Monday, March 24, 2008

Bubbles Tend to Burst.

How many bubbles have you seen and how many eventually burst? The dot com bubble burst at the turn of the century. If you had any money left you bought real estate and that bubble burst in 2006. Got any money left how about gold and commodities that one may be bursting right now and the last bubble the fall of the weakness of the US Dollar.

In fact we may have two bubbles bursting at the same time in commodities and the dollar. Do you have any money left? If you do, get ready for much lower returns going forward. The one thing that drove all of these bubbles was leverage. Take a high-risk investment and borrow as much as you can to juice the return that is a description of leveraged investment bubble. One company that recently went out of business bought government guaranteed mortgages and leveraged them 32 to 1.

Leverage that inflates the returns of high-risk investments increases the risk of a significant fall when the crash comes. If you’re a farmer and you have bought equipment based on the price of corn or wheat how will you make the mortgage payment on that $250,000 tractor if the price of wheat drops from $15 to $2.50 a bushel?

In London the government recently announced that they were going to impose a new tax on non-Britain’s living in London. For each person living in the city who is not a British citizen they will have to pay a tax of 30,000 pounds if they want to continue to work and or live in London. That means an investment banker who works in London and has his wife and two children with him will have to pay 120,000 pounds, about $240,000, to live and work in London. As you read this you are asking the same question I was asking myself when I saw this story, why is the government doing this? I can't come up with the answer other than the basic tax revenue isn't sufficient to provide for the services needed by the citizens. The housing market collapsed and people are leaving in droves, another bubble bursting. When I heard this I thought of the cab diver we met last May in London, and his family of eight, from India, living in London. How can he afford to stay?

The bursting of the commodity and dollar bubbles will have significant complications to the world economies. US companies that have been reporting strong overseas earnings also report that the weak dollar has added significantly to earnings. As the dollar reverses those earnings will turn into losses because of the decline of the local currency when reported by the company. The decline in the demand of the commodities will effect major exporting countries like the ones in central and South America, that have seen their economies expand based on expanding commodity prices. Government revenue will decline as prices for commodities decline. We may see increased tension in the Middle East as these countries see a significant decline in oil prices and they don’t have the revenue to support the needs of their populations.

As I indicated above returns will be lower at a time when million of Americans are facing retirement with diminished assets. Think about this time line and see if it fits you and your money.

In 1999 you finally moved your money into an Internet mutual fund by 2001 you lost about half. You say enough with this I go to real estate so you leverage what you have left to buy that investment condo in Naples. Its on the market for less that what you owe and no body is looking. You can’t rent the condo so you are spending what savings you have left to pay the bills.

You are 10 years closer to retirement and what do you have to show for all of your investing? If you have any money left you can buy a CD for 12 month at 2.31%. With inflation at 2.5% and taxes at 36% you have very little left till the next leveraged opportunity comes along and takes what is left.

Dan Perkins

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