Ep. 24 A History of Financial Bubbles & How to Prepare
The Financial Commute

Ep. 24 A History of Financial Bubbles & How to Prepare

Ep. 24 A History of Financial Bubbles & How to Prepare

The Financial Commute

On today’s The Financial Commute episode, Chris Galeski welcomes Wealth Advisor Bruce Tyson to discuss valuations and asset bubbles. In the past, some institutions issued fiat currencies, or notes, which were not backed by physical assets. Similarly, today, there are companies that Bruce refers to as “zombie” companies that we should be cautious about investing in because their shares are not backed by real assets or earnings. These companies are called zombie companies because their earnings are not sufficient to cover their interest obligations.

Furthermore, Bruce discusses asset bubbles, which are when assets rise in price without fundamentals to justify the price spike. For example, there was a tulip bubble in the 1600s in Holland where people would pay thousands of florins for a tulip bulb. However, one day, the tulip bubble burst as consumers stopped paying increasingly inflated prices. Earnings are what give value to stocks; without earnings, the stock might be a bubble.

Finally, Bruce and Chris say that because interest rates have now increased, bonds are now paying a higher interest rate. Thus, Bruce encourages listeners to consider investing in bonds, as they may also carry less risk than stocks because asset bubbles can be a more prominent factor in stocks than bonds.

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Hello, everybody, and thank you for joining us for another episode of The Financial Commute. I'm Chris Galeski, your host joined by Partner and Wealth Advisor Bruce Tyson. Bruce.

Good afternoon.

You know, we were having a fun conversation about the markets, about modern monetary theory. The debt ceiling. So many different things that come into play when it comes to investing. And it made you think of a number of instances that we have seen in history before that, you know, free money or just wacky things happen when valuations kind of get out of control.

Right. So many years ago, I read a book called, and I have it here with me, Extraordinary Popular Delusions and the Madness of Crowds written by Charles Mackay in 1841. Wow. So it's been around a long time and there were many financial bubbles before then. And this one has a foreword by Bernard Baruch, the legendary investor from the first part of the 20th century.

And he says that this book saved him millions of dollars. Really? Yeah. And he's a smart investor, so it made sense to look into the book. And I just found so many fascinating parallels between today and things happening hundreds of years ago.

So let's put that into context why there might be parallels. If you rewind maybe 20 something years ago, the U.S. maybe had a small deficit, smaller deficit. But then you fast forward over, you know, 22/23 years. We had the great financial crisis. We had COVID. We had 0% interest rates. And now all of a sudden, the U.S. has $30 trillion worth of debt.

Right. But it's not just the U.S., It's globally. Right. So all of this money is now in the system and it creates sort of asset bubbles or.

Right. So there was one of the bubbles is referred to as John Law, who is a Scotsman, versed, well versed in finance and John Law and the Mississippi scheme and it's a long story, but he went to France and he was talking to the region of France, the next king was too young so there was a regent and the regent didn't know anything about finance.

But John Law showed him that you could issue notes backed by real estate or by taxes. And this is this was good. That was a good way to get some paper money into the system because they weren't using paper money, they were using coins. And the problem was every few years that the state would devalue the coins and they would, you know, have you turn in one set and issue smaller ones, you know, less gold, less silver.

And the populace was upset. And then there were other banknotes issued by the prior king that was King Louis, the 14th, who was very extravagant. You know, I think he did Versailles.

Yeah. Yes. It's an amazing place.

Spent a lot of money. And so the populace, I mean, was upset with all the spending. And so they were looking for a new way to do things. And so John Law suggested this method of doing paper money. And what happened was that the Regent liked it so much that where John Law wanted 60 million, you know, of the currency floated then the regent said, let's just do 500 million.

Wow. And then it got bigger and bigger. And so again, the finances were, you know, became a problem. But because it was at first, it worked really well, just like our systems seem to be working pretty well. But then so one of the things because it was working so well, John Law asked for the rights to do to get trading rights to Mississippi, and he was talking about all the gold you could find in Louisiana.

And so this is the Mississippi scheme. And then people went there was a feeding frenzy. Now, because all this money out there, because of the printing of money. And they were just running up the cost of every share. And they were issuing more and more shares. And there was nothing there was no assets. Nothing tangible.

What the profits were going to be when the Mississippi scheme worked. Of course, it never really got off the ground. So that was some kind of ruination. And, you know, that was something that.

That's one of the first iterations of maybe modern monetary theory. And so some of the yeah, the trials and tribulations that we face today when interest rates are zero, you can borrow and print as much as you want, right? But eventually you're going to have to pay that back or figure something out. But while the money is out there in the system, it's got to go somewhere and it's creating asset bubbles, whether it be real estate or stocks or crypto or even companies that we call zombie companies, companies that don't have any earnings.

So one of the things that happens is that there is such a feeding frenzy for these shares that other people thought, hey, I can sell shares in something else that wasn't particularly real.


And there was one instance where a guy set up a company that said, We don't it doesn't really do, we can't tell you what it is, but it's going to cost 100, 100, you know, units on a currency unit, 100 a share, and you only have to put down a deposit of two. And by the way, you can get a 100 hundred, let's say, or, you know, 100.


Dollars a year in in annual income for this, putting down $2 and then paying 90 later. But so over the course of 5 hours, he wound up selling $2,000 worth of of of shares. And then he just left the country.

The silliness that happens from time to time when sort of expectations or money is kind of frivolous. That's a good example of a different type of zombie company. But as you as you and I discussed, we've lived through these types of things. Many times before. And you've got kind of what's going on in the markets right now where these zombie companies or companies that aren't profitable have been able to borrow money and stay afloat for so long now that their interest or borrowing costs are expensive, they're struggling or maybe have come down a lot in price.

We lived through it maybe a little bit in the financial crisis and how much risk banks had. And then obviously in the tech bubble back in the late nineties, right.

So with interest rates higher, these zombie companies are really going to have to figure out a new way. Yeah, or they're just going to have to close down, you know, close up shop. The zombie companies, there's an actual definition of zombie companies. It's that the earnings don't pay for the debt service. Yeah. At some point the lines cross and there's no more you know, there's no value in the company.

I think that as an investor, a finance professional and somebody that, you know, talks to people about money for a living, I think that's the hardest concept for people to completely understand. Right? Because if you're a person and you don't make enough money to pay your debt or even just the interest on your debt, you file for bankruptcy, there's consequences.

But then somehow there's these companies and sometimes they are brands that we touch and feel, or there's our government that does not have to operate by the same rules for a long period of time. It's really hard to comprehend.

Right. So there's an old saying that if you can't pay back the bank $1,000, you've got a problem. But if you can't pay back the bank $100 million, the bank's got a problem.

Right. Right.

And they want to work with you to solve that problem.

The too big to fail. One of the most famous sort of bubbles in history is the tulip crisis or tulip mania.

So tulips were originally, I think, discovered in in Kazakhstan, and they made their way to the sultans, the Sultan Suleiman in the Ottoman Empire. And Tulip comes from the word turban. And so anyway, he gave of them as a gift to the Viennese ambassador, who then somehow that made its way to Amsterdam. And that was a shiny new toy.

And the fashion was everybody had to have it. You know, this was like in the 1600s. And there was a new mercantile class and there was more money from trade. And Amsterdam was a big trading center and they had more money. So it just, the schemes were amazing and there are just some crazy numbers here.

And the two and two factor is four factor comes in when we think, okay, company has this amount of earnings and this amount of shares and what's a fair price to pay. And we keep going back to what's a fair price to pay and these companies were just in this last year, there were so many of them there was no real rationality for those numbers.

And that's how a fellow like Sir Baruch would, you know, could save money because he wound up seeing these things happening in 1927, 28 and 29 before the crash. But he was shorting into it. He was like he was shorting. It is rising and getting killed in riots. And then one day it paid off for him.

Well, it's a difficult thing. I mean, if you just look at the competing forces, the last call it, 12, 15 years as interest rates have been zero. Now they're not. The Fed's trying to combat inflation. They're raising rates. But for a long period of time, interest rates were all time lows. Right. So you had the dividend yield on the S&P 500, maybe close to 2%, and you had the interest on a ten year Treasury one of the safest things to invest in at the time was at 2% or even lower.

Right. Or even much lower than that. And so as an investor, the only way you lose is if ten years later, the S&P 500 is worth less than it is today. But you're going to collect more income along the way, Right. And so it just forced so many people to kind of go out there. And so when we're looking at investing today, we're not saying don't take on risk.

You've got to take on risk to get growth. But, you know, be mindful of the risks that you're taking on. And there are some really attractive opportunities that don't carry on as much downside risk as maybe, you know, stocks or some other assets, right?

So now you can easily get 5% on safe investments, and that's less competition for stocks. So a lot of, say big pension funds who need their bogey is typically making 7% so they can make 7% with some of the more aggressive bonds, but they can achieve their objectives of 7% without having to buy stocks. So the demand for stocks would be less than it was before.

Yeah, that makes sense. You know, Bruce, thank you for coming on and talking today about a number of, you know, crisis’s, you know, certain bubbles that we've experienced many times in the past and in other ways that we can help protect ourselves. Really appreciate it.

Glad to be here.

General Disclosure:

Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.