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Here comes another bubble

May 15, 2009

You must be wondering that we surely have gone nuts. Prices of most assets across the globe are falling like nine pins and here we are, trying to talk of a topic that may easily qualify as being one of the most out of place. But we beg to differ. We believe that the fall in asset prices has already led to the creation of one giant bubble. And that bubble may pop any time soon. In fact, the popping may have already begun. Not many of us most have given this serious thought but the fact remains that the money that is lying in our bank accounts or the cash that we have stashed in our homes is an asset. We are so much used to thinking of equities, bonds and commodities like gold and silver as assets that the fact that cash or hard currency can also be called as an asset must have seldom crossed our minds. Hence, if currency is an asset then even it is subject to the same boom-bust pattern that the other assets are subjected to.

But wait! No one has ever seen currency rise in value much like equities or gold. And if it does not rise in value, how can it led to the formation of an asset bubble? The fact remains that while a currency cannot rise in value, other assets like equities or gold prices can definitely reduce. And this exactly what happened across the globe few months back and which led to the greatest recession since the Second World War that we are all witnessing currently.

Investors across the globe rushed towards the safety of cash. In other words, abandoning most of the asset classes, they piled onto the relative safety of one asset class, cash. The same cash that previously used to buy one ton of say steel and aluminium was now able to buy a lot more, thus reinforcing our earlier contention that currency is indeed an asset and can rise and fall in value in relation to other asset classes.

But this was a few months back. Slowly and steadily, other asset classes have once again started rising in value. Your cash buys a little less of quite a few assets these days as compared to say a year back. Secondly, new cash is being created by central banks across the globe and once the money multiplier comes into effect, there is likely to be a huge increase in supply. And as any basic economics textbook would suggest, greater supply eventually leads to lower price.

Although the currency cannot lower in value just as it cannot rise in value, it can definitely buy less of other assets just as it could buy more of them a little while ago. And this will definitely be not good for your purchasing power. So, the odds that the cash that you have in your possession could well be the next asset bubble to pop are indeed on the higher side from a longer term perspective.


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