Sunday, October 12, 2008

What a week - month - 23 years -- and some good news

It's been a crazy week.

Scratch that. It's been a crazy month.

In fact, it's been a couple of crazy decades.

In an attempt to figure out where things are heading, I've been trying to wrap my head around how we got here and the nature of our mess. This is hard for quite a lot of reasons:
  • I'm not an economist
  • Most of the media is full of retards
  • Most of the economists chiming in are from the same Keynesian school of thought that got us in this mess.
  • The economy is huge and complex
  • I have a job that unreasonably eats up 8+ hours each day

The current economic situation isn't a surprise and didn't happen overnight, or even over the past year or so. Rather, it is a reasonably predictable result of the monetary policy followed by the US Federal Reserve and central banks of other nations (predominately Europe) since ~ 1995. From 1979 - 1995 the Federal Reserve ensured that the broad money supply did not grow significantly faster than the growth of the economy as a whole. This kept inflation in check and allowed money to be a consistent measure of value and the economy from year to year.

Since 1995, the broad supply of money in circulation has increased at almost 9% annually while the nominal GDP increased only 5.3% annually. That 3% gap might not sound like much, but over the long haul it makes a tremendous difference. A simple rule of 72 check shows that the gap between money supply and GDP will double in about 24 years at this rate. Hmm... 1995.... 2008... 23 years... DOH!

The result is effectively twice the amount of cash chasing the same amount of goods. Having the money supply advance this much faster than growth skews purchasing and investment decisions.

Normally, this would have cause inflation to soar here in the US. Why didn't it?

Around the same time, the low price of oil and cheap international communications connectivity, ala the Internet, allowed the US to move much of its manufacturing offshore, to countries with dramatically lower costs. Our inflated dollars weren't spent here, they were spent elsewhere, inflating those countries. With our high costs of labor, these countries couldn't buy much that we build, so where did all those dollars go?

What happened is the dollars drove asset booms. In the late 90s, the dollars flowed into the stock market, especially tech stocks (driving demand and therefore prices up), after 2000, the dollars flowed into real estate (again driving demand and prices up). A funny thing happens when demand rises sharply, supply shows up to meet it.

During the tech bubble of the late 90s, all sorts of stupid businesses ideas showed up to meet the demand for technology companies. Many, many geeks got nice cars and ate good food. As one of those nerds (minus the nice cars bit), it was a great time. When the demand left, it didn't go slowly, it just left and the tech sector tanked hard. Then, in the real estate bubble, houses and entire subdivisions sprung up just as fast as builders could plant them. Again, when the demand collapsed, so did the entire construction sector. This time though things were different in a worse way.

The massive sell off on Wall Street has brought the Dow down nearly to the inflation adjusted level it was at just prior to the 1995 monetary policy change. If instead of being driven by the asset boom caused by all the extra money, the Dow had been driven by GDP growth, it would be trading at 7829 today. Remarkably, that's close to the territory it has been venturing in.

If you can pick companies that won't actually disappear we might be moving into a decent buying season. That could be a tough if. More on that later.


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