According to Austrian Business Cycle Theory, injections of money and credit by central banks lead to artificially low interest rates, incentivizing investment into longer-term, more capital-intensive projects that wouldn’t be profitable at higher interest rates. When those projects are completed the realization comes that there is insufficient demand for them. Resources have been malinvested, put to use in producing goods not demanded by the market. Companies are forced to lower prices, liquidate assets, and lay off workers in order to put their malinvested resources back to productive use.
Similar things happen on a smaller scale in households. As money flows into the economy and salaries rise, people feel flush with cash and begin to increase their discretionary spending. Expectations about the future increase too, leading people to believe that the good times will never end. As the bubbles burst, however, and the layoffs begin, people begin to realize what is coming and pull back on their spending. Dining out is replaced by dinners at home, cars and houses may be downsized, and spending on frills and luxuries is curtailed.
It’s been a while since we’ve put together a bubble watch post, so here is a little compendium of some news items from the past few months that might be indicators of bubbles. While it isn’t always possible to identify which bubbles are going to burst and when, nor how important such bubbles bursting may be, smaller bubbles can serve as leading indicators of overall bubble creation or point to even larger bubbles in the overall economy. The skyscraper index is a well-known example of a smaller bubble indicator, but it’s not the only one.
The Classic Car Market
The classic and exotic car market is something we’ve covered before. Classic cars are apparently the best-performing luxury asset class over the past decade, more than doubling the overall return of the second-place investment, wine. But price growth has remained nearly stagnant this year after a near 20% increase last year. Is that an indication that collectors and investors are sated and have lost interest in bidding up prices? Or does it demonstrate that well-heeled purchasers are worried about the future and choosing to forgo purchasing another fast car in order to have cash on hand to weather an upcoming financial crisis?
The Shipping Industry
By now most people are probably familiar with the Baltic Dry Index and its use as a barometer for overall economic health. As the thinking goes, a higher index indicates more shipments of goods, which is an indicator that the economy is healthy. Vice versa, a lower index indicates fewer goods being produced and shipped, an indicator of an economy entering recession.
One of the reasons for falling shipping prices recently is that of severe overcapacity within the shipping industry. Is this overcapacity a result of declining industrial production or a case of malinvestment caused by low interest rates, or maybe a little bit of both? The lead time between a ship being ordered and its being delivered can be several years, by which time economic conditions may have deteriorated and lead to the ship’s no longer being needed.
Large containerships are also very expensive to produce. They are often leased or chartered by their owners. All of this makes the industry one that is particularly sensitive to interest rates. With central banks working to try to keep interest rates low for the past several years, is the shipping industry the victim of those low interest rates? Is the excess capacity caused by unnaturally low interest rates that have spurred ship production and caused excess capacity?
A ten year-old Panamax ship that was sold for scrap this year became the youngest ever containership sold for scrap. That certainly seems to indicate that the shipping industry has become so distorted by easy money that younger and younger ships are getting sent to the scrap heap rather than being idled. That means that it’s judged to be cheaper to scrap a ship and buy a replacement at some point in the future rather than idle an existing ship. Since this wouldn’t happen during normal economic times, it must be the case that the shipping industry has been heavily influenced by bubble finance. So when will this bubble burst, or is it starting to burst already?
Demand for Fine Whiskeys
Whiskey is another one we have covered before, but the market is now so hot that there is a new exchange-traded fund that tracks liquor producers. Yes, demand for liquor has grown significantly in recent years, with distillers ramping up capacity to try to meet demand. Demand is especially high for longer-aged bourbons and Scotches whose quantities are necessarily limited. But will demand for high-end booze remain elevated?
The ETF’s creators seem to think that we are at the beginning of a 25- to 40-year boom period for liquor production, and indicate that the entire industry thinks so too. This type of ebullient attitude about any asset is often an indicator of a looming bubble. After all, will demand for Macallan and Pappy van Winkle still be as strong 12, 18, or 25 years from now as it is today? Will consumers’ tastes remain constant for decades? As distillers ramp up production and buy more buildings and oak barrels in which to age their spirits, they certainly have to consider fluctuations in the market. Is the current boom just the result of a faddish interest in mixology, buoyed by millenials with disposable income? Will demand for high-end liquor and fancy cocktails come crashing down when the next financial crisis hits and households have to start tightening their belts?
Marilyn Monroe’s Gown
The gown worn by Marilyn Monroe the evening she sang “Happy Birthday” to President John F. Kennedy recently sold at auction for $4.8 million, far in excess of the expectations of $2-3 million and nearly quadrupling its 1999 sale price. Purchased by Ripley’s Believe It Or Not!, the gown is likely destined to be showcased at a museum. Just as with the art market, which has seen record-breaking prices over the past couple of years, the celebrity memorabilia market could also be spurred by easy money. These are tough markets to gauge, given the small number of buyers and the infrequency with which these artifacts change hands. Can Ripley’s count on enough visitors to its museums to make the purchase of this gown worthwhile, or will this end up being a $5 million boondoggle?
Defaulting Auto Loans
The auto loan market is another one which many analysts have indicated shows some signs of a bubble. While the housing market has remained relatively tame in the aftermath of the crisis, some of that can be chalked up to bank regulators exercising a heavy hand, seeking to prevent a replay of 2008. But no crisis is exactly like its predecessors, and in their efforts to prevent a repeat of the housing crisis regulators may have turned a blind eye to the number of auto loans made to subprime borrowers. As auto loans continue to increase, the number of loans in default is increasing as well. If this pattern continues it could cause difficulties for many financial institutions.
Financial regulation is in many ways a game of whack-a-mole – steps are taken supposedly to prevent the next crisis but those steps are really just a reaction to the last crisis. The next crisis is always something not anticipated beforehand and it’s only when the bubble has already been created that the “Oh s#!&” moment occurs but by then it’s too late to move to deflate it. The best way to get out of a bubble is never to get into one in the first place. But that would require turning off the easy money spigot that emanates from the Federal Reserve, which Wall Street and the federal government are loath to do. Until the tyranny of centralized economic planning by central banks is put to an end, bubbles will remain with us. The best we can hope for is to identify them when they start and take measures to protect ourselves from the crashes that inevitably result when those bubbles burst.