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speculative asset bubbles (internet, housing, commodities)

Page history last edited by Brian D Butler 15 years, 2 months ago

Table of Contents


 

 

 

Speculative Asset Bubbles: 

 

In "Irrational Exuberance", published in 2000 by a Yale economics professor, Robert Shiller, he described a speculative asset bubble as "a situation in which temporarily high prices are sustained largely by investors enthusiasm rather than by consistent estimation of real value".  

 

why do bubbles happen?

Mr Bernanke believes that most bubbles originate in failures of microeconomic regulation – either bad regulation, or non-regulation of markets stricken by information and incentive problems. In this respect he fundamentally differs from Mr Greenspan, who sees bubbles as being deeply rooted in human psychology: greed and fear.

 

Conformity:  blame the psychology of the masses.  As people have a strong desire to be apart of the group, that leads us to be susceptible to fads, and trends in thinking.  Many people would rather go with the group than to take a risk alone.  Call this "herd mentality" if you will.  

 

Illusion of control:  people believe that they are in control when in fact they are not.   This is seen when people are willing to pay 4 times more for a lottery ticket in which they choose the numbers as compared to one in which the numbers are automatically generated.  Also, people will bet more on the flip of the coin (heads or tails) if they can call it in the air, rather than after it has landed (as if they can somehow change the outcome in the air by wishing for it). 

 

So, people generally might see that a crash is coming, but the believe that they will be able to get out in time, and that they somehow have some degree of control over its outcome by being "connected" to it. 

 

Main lesson:  make sure your investments are based on your own analysis, and not on the opinions that you read in the financial papers!  Conduct your own analysis of what you think the assets are valued.  Challenge your assumptions, and invite others you respect to also challenge your assumptions to make sure you stay grounded in reality!

 

 

Blame the Fed?

The Fed, some analysts claim, took interest rates too low for too long following the Russian crisis in 1998, allowing the dotcom bubble to build, then repeated the mistake following the dotcom bust in 2000, which led to overheating in the housing market. “Rather than bursting bubbles they should make sure that monetary policy does not cause the bubble in the first place,” he says.

 

how to tell if there is a bubble:

“When you have a rise in indebtedness or capital inflows accompanying a run-up in asset prices, it is more likely to be something to worry about,” says Prof Rogoff. At a minimum, rising indebtedness suggests the economy would be more exposed to a sudden fall in asset prices if it turned out that there was a bubble.

 

current Federal Reserve policy regarding asset bubbles:

The US Federal Reserve’s current strategy of ignoring bubbles as they inflate but cleaning up the mess afterwards is under fire from economists who argue that it results in a bias in monetary policy that, over time, will result in rising inflation.

 

 

should we try to stop them (the cure might be worse than the cold)

Some experts saw bubbles in technology as early as 1996 and in housing as early as 2003 – even though most analysts now believe that prices were not then unrealistic. Efforts to suppress bubbles that do not really exist could do enormous damage.  Note that banks do not have a clear informational advantage over the market in judging when an asset is overvalued. 

 

If they looked to regulation rather than monetary policy, there are other potential drawbacks. If the Fed were to tighten regulations to try to contain a bubble, financial institutions could simply move offshore. Moreover, while public opinion largely accepts the idea that interest rates should be set by experts and not politicians, central bank autonomy cannot be taken for granted.  Aggressive regulation attempting to curb a perceived bubble would risk a political backlash from those with interests at stake in continued asset price growth – such as tech entrepreneurs and investment banks in the late 1990s and home builders and home owners in the 2000s.

 

monetary policy is not the right tool for the job:

Greenspan/Bernanke objection of 2002 – that monetary policy is not the right tool for the job.  Both Mr Greenspan and Mr Bernanke have argued that bubble dynamics are too powerful to be arrested by anything other than very large increases in interest rates that would devastate the broader economy. This is why Mr Bernanke concluded in 2002 that interest rates were not the right tool for the job. “One might as well try to perform brain surgery with a sledgehammer,” he said.

 

Mr Bernanke and his colleagues today are attracted by the idea of dealing with bubbles in a more surgical way: using regulation selectively and aggressively to target specific excesses.

 

 

 

 

 

 

"Leaning against the wind"

There is alot of talk about "leaning against the wind" (in setting monetary policy) in Europe, but this approach only works if the bubble is susceptible to moderate increases in interest rates. 

 

 

New thinking:

The proposed "macro-prudential authority" would allow the Fed to order any financial institution to alter behaviour it believed jeopardised overall financial and economic stability. For example, it could require banks to hold fewer mortgage-backed securities or set aside more capital against them.

 

 

 

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What is causing the current price spike in commodity prices?

 The next bubble to burst may be commodities in 2008

Theories

 

  1. Aa large part of the run up in prices in commodities is due to China's booming economy, and their need for resources to feed that boom.  But, what happens if Chinas growth were to slow?  (see our discussion:  Changes are happening in China). 
  2. Another reason for the boom in commodities prices may be due to speculation.  Is there a speculative bubble in commodities?  What happens to economies in emerging markets if that bubble bursts?  

 

How far will the housing market fall?

 

 

Housing index:

 

There are three indexes out there.  Only one is good.  See S&P Case-Shiller index

 

Be very careful of the REALATORS index....which is too optimistic, and also of the FEDERAL Reserve index, which is based on the data from Fannie May, Freddie Mac....because they dont include subprime lending, and are therefore too optimistic as well.  

 

The only good, best index is from Case/ shiller.

 

 

See also:

 

 

Related Content from GloboTrends

More from GloboTrends: federal funds ratecredit crisis of 2007,   Double bubble trouble - two bubbles burst in the USA , The next bubble to burst may be commodities in 2008 , internet bubble , Investing in emerging stock markets

 

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