Are we living in a time of asset bubbles?

Here is one typical complaint about bubbles, from Jesse Eisinger, excerpt:

We are four years into the One Percent’s recovery. Now, we are in Round 3 of quantitative easing, the formal term for the Fed injecting hundreds of billions of dollars into the economy by purchasing longer-term assets like Treasury bonds and Fannie Mae and Freddie Mac paper. What’s that giving us? Overvalued stocks. Private equity firms racing to buy up Arizona real estate. Junk bond yields at record lows. Ratings shopping on structured financial products.

These are dangerous signs of prebubble activity.

Here is a Krugman rebuttal.  I will offer a few points on a series of debates which in general I have stayed away from.

1. I don’t find most predictive discussions of bubbles interesting, while admitting that such claims often will prove in a manner correct ex post.  “OK, the price fell, but was it a bubble?  I mean was there froth, like on your Frappucino?”  Or to quote Eisinger, it might also have been “dangerous signs of prebubble activity” (what happens between the “prebubble” and the “bubble”?  The “nascent bubble”?  The “midbubble”?  The “midnonbubble”?)

2. Good news and improving conditions may well bring more bubbles or greater likelihood of bubbles, but that is hardly reason to dislike good news and improving conditions.

3. Relative to measured real interest rates, stocks look cheap right now.  That doesn’t mean they are, but reread #1.

4. No one understands the term structure of interest rates, no matter what they tell you.  Reread #1.

5. I don’t see why anything particular about the current state of affairs, at least in the United States, needs to be “unwound.”  I sometimes draw a distinction between those of us who have been thinking about interest on reserves since S. Tsiang, Fischer Black, and the Reserve Bank of New Zealand, and those of us who have not.

6. One coherent definition of bubble is that of a hot potato, traded in a world of heterogeneous expectations, but which must ultimately pop, because eventually the price of that asset will consume all of gdp, a bit like those old Tokyo parking spots.  Fair enough, but I don’t see that in many asset markets today if any (Bitcoin for a while?).

7. Another coherent definition of a bubble has less to do with a dynamic price path and ongoing resale for gain, but rather there may be a (temporary) segmentation across classes of asset market buyers.  The obvious candidate here is that  many people and institutions have been frightened into Treasuries and away from almost everything else.  That could mean we have a real interest rate bubble, but it also could mean that lots of other assets are undervalued, at least if the liquidity effect defeats the higher real interest rate effect of moving out of Treasuries.  (It would be odd to think that a shift of funds out of Treasuries and into stocks would cause stock prices to fall, but perhaps some people fear this.)

I don’t agree with this view, but I do feel I understand it.  The most likely “bubble” is then in real interest rates, due to a (temporary?) skewing of the risk premium.  That all said, I do not think this should be called a bubble.  Changes in the risk premium and “bubbles” have traditionally been considered alternative explanations for asset prices.  Reread #1, and reread #4 while you’re at it.

8. Ruchir Sharma made some interesting points yesterday:

Far from fighting off a deluge of foreign capital, leaders from India to South Africa are struggling to attract a greater share of global capital flows in order to fund widening current account deficits. Over the past decade, the foreign exchange reserves of the developing world grew at an average annual rate of 25 per cent, swelling from $570bn in 2000 to $7tn in 2011. But over the past year, the average rate slowed to a crawl of barely 5 per cent.

The idea that money is still flooding emerging markets misses the big picture, which is that global cross-border capital flows are down 60 per cent from their 2008 peak. The largest shares of cross-border capital flows are in bank loans, trade and foreign direct investment, which are slowing worldwide.

9. I expect the real economy over the next twenty years to be more volatile than it was say in the 1990s.  In that sense, many current asset market prices may be revised and quite dramatically.  Still, I don’t find the bubble category to be so useful in this regard.  We really don’t know what is going to happen and that is why the current prices are wrong, not because of a “bubble.”

10. I am probably done blogging about bubbles for a while.  Satisfying you was not the goal of this post, but that is in the nature of the subject area, not out of any desire for spite.


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