Common sense is an important characteristic that people should possess. However, when there is an economic upturn in the economy, individuals should ask themselves some questions. The first question should be: 1) Is this economic upturn justified? The second economic question should be: 2) Are there multiple economic indicators that support this upturn? The third economic question should be: 3) Do the multiple economic indicators project continued growth or do they project some other changes?
The time when Alan Greenspan arrived at the Fed in 1987 until the dot-com crash in 2000-2001, Americans began to change the way they managed their money. If Americans had asked themselves the above three economic questions, then bubble-economics would not have developed and the dot-com bubble would not have grown and burst. A bubble happens when a sector of our economy or a segment of our economy grows at a rate that is outside the normal rate of expected growth. Bubbles have been around for many hundreds of years; they come and they go. During the above stated time period, Americans began to move their savings away from commercial banks and placed their funds into stocks and mutual funds. While there is nothing wrong with this, the magnitude of change was outside of reasonable economic parameters. In 1987, Americans had $ 2 TRILLION in stocks and mutual funds. When the dot-com crash happened in 2000, Americans had $ 13 TRILLION in stocks and mutual funds. This shift represents more than a sixfold increase in a 13 year period. That type of shift was motivated by greed and not justified by any economic indicators.
During the same time period, household investments in stocks and stock mutual funds grew at a 17.5% compounded rate. During this same time period, our GDP grew at a rate of 5.7% . Without calculus and other forms of advanced mathematics, I believe that the average American can understand that a bubble was forming.
In 2000, the dot-com bubble burst and many Americans lost some portion of their hard earned savings. In ” Financial Common Sense – Part 2,” I will explain in readable English how the second bubble formed and why the second bubble burst. In ” Financial Common Sense – Part 3,” I will project when the next bubble will form and why the third bubble will burst.
The Dow and the S&P 500 reached new record highs in the history of our U.S. markets on Friday, November 22, 2013. Also, economic indicators appear to look good for the first six months in 2014. However, Americans can be certain that a bubble is forming forming somewhere that even the best economists can not predict.
R. Van Conoley