New York, Thursday January 20, 2010.

We are presently experiencing a marked deterioration in the quality of bubbles.

The first one in the 1990’s was a high quality one.
The dotcom was a bubble generated by the unlimited prospects of a new technology.
The internet revolution led to excessive speculation from investors.
But the excitement was based on real productivity gains in the economy.
It all created an instant wealth effect.
That bubble eventually burst.
But the world has permanently been transformed in the process.

The US housing bubble started shortly after that.
This one was manufactured by Freddie and Fanny as well as unreasonably low interest rates.
It was a different animal.
The wealth effect was no less impressive, but it did not add much value to the economy.
Unlike the dotcom frenzy, speculation on real estate did not improve productivity.
Nor did it create new industries.
Finally, because this bubble was hugely magnified by greedy bankers, its popping resonated around the world.

So, a third bubble came to the rescue.
It is in full swing at the present.
This one, the commodities bubble, has yet another origin: the printing presses of China, US and Europe.
It is also the lowest quality bubble of this cycle.
It is not the result of a transformational technology.
Instead of improving productivity, the commodities price inflation is only adding to manufacturers’ cost.
Neither does this bubble create a wealth effect.
Instead, it merely transfers wealth from the many to the happy few.

And then there is the mother of all bubbles: today’s ballooning public debt in the industrialized world.
Its nature and effects are once again very different.
This is a bubble whose bursting would be welcome, not feared.

So, moving from bubble to bubble, what is an investor to do?
Facing unprecedented levels of public debt as well as an acceleration of commodities-induced inflation, where does one hide?

Cash is not king.
Its value is rapidly depreciating.
In fact, investors can no longer afford the luxury of not borrowing.
Locking debt at a fixed rate today is like getting free money.

Yet, US consumers are deleveraging.
And companies are hoarding cash.
No matter Apple’s success, sitting on $ 50 billion of cash is going to destroy a lot of shareholders’ value.
It is unlikely to return anything close to the cost of capital.
A cost that is rapidly rising.

There could be another cycle at play here.
For years, analysts concentrated mostly on the P & L.
However, in the stagflation years of the 1970’s, balance sheet analysis was what mattered most.
Today, a whole new generation of analysts may have to learn those skills as well.
As times will get tougher, strong balance sheets will guarantee survival.
But too much financial conservatism will greatly diminish shareholders’ return.

Herve’ van Caloen
Doctor in Bubbleconomics

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