Dear Friends,
It seems to me, when a sinkhole opens up in a road, it is dangerous, but when a asset’s value collapses into a sinkhole, the economic results can be ruinous. Most of us are familiar with the idea of bubbles in asset prices but economic theory, (as far as I know), is not aware of asset sinkholes. The concepts are similar in many ways. They are both fueled by an opinion without regard to the underlying basics. A sinkhole is an asset price that is considered to be safe because it has always been safe, while a bubble grows due to the sentiment that it will grow. In both instances the asset value is based on opinion rather than essentials. This concept has direct implications to our present economic circumstances… ignorance of it leading to personal and national economic disaster.
A sinkhole is a situation where a road is undermined by water flowing underground. The surface appears fine but the ground holding it up is slowly eroded away. The surface tension will keep the road intact even as the underlying structure is gone. In ignorance we will drive our cars with our families in them directly over a sinkhole. If we are lucky it will hold while we are on it. At some point, the road will collapse… catastrophically. This is common throughout the world. Sinkholes sometimes engulf acres in area swallowing everything above.
Any asset can become a sinkhole. The value of money is the most pernicious but equities, commodities and goods can all become value sinkholes. Money is the most pernicious because it has the greatest potential to collapse an economic system. Equity sinkholes can result in the loss of retirement savings, investment and jobs, commodity sinkholes cause dislocation in mining and smelting operations, reverberating throughout an economy. No asset that becomes a sinkhole is benevolent. Anytime an asset looses it’s value in a catastrophic way economic dysfunction follows.
Bubbles and sinkholes are similar in that they are dependent on opinion rather than underlying value. Sometimes called the greater fool theory, a bubble in an asset price, like the tulip bubble in Denmark, is fueled by the opinion that that asset will continue increasing indefinitely. Even the person who understands a bubble is forming may make money from it. They buy the asset with the intention to sell it before the bubble bursts… to the greater fool.
People think that because the value has remained constant for a long time it will remain constant forever. As we all know… nothing is forever. The value of assets rise and fall for a myriad of reasons. However, when people believe a price will remain constant, but the actual value is eroded away, by government action or some other market fluctuation, opinion provides the structural power to hold up the perceived price. Once the underlying value is sufficiently eroded there will be a catastrophic collapse in the price. Anyone caught over the sinkhole will be sucked in.
I have never read about the theory of asset value sinkholes, I independently created it to describe present circumstances, but the concept seems intuitive to me… Not to say someone else hasn’t thought of it first. We must not confuse a sinkhole with a value trap. A value trap is where an asset, usually an equity, is bought at some price but the price slowly falls. The investor holds onto the asset in hopes it will rebound and he or she can get out of it. The slowly dropping price traps the investor, until all the value, and invested money, is gone. A sinkhole is a sudden collapse of an asset value due to the undermining of it’s fundamentals.
The most obvious historical example of a sinkhole is hyper inflation. The value of a currency remains relatively stable until the sinkhole opens. Then governments try to fill the sinkhole with printed fiat money. This not only doesn’t fill the hole, it actually undermines that asset’s value, further enlarging the sinkhole. The actions of the government and investors become a closed loop… each fueling the others foolishness, until all value has been drained from the money, and the economy must be restarted with a new currency.
We have an example today in the US dollar and US treasuries. They are perceived as safe because they have always been safe. The growing printing of dollars and spiraling US debt are ignored because people think there is a new paradigm of economics. This is the hallmark of bubble mentality and we see it full blown in sinkhole theory. The irrational exuberance in the price of treasuries drives otherwise prudent investors to seek the “safe haven” of US bonds and dollars. The group think is reinforced by the way the value of the dollar and treasuries defy economics. People point to a zero velocity of money in the US, ignoring the fact that the moment the velocity of money becomes more than zero, the sinkhole will abruptly open.
The result of a sinkhole in the value of the US dollar and treasuries will inevitably be bad for the world’s investors, companies and workers. If the US dollar collapses into a sinkhole and experiences high inflation, let alone hyper inflation, the resulting loss of capital in the world will be devastating to the world’s economy. Most probably the sinkhole is inevitable now, due to the malfeasance of our elected leaders, and economists, in both the US and Europe, but an understanding of the forces that led up to the collapse may help future generations avoid such dilemmas. I am not hopeful though, look at how long economic bubbles have been known and understood… to no avail.
Sincerely,
John Pepin
