Effects of a Bubble Economy

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Introduction

There is a new concept to the understanding of the world economy as suggested by Wiedemer et al. (3). It is known as the bubble economy. Just like areal bubble, it begins small and grows larger by the moment than suddenly bursts and disappears into the atmosphere. In much the same way, a bubble economy will grow incrementally with a variety of bubbles that wok together to boost each other to rise, this bubbles could include real estate, government debts, loans and stocks. The bubbles will push the economy up but then the inevitable will happen over time; they will burst and fall down faster than they rose.

The bursting of these bubbles will happen in two phases. Phase one is what the authors describe as the “bubble quake” and phase two is what the authors describe as the aftershock. The phase one will involve the collapse of the sectors that pushed the economy on an upward trend. The phase will see the collapse of sectors like the real estate, loans and stocks. The authors suggest that at the apex of the bubble quake, the aftershock will come in which will result in the collapse of the dollar and the government debt.

Preparedness

Every citizen knows that the Fed will put measures in place to curb inflation. In the event of an inflation the fed will come up with measures to ensure that the effects of the inflation are put in check and the government recovers as son as possible. However, few people really trust the initiatives of the Fed. When the recent inflation was at its highest point, the fed came up with a very controversial measure; they suggested increasing the rate of inflation.

The Fed realized that people were afraid of spending due to the hard financial times and they were therefore playing safe by leavening their investment in stocks and bank intact. To stimulate spending, the fed decided to set an inflation rate of 2% opposed to the 1% per annum. The rationale behind this move was that if people knew the prices are going up in the next year, they would prefer spending this year when the prices are still a manageable. This would in turn spur economic growth which would in turn put a check on the inflation. While this is an idea that is practical, it makes sense only to the economist while the lay man complains all the way (Hetzel, 57).

While all politicians, republican, democrat, liberal and conservative agree that the government has enough machinery to deal with inflation, there remains a big question since government has not yet demonstrated this through the past inflations. As Wiedemer et al. (3) states, the government in fact has only the power of making more paper and plastic money. And printing of more money has not been a solution for any inflation in history. It in fact fuels the rate of the inflation. The action of the government is actually what determines how the wheel of the inflation will turn as any carelessness on the part of government will result in an unprecedented economic crisis, which is described as the aftershock.

Many people appreciate the fact there is a looming financial crisis but they will rather be dumb about it. Maybe the notion in the minds of many people is that if they ignore the problem, then the problem will eventually go away. But as Wiedemer et al. (3) observe the only remedy that is authentic is talking about the problem. this will not only help in getting us prepared for what is ahead of us but it will also enlighten the minds of people thereby making people realize some possible solutions.

Bubble Quake

The recent bubble quake was anything but recent. It began building up from as far back as the 1980s when administrators and policy makers began running the government on huge financial deficits. There were a variety of bubbles that have contributed to the financial growth over the years which culminated in the bubble quake. Wiedemer et al. (25) suggests six main “bubbles” namely, real estate, private debt, stock market, unrestricted spending, and the dollar and government debt. This six have worked together over the years giving the impression that everything was alright until the eventual financial meltdown.

The initial quake that hit the shores of America in the year 2009 was as a result of the bursting of four bubbles; the real estate, stock market, private debt and excessive spending. The government has seemingly weathered the storm and people are back to their comfort zones but unknown to them, there is a looming crisis that is bound to strike in the next couple of years. This will be as a result of the bursting of all the six bubbles

Real Estate

The price of real estate has escalated by almost 100% within a six year period of 2000-2006. This is despite the fact that the earnings of people who are supposed to be purchasing this houses rose by a mere 2%. This is cause for alarm since the prices of house usually don’t increase that much especially when the salaries are not increasing significantly. As Wiedemer et al. (27) state, there has been no such increase of housing costs until in the 2000-2006 year period.

Stock Market

Wiedemer et al. (28) noted that the worth of monetary assets was averagely at the rate of 450 from as early as 1960 all through the years. However, there was a sharp contrast in this as by the year 2007, the rate had risen to almost 1000 percent. Looking further back, the stocks had previously registered a steady growth rising by an impressive 300% in the 1928-1982 periods. The subsequent years saw a continual growth in Dow reaching over 1200% but ironically, there was no related growth in the GDP.

Private Debt

As already noted, the US economy registered impressive economic growth between 1928 and 1982. However, the rise in Dow by 300% was not reflective of the growth registered. The 1400% after the period of 1982 is what is surprising.

The Dollar

It is common knowledge that the dollar that was one the mightiest currency in the world no loner enjoys that position. The dollar was once coveted by many by investors because of the value that the dollar had. The dollar was used by the investors to invest in the other bubbles like real estate and their collapse eventually led to the collapse of the dollar as well.

Government Debt

In 2006, Government debt reached a record high of $8.5 trillion. This can arguably be said to be the most impressive of all the bubbles. The debt is projected to grow even larger in the subsequent years. The implication is that with such a huge debt, no one will be willing to lend the nation more money.

The Aftershock

Wiedemer et al. (28) admonishes the American population that contrary to what they think, the real effect of the bubble quake is not in the initial effects that are felt due to the inflation. What the society needs to be wary of is the long-term effects of the bubble quake. The aftershock of the collapse of the other sectors as described in the bubble quake has far reaching effects due to the pressure that it exerts on the dollar as well as on the government.

Understanding the value of the dollar is important in understanding the effects. The value of the dollar can be given by the classical supply demand curve. Before the onset of the bubble economy, there was an impressive demand for the dollar. The higher the demand got the more valuable the dollar became. There was also a huge demand for American assets which further led to an increase in demand foe the dollar. While more foreign investors invested in the economy, the dollar grew more valuable. However, just as is the case for a bubble economy, the investments resulted in a rise on return rates on the various investments. In such a scenario, the dollar can only be strong if there is demand for the sectors like real estate. As the demand for these and other assets falls, so will the demand for the dollar. The reason is because the dollar was in demand since it was needed to make purchases. This explains why the dollar eventually collapsed after the other bubbles collapsed.

The government has come up with strategy after the other to try and revive the dollar but none seems to be working. The reason the dollar has not been salvaged is because in principle, the other bubbles that had led to its rise have since collapsed and the dollar could not stand on itself so down it went with the other sectors. One major difference between the dollar and the other bubbles is that it in fact did not rise to high levels like the rest of the bubbles. In fact the reason why the dollar is considered a bubble is not on is ability to rise but rather on the fact that it is very delicate and can burst with just a little prick (Wiedemer et al. 63).

Losing Investors

Many people think that the security America has is that the investors can’t leave the American economy since it is the best place to invest. But this is a notion that was true in the previous years while it slowly becoming apparent the investments in the US market are not performing too well. Juxtaposing the European economy with the American economy confirms this. Where the value of the American dollar has collapsed by a record decline of 60%, the euro dollar has increasingly gained ground. In fact, countries in the European part of the globe were not adversely affected with the recent economic meltdown. Investors prefer investing in an economy that is best insulated to fluctuations in the market and one that is least affected by any scale of financial crisis.

One other important factor to consider is that most foreign investors actually maybe their targets base of investment in their home nations. It is only normal that these investors will prefer to invest more in their home country than continue investing in an economy that is facing turbulent times. Some of the investors are actually franchises and this makes it very easy for the investors to pull out if they realize that the investment is not worth the while.

The notion that America is the only place for the foreign investors no longer holds water especially after the bubble quake. One other important consideration that is suggested is that money doesn’t need to be leaving the American Economy for there to be a loss in investment. All that needs to happen is for the money to flow into the economy but at very low rates (Wiedemer et al. 67). Many people also hold the view that the dollar is by far too important to be allowed to collapse. One of the examples that inform this is China. China has invested so much in the dollar that it is though that it will assist in upholding it due to the vested interests. But the reality on the ground is that China does not control the economy.

Change in Value

Only a slight change in the demand is sufficient to catapult a change in value. A good example would be the value of a stock. If one was the last trader to buy a stock at 200 dollars, then it follows that the value of the stock will be 200 dollars. This remains true for everyone that holds the stock irrespective of the amount they paid for the same stock whether higher or lower. The value of assets actually fluctuates very easily due to the principle of using he margin in determination of the price.

The value of the dollar works on the same underlying principle. There doesn’t have to be a very large volume of dollars sold to impact on the value. The principle of margin pricing is used to determine the value of the dollar. The implication is that a decline of the dollar will have a spiral effect. It will decline at a very rapid rate once initiated for whatever reason.

Using the hypothetical case of the stock, the stock value can decrease at such a rapid rate that an investor will have no time to sell the stock before he experiences too much of a loss. Much in a similar way, the decline of the dollar can happen so quickly that the foreign investors will have no chance to sell off their investments while it is still profitable to do so. Again, just like in the stock example, the lucky investor is the one that sells off his stock early. The rest will have no option but to incur the loss. This explains what happened to many industries at the height of the global financial down turn. But as the investors rush to make an early sale, it will as a result lead to an even sharper decline of the dollar. The collapse of the dollar will encourage the investors whether foreign or local to dispose off the dollars in favor of other currencies like gold or the Eurodollar (Wiedemer et al. 69).

Conclusion

It is expected that the American economy will continue to be greater than the economy of Japan and the economy of Europe for the next couple of years. This however does not guarantee that the dollar will become stronger than the Euro or than the other world economies. Like we have already established, the strength of the dollar is fully dependant on the law of demand and supply. If the demand of the dollar improves, then the value will also increase. But the demand of the dollar is dependant on the investment opportunities that are existent.

An attractive environment for investment will spur more investment. The investors will need more dollars to invest in the American economy. As the demand for the dollar rises, it will result in the increase of the value of the dollar. On the other hand, if the investment environment remains unattractive, the investors will prefer buying the euro and investing in Europe or other economies. The foreign investors that are in the American environment will also prefer taking their investment to their home nations as they would not be faced with any risks that relate to foreign exchange.

Works Cited

Wiedemer, David et al. Aftershock: Protect Yourself and Profit in the Next Global Financial Meltdown. New Jersey: John Wiley and Sons, 2009.

Hetzel, Robert. The Monetary Policy of the Federal Reserve: a History. London: Cambridge University Press, 2008.

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