Asset bubbles, what are they and why do they occur?

Today I’d like to talk about asset bubbles, but first a little about collectors’ items.

Back in 1986, a company called Pannini released an amazingly popular sticker collection book by the name of Football ’86.

The idea was that for a few pence (ahh, inflation) youngsters could buy a packet of stickers bearing the photos of soccer players from all the major British teams and the respective trophies for which they competed. The goal, of course, was to fill the entire book and show off proudly to your mates.

Cleverly, Pannini often gave away the actual books for free in order that eager kids then felt compelled to buy the stickers. It worked a treat!

Whether or not it was true, there were always rumours that Pannini printed fewer stickers of certain players, and these elusive few became hugely sought after.  A few stickers were made in a special silver colour, such as the ‘FA Cup’, and these also became must-have stickers.

After a while the craze passed, strangely to be replaced by ‘spinners’, which was how the ever-creative Coca-Cola company cleverly re-branded one of the simplest of all toys, the yo-yo.

If you still own a completed Football 86 book in mint condition it would retain some value (£40) as a collectors item, but the market today has once again become relatively small.

 

Tulip mania

The search for Pannini FA Cup stickers paled into insignificance when compared to what was perhaps the first ever great economic bubble, the Dutch tulip mania.

The tulip mania peaked in 1637, when the price of a single tulip had become as expensive as ten times an annual skilled salary!

While it may seem ridiculous in retrospect, at the time landowners were prepared to offer many acres of land in exchange for the in-demand item: the humble tulip. Such manias tend to be characterised by wild price volatility and hugely irrational exuberance.

 

Bitcoin bubble

The latest craze of the last four years or so has been the ‘bitcoin’, a virtual currency which owners can store in electronic ‘wallets’. Confusing? Yes, it is a little, although this article has a game stab at explaining the concept. Back in February, bitcoins were trading for only $20, but since then…

Since this chart was produced, over the last weeks, bitcoin prices have been all over the place. From a peak of well over US $200, the price quickly swung to a low of just $105, yet by Wednesday the price had rebounded to $175 before plummeting again to $120 on Thursday.

The extreme volatility caused one major exchange to call a 12 hour halt to trading and has caused skeptics to question whether an item with such wild swings in prices can even be referred to as a “currency” at all.

The total supply of bitcoins in circulation today is said to be worth around $1.3 billion. Where that figure will be in 6-12 months time is anybody’s guess.

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The end of the gold standard

The problem with a virtual currency is that its value only holds up while those trading it hold a faith in its enduring value.

One of the greatest challenges facing us as individuals today is that our actual currency – our dollars and cents – are in a similarly precarious position. Since money is no longer backed by the gold standard, over time there is a risk that the value of cash diminishes materially.

History has shown us that over time, our currency becomes severely devalued as its worth is destroyed by the ‘silent thief’ inflation.

This is no accident, for the RBA in Australia has a targeted range of inflation of 2-3%: it is actually the policy to devalue our currency over time.

Confusingly, this presents us with a dilemma, and Ben Bernanke in the US highlighted how we often spend more time thinking of where to put our money (to avoid its value being inflated away) than we do thinking of how to put our money to productive use.

 

What to do? Assets of enduring value

With the gold price having been hammered by 23% since September 2011 and the great gold price bubble of the last 12 years finally appearing ready to deflate, investors are finding a need to look elsewhere.

The reason holding shares in the industrials index can be a smart idea is that profitable companies will always have value.

Every day people will up and eat their cornflakes, and as an owner of shares in all of Australia’s major food companies, you can breathe a great sigh of relief.

Others turn to residential property as another example of a ‘tangible asset’ in which to store their wealth. It is certainly a proven investment strategy, but I’ll add one caveat: real estate, just like bitcoins and tulips, is only worth what someone else is prepared to pay for it. Therefore, you should only own property where there is a huge demand and a growing population.

In recent years, some groups have tried to organise a “homebuyers strike” in protest against house prices being expensive in the major capital cities (at least, I assume they refer to those capital cities, because elsewhere in Australia, property prices can often be reasonably cheap).

 

The logic is flawed

One might as well try to organise a strike on breathing.

People will always need somewhere to live close to employment and city centres, and as the population booms, so does the demand for quality property.

Surely the future for Australia’s housing affordability should be focussed on transport and infrastructure so that we can use the vast size of the country more effectively as the population looks set to increase from 23 million to a staggering 40 million by 2050.

But while we continue to obsess over how we can shoehorn millions more of us into a handful of popular beachside and inner-city suburbs, prices will continue only to move in one direction.

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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


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