bubble shot

Ever hear the expression “nothing lasts forever”? It’s something that the financial industry either ignores or doesn’t know. With all the turmoil that happens in our world today–whether it be political, environmental, or financial–financial institutions have to somehow maintain consumer confidence.

Historically, the financial health of any nation has gone up and it has gone down. Eternal perpetual growth has never been a reality and yet has to be maintained so that governments can have all the toys of a typical superpower: powerful military, infinite resources for social programs, cheap everything. So how do governments make this happen? How do governments stave off disaster and continue to build what seems to the laymen to be a continually building economy?

It’s Why People Buy Mutual Funds

I suspect most people have suspicions about investing their money when they sit down with a financial advisor for the first time. It’s a new world and to help them ease into it, the advisor explains that as long as they invest within their risk tolerance, everything should be alright. They go on to explain the correlation between risk and return. Many people will be intelligent enough to know that correlation is not causality. So as a marketing piece, the advisor whips out an Andex chart.

An Andex chart tracks the performance of the stock indexes over long periods of time. And as you can see from this example, it’s hard to not be convinced. Your worries of a down market are quelled and your confidence in investing is gained. More importantly than “what” you see on the Andex chart is “why” it looks like that.

Why is it that the Great Depression, both world wars, every recession, the tech bubble, 9/11 and recently the sub-prime mortgage debacle have had such quick recoveries? The answer? Bubbles.

It’s Gotta Pop Sometime

A bubble in the financial sense is like it sounds. It’s where the value of something expands, kinda like blowing up a balloon. It gets to a point where it has more air than it can hold and it either deflates or pops. We’ve seen a number of example like the ones I listed above.

Why would you have to create a bubble? Why create an economy that depends on ridiculously quick, expansive and most importantly unsustainable growth? Why is there the need for the superpowers of the world to have their toys? It’s a simple matter of politics. The seemingly neverending ways that our governments can work their way out of these messes give us confidence. In turn, they get our votes.

The way these bubbles pop is also simple. The amount of wealth is like energy. It’s fixed. We can’t create wealth out of nothing. This is because our perception is what makes something worth anything. And the more we have of something, the less we want it.

Think of the economy in terms of an oil tanker. As it sails across the ocean, the oil sloshes around a bit. It waves to one side of the ship and then waves to the other side. It’s goes from one extreme to the next. Downtime in the economy is a bad thing, so politicians foster growth in a sector of the economy with tax incentives and/or political support.

One Bubble After Another

Remember the tech bubble? The Internet was the next big thing (which it was and still is), so everyone poured money into it and the economy grew. Then it went down… hard! People lost confidence in it when they realized that the world wasn’t big enough for every tech startup that wanted to make it big. I mean how many Amazons do we really need?

So, to pump up the economy once again, the real estate bubble came. Once that came down from sub prime mortgages, the bond bubble started to grow. Governments had to recoup after the massive losses from the subprime mortgage, so they issued bonds (LOTS of them). Of course, that means there’s the need to make even more money to not only pay back those bonds at interest, but to also grow the money enough for the things they needed to pay for.

And now it all comes to this, the most recent and biggest bubble of them all: stimulus packages! Central banks stimulate the economy by pumping in loads of cash to bail out failing corporations and to encourage the perpetually growing consumer society that we so heavily depend on.

A Bubble Can Only Get So Big

So, when there are no more bubbles to be popped and the economy completely deflates to its ACTUAL size, what happens?

The buying power of our dollar is weakening and the economy is getting more inflated, yet consumer confidence is on the rise. This is not a call to action to pull your money out and buy gold (although it’s not a bad thing). It’s to be more cognizant of where your money is and the advice you’re getting from your financial professionals. When they tell you the economy is on the rise and that it’s a great time to invest, ask them how they know that and more importantly, why they believe that.

Because another thing about bubbles is that they do a great job of eclipsing the true facts.