three years ago.

Until then, it is probably safe to buy some gold or silver and put it away. When the TV shows start, take a bit of a profit by selling it to the latecomers.

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