The “Sugar-Rush” Economy

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It’s useful to think of the economy as we’ve known it as the “sugar-rush economy.” Allow me to explain.

Scientific research indicates that heavy doses of refined sugar may impact the human brain in a manner similar to addictive drugs. Stanford professor and neuroscientist Eric Stice has run experiments using MRI scans to study how our brains respond to sweetness. Consuming sugar releases dopamine, the brain’s “reward” chemical. The impact is similar to that of cocaine and other addictive drugs.

After scanning hundreds of volunteers, Stice concluded that heavy sugar consumers steadily build up a tolerance. The result: One must consume more and more sugar to release the same amount of dopamine. This process dampens the “reward center” of your brain in response to food.

The rising tolerance of the human brain to drugs (or sugar) mirrors how economies can build up a tolerance to government deficits and central bank stimulus. Balanced budgets and shrinking money supplies would bring about withdrawal symptoms that crash the economy.

So in order to maintain the status quo, the prescription is more drugs, more sugar, more spending and money printing. And if the effect starts to wane and withdrawal symptoms appear, the economists running policy predictably say, “Double the dose!”

Bubble-driven economies build up a tolerance for ever-higher doses of money and credit. The “Austrian” School of economics warns that once economies fall into addiction, the long-term consequences are tragic: either a deflationary collapse or hyperinflation. I agree with that assessment.

An alternative path might be a policy that proactively weans the system from addiction, but such a policy is politically impossible these days.

The Federal Reserve, along with every other central bank, has for the past decade been trying to prop up an unstable mountain of debt while simultaneously avoiding the collapse of confidence in their currencies.

The Fed’s rate hikes in 2017 and 2018 were partly to rebuild confidence in the dollar. Nothing builds confidence in paper money like being able to earn a positive real interest rate while holding it on deposit.

But we know how that confidence-building exercise ended at the end of 2018. The Fed retreated at the first sign of adversity and went right back to placating the financial system tantrum with sugar.

Interest rates on U.S. dollar bank deposits and Treasury bills were above zero for such a short period of time that the economic system barely had any time to get used to it. Now we face the prospect of zero interest rates for years into the future.

That might sound good if you are a borrower, but don’t forget that there’s a lender on the other side of the transaction. And in today’s economy, lenders employ many Americans and earn interest that’s passed on to pensioners. There are clear consequences to endless zero rates, as Japan’s financial system has shown everyone.

The Fed was in a difficult balancing act over the entirety of the post-2008 economic recovery. Now throw in the radical uncertainty of the economic ripple effects of the coronavirus and it’s become near-impossible for central banks to deliver an outcome that’s pleasant for investors.

Here’s a very important lesson of our debt-addicted system, one that doesn’t bode well for the future:

When an economy’s debt grows, it transfers what would have been future economic activity into the present. So it’s reasonable to assume that because the stock of global debt soared over the past decade, a large amount of production and consumption activity was pulled from the future to the present.

If the Fed’s balance sheet swells in size to $10 trillion or $20 trillion, it won’t make consumers more likely to borrow more money if they don’t want to borrow.

Even worse, from the Fed’s perspective, would be if consumers and companies go into balance sheet repair mode and pay down debt. That acts to transfer income earned today to pay for the purchases made yesterday on credit. From the Fed’s perspective, that behavior is like “anti-stimulus.”

But if consumers are offered zero interest on saving money and are still paying interest on their debt, can you blame them if they choose to pay down debts with the stimulus checks that will be mailed out in the weeks ahead?

If you think about the time-shifting nature of debt accumulation, this is the essence of how central banks supposedly stimulate economies. It simply scrambles everyone’s time preferences and robs the future, leading to bad decisions. It’s all very short-term.

The transfer of future economic activity into the present carries with it the problems we saw during the U.S. housing bubble: The borrowed-against future eventually arrives and brings with it a collapse in demand for the already-bought items.

Consider the spike and crash in U.S. new home construction. When single-family housing starts peaked at a 1.6 million annual rate in early 2006, several years’ worth of future demand was pulled into the present.

Low mortgage rates and lapsed underwriting standards caused years’ worth of demand to be constructed and delivered in a single year. The bust ruined millions of homebuyers’ credit scores, keeping them out of the market for years to come.

It took until 2012 to see a renewed uptrend in housing construction, and even now, despite favorable U.S. homeowner demographics, the level of starts is still 33% below the 2006 peak.

Such are the consequences of promoting bubbles. Wouldn’t it be better to not have bubbles in the first place?

You would think, but central bankers always seem to think they can keep everything in check.

Their goal of targeting a precise level of inflation expectations for future inflation, as though the economy were a thermostat, is not realistic.

Pursuing this goal creates more problems than it supposedly solves. Pushing consumers and businesses to buy today with the expectation of higher prices in the future is hardly different from promoting the wild growth in debt-driven housing activity in 2004–07.

The Fed’s money printing experiments infuse sugar rushes into the natural pace of economic activity, followed by hangovers.

This rush-hangover-rush-hangover cycle is a result of crony capitalism and central banking; it’s not the result of real capitalism. This system has resulted in fragile balance sheets at both the corporate and household level.

This brings me to corporate profit margins and how they are at risk in an economy fueled by the sugar rushes of federal deficits and money printing.

A private sector that once operated on a diet of healthy foods now lives from one sugar rush to the next. Deficits and money printing have degraded the health of most businesses.

Rather than live on the steady nourishment of savings and capital investment, more and more company leaders have resorted to short-term gimmicks to hold onto their executive titles and board seats.

A big gimmick was the wave of unaffordable stock buybacks and dividends we’ve seen over the past decade.

Rare is the company that produces so much excess cash so consistently that it can afford ever-rising distributions of cash to shareholders. Companies that can only afford to return cash to shareholders under favorable conditions (this describes most companies) wind up with little in reserve during lean times.

They discover that they squandered resources when some catalyst like the coronavirus comes along and they wish they still had the cash that they wasted on stock buybacks.

But they don’t have it. And they want to be bailed out for their errors. Again, that’s not capitalism. It’s crony capitalism.

And we’ll all be paying for it.

Regards,

Dan Amoss
for The Daily Reckoning

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It’s Over

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The financial elites are pushing a narrative that asset prices, sales and profits will all return to January 2020 levels as soon as the Covid-19 pandemic fades.

Get real, baby.

Nothing is going back to January 2020 levels. Rather than the “V-shaped recovery” expected by Goldman Sachs et al., the crash in asset prices will eventually gather momentum.

Why? It’s simple: for 20 years we’ve over-invested in speculative bubbles and squandered borrowed money on consumption and under-invested in productivity-increasing assets.

To understand why the market value of assets will relentlessly reprice lower, a process sure to be interrupted with manic rallies and false dawns of hope that a return to speculative good times is just around the corner, let’s start with the basics:

The only sustainable way to increase broad-based wealth is to boost productivity across the entire economy.

That means producing more goods and services with less capital, less labor and fewer inputs such as energy.

Rather than boost productivity, we’ve lowered productivity via mal-investment and by propping up unproductive sectors with immense sums of borrowed money.

The poster child for this dynamic is higher education: rather than being pushed to innovate as costs skyrocketed, the higher education cartel passed its inefficiencies and bloated cost structure onto students, who have paid for the bloat with $1. 6 trillion in student loans few can afford.

As for Corporate America squandering $4.5 trillion on stock buybacks, the effective gains on productivity from this stupendous sum is not just zero. It’s negative, as the resulting speculative bubble suckered in institutions and individuals who’d been stripped of safe returns by the Federal Reserve’s low-interest-rates-forever policy.

What could that $4.5 trillion have purchased in terms of increasing the productivity of the entire economy?

Considerably more than the zero productivity generated by stock buybacks. The net result of uneven gains in productivity and the asymmetric distribution of whatever gains have been made is stagnant wages for the bottom 90% and rising costs for everyone.

Those of us who are self-employed or owners of small businesses know that healthcare insurance costs have been ratcheting higher by 10% or more annually for years.

Whatever gains in health that have been purchased with the additional trillions of dollars poured into the healthcare cartels have been offset with declining life spans, soaring addictions to opioids and numerous broad-based declines in overall health.

The widespread addiction to smartphones and social media have deranged and distracted millions, crushing productivity while greatly increasing loneliness, insecurity and a host of social ills.

Two dynamics define the economy in the 21st century:

1. We have substituted debt-driven speculation for productive investment

2. We have substituted debt for earnings

This is why the repricing of speculative-bubble assets can’t be stopped: debt-driven speculation is not a sustainable substitute for investing in increasing productivity, and debt-fueled consumption masquerading as “investment” is not a sustainable substitute for limiting consumption to what we earn and save.

All bubbles pop, period. Once Corporate America’s credit lines are pulled and its revenues and profits plummet, the financial manipulation of stock buybacks will end. That spells the end of the 12-year bull market in stocks.

As the tide of speculative mania ebbs and confidence wanes, the world’s housing bubbles will all pop, and the $1.4 million bungalows will drift back down to their Bubble #1 highs around $400,000, and perhaps even drop from there.

As for collectibles and other play-things of the super-wealthy: the bids will soon vanish and yachts will be set adrift to avoid paying the dock fees.

Regards,

Charles Hugh Smith
for The Daily Reckoning

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What Really Happened Last Week?

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Yes, but why was last week’s correction so pitiless?

Monday we put our finger on “passive investing.” That is an investing strategy that flows with the tides.

A rising market tide lifts all vessels — even the leaking, decrepit, unseaworthy hulks.

But when a strong gravity pulls the water the other way… all go down with it.

And it was an angry moon last week, exerting a mighty tug.

But passive investing may only tell a portion of last week’s harrowing tale.

We have clawed our way deeper into the facts — and deeper again — to arrive at a fuller explanation.

Details to follow. But here is your hint:

It implicates the Federal Reserve… despite our unshakeable faith in its infallibility.

First, today’s tidal reading…

Stocks Rise on a Surging Tide

We are pleased to report the water rose today. And high…

The Dow Jones rose 1,173 points — its second-highest (point) gain in history.

The S&P gained 127 points. And the Nasdaq, 334.

And so all three indexes have uncorrected. That is, they have all three emerged from correction.

But why?

Explains CNBC:

Stocks surged on Wednesday as major victories from former Vice President Joe Biden during Super Tuesday sparked a massive rally within the health care sector…

Tuesday’s primary results sent health care stocks flying. The S&P health care sector surged 5.8%, posting its best day since 2008. UnitedHealth and Centene jumped 10.7% and 15.6%, respectively. Shares of UnitedHealth had their biggest one-day gain since 2008.

Many investors have applauded Biden for his middle-of-the-road tact in contrast to the more progressive policies of Sanders and Sen. Elizabeth Warren.

Gold shed $6.10 today.

But the somber bond market merely shook its head… and sighed. 10-year Treasury yields remain under 1%.

But to proceed…

If passive investing does not fully explain last week’s fearsome correction… what does?

The Great Liquidity Flood

Our tale begins last September…

A main line ruptured deep within the financial plumbing. And liquidity ran dry in the critical “repo” market.

Pouring icy sweat, panicked, the Federal Reserve rushed in with the hoses… and let the valves out.

It emptied in so much liquidity over the next four months, it inflated its balance sheet $400 billion — a $1.2 trillion annualized rate.

Not even during the lunatic days of the financial crisis did it carry on at such a gait:

IMG 1

The stock market surged on the rising water, nearly perfectly, four months running:

IMG 2

And so the Federal Reserve inflated a bubble — a bubble within a greater bubble.

But here our tale gathers steam…

The Fed Closes the Hoses

In December, the Federal Reserve tightened the valves. And liquidity, formerly flowing in gushes, dwindled to a trickle.

And so the delirious stock market lost its energy… like an airplane that has lost its lift.

The thing went on momentum for a time. But nothing was pushing it along. And so it was vulnerable…

We introduced you to Mr. Graham Summers yesterday. In reminder, he is a senior market strategist at Phoenix Capital Research.

From whom:

From September 2019 to December 2019, the Fed provided some $100 billion in liquidity to the financial system every single month.

The Fed then stopped these policies on a dime in mid-December. From that point onward, the Fed’s balance sheet, which expands when the Fed is providing liquidity to the financial system, completely flatlined…

Lost amidst all the talk of the coronavirus and potential global economic contraction is the fact that the Fed’s balance sheet has been flat to down since early December. This tells us the Fed completely ended the aggressive liquidity pumps it was running from August through the end of the year…

You can see these developments in the chart below:

IMG 3

The “Pin” That Popped the Bubble

Then the coronavirus chewed through its leash… and ultimately through the ticker tape.

But it was merely the “pin” that punctured the bubble, says Summers:

Now, you can see the impact these policies had on the stock market in the chart below.

The Fed created this environment with its monetary policies. The fear of an economic slowdown due to the coronavirus was simply the “pin” that burst this mini-bubble.

IMG 4

What does Mr. Summers conclude?:

The big lesson here is this: The financial system is now completely addicted to Fed liquidity. The Fed can try to talk tough about withdrawing liquidity from the system, but at the end of the day, the market is going to force the Fed’s hands.

In turn, we conclude:

Passive investing — twinned with plateaued liquidity — conspired tp deal markets the swiftest, sharpest correction since 1928.

This fearsome combination sent markets careening from record heights to correction in a mere six days.

But you can be sure the Federal Reserve is preparing to unfurl the hoses yet again…

Liquidity Running Dry Again in the Repo Market

It appears the repo market is entering another drought. And the major banks — primary dealers, so called — have reacquired a panting thirst.

They have requested $111.48 billion in overnight loans from the Federal Reserve.

But the Fed can only dole out $100 billion under existing arrangements.

“Oversubscribed” is the term.

That $111.48 billion comes on top of the $108.6 billion dealers requested the night before — again, oversubscribed.

The Federal Reserve had intended to suspend repo operations next month. But reports The Wall Street Journal, in predictable understatement:

Those plans could change amid the rapidly shifting economic and financial outlook. Some in the market are already wondering if the Fed will increase the size of its temporary operations to accommodate the high level of demand from banks.

We wager high those plans will change. 180 degrees.

Will it reinflate the stock market?

We have no answer. The market faces a mighty foe in a miniature virus.

But little surprises us these days.

Dangerously Low on “Dry Powder”

Meantime, the Federal Reserve squanders what little “dry powder” that remains.

Yesterday’s 50 basis point blast reduced the federal funds rate to between 1% and 1.25%.

Goldman Sachs projects another rate cut when the FOMC huddles in two weeks. And another in April (each 25 basis points).

If true, the Federal Reserve will be reduced to scraping powder off the floor. If recession swept in tomorrow… it could scarcely fire off a cannon.

And given the global economic outlook…

It will be unable to restock its magazines for years and years — and years.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The Biggest Fraud in History

This post The Biggest Fraud in History appeared first on Daily Reckoning.

My readers know that I’m a longtime critic of bitcoin. Bitcoin rose from about $2,000 in May 2017 to $20,000 by December 2017 in one of the greatest asset price bubbles in history.

I argued repeatedly that it was nothing but a massive bubble and that the bubble would probably burst when it hit $20,000.

In late 2017 it did.

Bitcoin crashed from $20,000 all the way to $3,300 by December 2018 — an 83.5% collapse in one year and the greatest recorded asset price collapse in history.

The crash of bitcoin was even more dramatic than the infamous collapse of tulip prices in the tulipomania in Netherlands in the early 17th century.

But suddenly, bitcoin is back in the news.

You’ve probably seen the headlines about bitcoin’s return. Bitcoin rose from $3,900 on March 26, 2019, to $8,100 on May 15, 2019, a gain of 52% in less than seven weeks.

Happy days are here again! Bitcoin mania is back!

60 Minutes even ran a feature on bitcoin last night.

Is this the start of a new rally back to the heights of $20,000? That seems highly unlikely.

Early Friday bitcoin plunged well over $1,000 in a massive flash crash, about 10% in one day. Easy come, easy go.

What caused the crash?

It seems that a bitcoin “whale” unloaded a massive holding.

A “whale” is a term for a cryptocurrency investor with a large amount of units, or “coins.” That gives them significant influence on the market control.

It’s been estimated that less than 450 people or entities own 20% of the entire bitcoin market.

And when someone buys or sells a massive amount, prices can swing dramatically, as we saw on Friday.

It is still not clear if the large sell order was deliberate or an accidental “fat finger” error.

Prices have recovered to some extent, and bitcoin’s trading around $7,800 today. But either way, Friday’s flash crash highlights a major weakness of bitcoin. It can all come crashing down like a house of cards, as bitcoin’s 2017–18 hair-raising plunge proves.

As an asset, bitcoin has very little to offer outside of speculation.

Bitcoin still has no use case except for gambling by speculators or the conduct of transactions by terrorists, tax evaders, scam artists and other denizens of the dark web. Bitcoin is still unsustainable due to extreme demands for electricity in the computer “mining” process.

It is still nonscalable due to the slow and clunky validation process for new blocks of transactions on the bitcoin blockchain. Bitcoin has no future as “money” because the supply of bitcoin cannot grow beyond a preset amount.

That feature makes bitcoin inherently deflationary and therefore not suitable for credit creation, which is the real source of any system of money. Bitcoin has been subject to continual price manipulation by miners through wash sales, front-running, ramping and other tried-and-true techniques for price manipulation.

The bitcoin infrastructure has been plagued with hacking, fraud, bankruptcy and coin theft measured in the billions of dollars. Bitcoin may go higher from here; it’s entirely possible. But it will then come crashing down again.

What is bitcoin’s intrinsic worth?

JPMorgan Chase has tried to break it down. They examined bitcoin as a commodity.

To arrive at its worth, JPMorgan Chase estimated the cost of producing each individual bitcoin by looking at factors such as electrical costs, computational power and energy efficiency. I mentioned these factors above.

When they crunched the numbers, what number did they come up with?

JPMorgan Chase estimated the intrinsic value of bitcoin at around $2,400. Let’s assume for now that’s accurate, or a reasonable approximation. Then even at $8,000, we can conclude that bitcoin is severely overvalued.

JPMorgan Chase compared bitcoin’s recent run-up to the bubble it experienced two years ago. Even though it is still far from $20,000, if we see another speculative frenzy it could undergo a similar run. But it would end the same way.

The bottom line is I would advise you to stay far away from bitcoin. Do not get sucked in by the hype.

Sadly, some people never learn. And my guess is that many will get burned all over again.

Read on for more.

Regards,

Jim Rickards
for The Daily Reckoning

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The 7 Stages of a Financial Bubble

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“Is there a real estate bubble?” That’s the question I’m asked repeatedly. When I reply honestly, “I hope so,” the person asking me will sometimes get angry.

“You want the market to crash?” asked one young man incredulously, at an event where I was a featured speaker.

“Yes,” I replied. “I love market crashes.”

Apparently not wanting to hear the rest of my explanation, he stomped off muttering something like “moron.”

I’ve covered this subject of booms, busts, and bubbles before in my columns and books, but since the world seems to be on the brink of so many different booms and busts, I think it’s a good time to revisit it.

Over the years, I have read several books on the subject of booms and busts. Almost all of them cover the Tulip Mania in Holland, the South Seas Bubble, and, of course, the Great Depression. One of the better books, Can It Happen Again?, was written in 1982 by Nobel Laureate Hyman Minsky. In this book, he described the seven stages of a financial bubble. They are:

Stage 1: A Financial Shock Wave

A crisis begins when a financial disturbance alters the current economic status quo. It could be a war, low interest rates, or new technology, as was the case in the dot-com boom.

Stage 2: Acceleration

Not all financial shocks turn into booms. What’s required is fuel to get the fire going.

After 9/11, I believe the fuel in the real estate market was a panic as the stock market crashed and interest rates fell. Billions of dollars flooded into the system from banks and the stock market, and the biggest real estate boom in history took place.

Stage 3: Euphoria

We have all missed booms. A wise investor knows to wait for the next boom, rather than jump in if they’ve missed the current one. But when acceleration turns to euphoria, the greater fools rush in.

By 2003, every fool was getting into real estate. The housing market became the hot topic for discussion at parties. “Flipping” became the buzzword at PTA meetings. Homes became ATM machines as credit-card debtors took long-term loans to pay off short-term debt.

Mortgage companies advertised repeatedly, wooing people to borrow more money. Financial planners, tired of explaining to their clients why their retirement plans had lost money, jumped ship to become mortgage brokers. During this euphoric period, amateurs believed they were real estate geniuses. They would tell anyone who would listen about how much money they had made and how smart they were.

Stage 4: Financial Distress

Insiders sell to outsiders. The greater fools are now streaming into the trap. The last fools are the ones who stood on the sidelines for years, watching the prices go up, terrified of jumping in. Finally, the euphoria and stories of friends and neighbors making a killing in the market gets to them. The latecomers, skeptics, amateurs, and the timid are finally overcome by greed and rush into the trap, cash in hand.

It’s not long before reality and distress sets in. The greater fools realize that they’re in trouble. Terror sets in, and they begin to sell. They begin to hate the asset they once loved, regardless of whether it’s a stock, bond, mutual fund, real estate, or precious metals.

Stage 5: The Market Reverses, and the Boom Turns into a Bust

The amateurs begin to realize that prices don’t always go up. They may notice that the professionals have sold and are no longer buying. Buyers turn into sellers, and prices begin to drop, causing banks to tighten up.

Minsky refers to this period as “discredit.” My rich dad said, “This is when God reminds you that you’re not as smart as you thought you were.” The easy money is gone, and losses start to accelerate. In real estate, the greater fool realizes he owes more on his property than it’s worth. He’s upside down financially.

Stage 6: The Panic Begins

Amateurs now hate their asset. They start to dump it as prices fall and banks stop lending. The panic accelerates. The boom is now officially a bust. At this time, controls might be installed to slow the fall, as is often the case with the stock market. If the tumble continues, people begin looking for a lender of last resort to save us all. Often, this is the central bank.

The good news is that at this stage, the professional investors wake up from their slumber and get excited again. They’re like a hibernating bear waking after a long sleep and finding a row of garbage cans, filled with expensive food and champagne from the party the night before, positioned right outside their den.

Stage 7: The White Knight Rides in

Occasionally, the bust really explodes, and the government must step in—as it did in the 1990s after the real estate bust when it set up an agency known as the Resolution Trust Corporation, often referred to as the RTC.

As it often seems, when the government does anything, incompetence is at its peak. The RTC began selling billions of dollars of unbelievable real estate for pennies on the dollar. These government bureaucrats had no idea what real estate is worth.

In 1991, my wife Kim and I moved to Phoenix, AZ, and began buying all the properties we could. Not only did the government not want anything to do with real estate, amateur investors and the greater fools hated real estate and wanted out.

People were actually calling us and offering to pay us money to take their property off their hands. Kim and I made so much money during this period of time we were able to retire by 1994.

The Best Time to Buy

Take market crashes. I love them because that’s the best time to buy—finding true value is a lot easier during such periods. And since so many people are selling, they’re more willing to negotiate and make you a better deal. Although a crash is the best time to buy, the market’s high pessimism also makes it a tough time to do so.

I remember buying gold at $275 an ounce in the late 1990s. Although I knew it was a great value at that price, the so-called experts were calling gold a “dog” and advised that everyone should be in high-tech and dot-com stocks.

Today, with gold above $1200 an ounce, those same experts are now recommending gold as a percentage of a well-diversified portfolio. Talk about expensive advice.

My point is that this current period is a tough time to buy or sell. Real estate is high, interest rates are high—and climbing, the stock market is a roller coaster, the U.S. dollar is low, gold is high, and there’s a lot of money looking for a home.

So, the lesson is: Now, more than ever, it’s important to focus on value, not price. When prices are low, finding value is easy.

When prices are high, value is a lot harder to find—which means you need to be smarter, more cautious, and resist your knee-jerk reactions. A final word from Warren Buffett: “It’s only when the tide goes out that you learn who’s been swimming naked.”

Now you know why I say, “I love market crashes.”

Although my wife and I continue to invest, we’re more like hibernating bears waiting for the party to end. As Warren Buffett says, “We simply attempt to be fearful when others are greedy, and to be greedy only when others are fearful.”

So instead of asking, “Is it a bubble?” it’s more financially intelligent to ask, “What stage of the bubble are we in?” Then, decide if you should be fearful, greedy, or hibernating.

Regards,

Robert Kiyosaki

Robert Kiyosaki
Editor, Rich Dad Poor Dad Daily

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