There's been a lot of talk in global financial circles about bubbles. You've probably already heard of stock market bubbles. In fact, in 2001, we had a nasty stock market bubble in the Dot-com crash. If you are too young to remember, let me do a quick recap for you. During 2001 and the years leading up to it, there was a huge appreciation in the stock market value of companies that didn't make money. You'll probably scratch your head and think how crazy that concept is. Well, these companies would normally just go out of business if they were normal companies. Unfortunately for the rest of the market, these companies were internet companies.
Internet companies during the height of the Dot-com bubble traded solely on hype. People were not worried so much whether their company is making money or even capable of making money, instead, they only focus on one thing and one thing alone – they focus on whether the price will continue to go up. This is the classic sign of a market bubble. When the market has completely divorced itself from basic fundamental economic reality like profit and loss, year over year profit growth and value, you know that there's a serious problem with the market. Sure enough, in 2001, the Dot-com bubble collapsed. We're talking about trillions of dollars erased overnight, which triggered a mild recession.
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The reason I am saying that it is a mild recession, was for the most parts, a large chunk of the overall American economy did not feel the after effects of the recession. In fact, the US economy quickly recovered and by the time 2008 rolled around, the stock market has set new records. The NASDAQ was going crazy once again and sure enough, just when every thought that the good times were back permanently, the market bottomed out. It was no surprise why it had to do that. After all, starting in 2004 all the way to 2008, the market has been in a real estate bubble. This was a stock market bubble fueled by mortgage-backed securities. Most American banks were cranking out mortgages and offering them to people who cannot afford them and then leasing these securities in the market. Since banks, governments and other institutional investors historically thought that mortgages were one of the most secure form of investment, you can see where all these investment mania was headed. So here we are in 2014 and the big question that everybody is asking, “Is the US dollar in a bubble?” Well, it depends on how you define bubble and what measure you use.
There are many ways to look at the US dollar. One school of thought is to look at the US dollar is its own store of intrinsic value – this is actually the main view among economists. They think that since the United States has such prestige and has such economic and military power, that the dollar at some level is just too big to fail, why? There's really no other currency to replace it. If the dollar gives way, we're talking about trillions of dollars of value vaporized overnight not just in the United States but all over the world.
You have to remember whether you're selling oil, selling gold, selling commodities, coffee, sugar, you name it – you normally would price those commodities in the form of dollars. Payments are made internationally in the form of dollars. If the US dollar went belly up, all that trade, which doesn’t necessarily have to involve the United States, will take a massive hit. It's like trying to band blood and your body is dependent on blood; it's a medium of exchange.
So from this perspective, there is no such thing as dollar over valuation. The dollar's value is tied into its intrinsic necessity. It's basically like if you want to cut into a bumper sticker slogan, too big to fail. The problem with this approach in defining dollar bubble economies and dollar bubble situations, is just plain history. This kind of thinking ignores history. The reality is that there were previous benchmark currencies.
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In the 1500's, the benchmark currency was the Spanish peseta because in the 1500's, the top dog when it comes to Europe was Imperial Spain. Well, when Spain imploded because it funded too many wars and it stopped producing and just imported the bulk of stuff that they needed and its manufacturing sector remains stagnant and actually declined, Spain, actually faded from the scene. The peseta was replaced by the French franc. In the preceding centuries, it was the French, the British and then now, the American took over the scene.
However, if you look at the rise and fall of the economies that took the center stage, you could see that their manufacturing capabilities decline, they borrow too much, they overextended themselves, they got on to all sorts of war – does this sound familiar? It definitely sounds like the United States now. It's been indeed out in the war in Iraq, which had just been concluded and cost billions of dollars, it was wrapping out Afghanistan, and it has a history of spending money on wars and military bases all over the world. If the logic of arguments against the idea of a dollar bubble rests on the concept of too big to fail, I'm sorry to tell you, but the United States, just by looking at the historical records and historical patterns is not too big to fail. It doesn't look like it will be an exception to what would otherwise be an iron clad historical rule. The reality is that empires rise and fall throughout history – from the Babylonian to Persians to Greeks to Romans to the Spanish, French, British, you name it – empires come and go. In trying to deny the concept of a dollar bubble based on the idea that a system is too big to fail is dangerously naïve.