My own personal theory of crashes is that they are caused by divergences between the financial markets and the real economy. Most of the time, markets do a pretty good job of anticipating the economy so that the market isn’t surprised by real-world developments and they are priced in well ahead of time. However, there are times when, due principally to government interference, but also to crowd psychology, momentum and price-chasing take over - leading to a mispricing of the risk. Then something happens to wake up the markets and a dislocation ensues as liquidity collapses. That’s a crash. Clearly the onset of the crash is a chaotic event, unpredictable and set off by the proverbial beat of a butterfly’s wings somewhere. As far as I am concerned, all the signs and portents are in place and the divergence is steadily increasing. So there is nothing to do but play the game, with a ton of protection in place so that, when the day does dawn, one is not hurt, and preferably profits.

All of the financial markets are in bubble territory. So is the housing market (and, indeed, much of the commercial real estate market). The jobs report last Friday was a disaster. If the employment trend doesn’t change, and change quickly, Alan Greenspan’s attempt to create sustained growth in the economy will have failed. I believe it will fail, although I must be open to being wrong about this. I can’t see an economy consuming its way to growth with little or no savings (0.6% now). But time will tell.

“When the price of houses in California soared 17% in 2003 and 22% in 2004, a curious thing happened: Instead of home ownership decreasing because fewer people could afford houses, it rose to record levels.”

Duh, that’s why it’s a bubble - when pure momentum takes over and people buy because the price is going higher.

They’re In — but Not Home Free

Nonfarm payrolls increased by 110,000 this morning. Since this included a large (179,000) positive adjustment from the birth/death model, it is probably safe to assume that the economy is losing jobs. The initial reaction was to sell the dollar against the euro. However, this was quickly reversed. The problem of the dollar against the euro is that the EEC economy is deteriorating even faster then the US. This means that the dollar and the euro are both ugly sisters, and the relative ugliness of one versus the other isn’t all that interesting. Particularly since the EEC recently abandoned the agreement to limit budget deficits which had been a key criterion for entry to the single currency.

This just makes me want to own valuable stuff. Like oil.