Jul 15th 2014

Booming Until It Hurts?

NEW HAVEN – In recent months, concern has intensified among the world’s financial experts and news media that overheated asset markets – real estate, equities, and long-term bonds – could lead to a major correction and another economic crisis. The general public seems unbothered: Google Trends shows some pickup in the search term “stock market bubble, but it is not at its peak 2007 levels, and “housing bubble” searches are relatively infrequent.

But the experts’ concern is notable and healthy, because the belief that markets are always efficient can survive only when some people do not completely believe it and think that they can profit by timing the markets. At the same time, this heightened concern carries dangers, too, because we do not know whether it will lead to a public overreaction on the downside. 

International agencies recently issued warnings about speculative excesses in asset markets, suggesting that we should be worried about a possible crisis. In a speech in June, International Monetary Fund Deputy Managing Director Min Zhu argued that housing markets in several countries, including in Europe, Asia, and the Americas, “show signs of overheating.” The same month, the Bank for International Settlements said in its Annual Report that such “signs are worrying.”

Newspapers are sounding alarms as well. On July 8, the New York Times led its front page with a somewhat hyperbolic headline: “From Stocks to Farmland, All’s Booming, or Bubbling: Prices for Nearly All Assets around World Are High, Bringing Economic Risks.” The words “nearly all” are too strong, though the headline evinces the newfound concern. 

It is not entirely clear why the alarms are sounding just now, after five years of general expansion in markets since they hit bottom in early 2009. Why aren’t people blithely expecting more years of expansion?

It seems that this thinking is heavily influenced by recent record highs in stock markets, even if these levels are practically meaningless, given inflation. Notably, just a month ago the Morgan Stanley Capital International All Country World Index broke the record that it reached on October 31, 2007.

The International Monetary Fund announced in June a new Global Housing Watch website that tracks global home prices and ratios. The site shows a global index for house prices that is rising, on a GDP-weighted basis, as fast as during the boom that preceded the 2008 crisis, though not yet reaching the 2006 record level. 

There is also the US Federal Reserve’s announcement that, if the economy progresses as expected, the last bond purchase from the round of quantitative easing that it began in September 2012 will be in the month after the Federal Open Market Committee’s October 2014 meeting. That kind of news story seems also to affect observers’ thinking, though it is not really much in the way of news, given that everyone has known that the Fed would end the program before long.

The problem is that there is no certain way to explain how people will react to such a policy change, to any signs of price overheating or decline, or to other news stories that might be spun as somehow important. We simply do not have much well-documented history of big financial crises to examine, leaving econometricians vulnerable to serious error, despite studying time series that are typically no more than a few decades long.

Until the recent crisis, economists were talking up the “great moderation”: economic fluctuations were supposedly becoming milder, and many concluded that economic stabilization policy had reached new heights of effectiveness. As of 2005, just before the onset of the financial crisis, the Harvard econometricians James Stock (now a member of President Barack Obama’s Council of Economic Advisers) and Mark Watson concluded that the advanced economies had become both less volatile and less correlated with each other over the course of the preceding 40 years. 

That conclusion would have to be significantly modified in light of the data recorded since the financial crisis. The economic slowdown in 2009, the worst year of the crisis, was nothing short of catastrophic.

In fact, we have had only three salient global crises in the last century: 1929-33, 1980-82, and 2007-9. These events appear to be more than just larger versions of the more frequent small fluctuations that we often see, and that Stock and Watson analyzed. But, with only three observations, it is hard to understand these events. 

All seemed to have something to do with speculative price movements that surprised most observers and were never really explained, even years after the fact. They also had something to do with government policymakers’ mistakes. For example, the 1980-82 crisis was triggered by an oil price spike caused by the Iran-Iraq war. But all of them were related to asset-price bubbles that burst, leading to financial collapse.

Those who warn of grave dangers if speculative price increases are allowed to continue unimpeded are right to do so, even if they cannot prove that there is any cause for concern. The warnings might help prevent the booms that we are now seeing from continuing much longer and becoming more dangerous.


Copyright: Project Syndicate, 2014.
www.project-syndicate.org




 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Mar 1st 2024
EXTRACT: "The lesson is that laws and regulatory structures are critical to state activities that produce local-level benefits. If citizens are to push for reforms and interventions that increase efficiency, promote inclusion, and enable entrepreneurship, innovation, and long-term growth, they need to recognize this. The kind of effective civil society Nilekani envisions thus requires civic engagement, empowerment, and education, including an understanding of the rights and responsibilities implied by citizenship."
Feb 9th 2024
EXTRACT: "Despite the widespread belief that the global economy is headed for a soft landing, recent trends offer little cause for optimism."
Feb 9th 2024
EXTRACT: " Consider, for example, the ongoing revolution in robotics and automation, which will soon lead to the development of robots with human-like features that can learn and multitask the way we do. Or consider what AI will do for biotech, medicine, and ultimately human health and lifespans. No less intriguing are the developments in quantum computing, which will eventually merge with AI to produce advanced cryptography and cybersecurity applications."
Feb 9th 2024
EXTRACTS: "The implication is clear. If Hamas is toppled, and there is no legitimate Palestinian political authority capable of filling the vacuum it leaves behind, Israel will probably find itself in a new kind of hell." ----- "As long as the PLO fails to co-opt Hamas into the political process, it will be impossible to establish a legitimate Palestinian government in post-conflict Gaza, let alone achieve the dream of Palestinian statehood. This is bad news for both Israelis and Palestinians. But it serves Netanyahu and his coalition of extremists just fine."
Jan 28th 2024
EXTRACTS: "According to estimates by the United Nations, China’s working-age population peaked in 2015 and will decline by nearly 220 million by 2049. Basic economics tells us that maintaining steady GDP growth with fewer workers requires extracting more value-added from each one, meaning that productivity growth is vital. But with China now drawing more support from low-productivity state-owned enterprises, and with the higher-productivity private sector remaining under intense regulatory pressure, the prospects for an acceleration of productivity growth appear dim."
Jan 28th 2024
EXTRACT: "When Chamberlain negotiated the notorious Munich agreement with Hitler in September 1938, The Times did not oppose the transfer of the Sudetenland to Germany without Czech consent. Instead, Britain’s most prestigious establishment broadsheet declared that: “The volume of applause for Mr Chamberlain, which continues to grow throughout the globe, registers a popular judgement that neither politicians nor historians are likely to reverse.” "
Jan 4th 2024
EXTRACTS: "Another Trump presidency, however, represents the greatest threat to global stability, because the fate of liberal democracy would be entrusted to a leader who attacks its fundamental principles." ------"While European countries have relied too heavily on US security guarantees, America has been the greatest beneficiary of the post-war political and economic order. By persuading much of the world to embrace the principles of liberal democracy (at least rhetorically), the US expanded its global influence and established itself as the world’s “shining city on a hill.” Given China and Russia’s growing assertiveness, it is not an exaggeration to say that the rules-based international order might not survive a second Trump term."
Dec 28th 2023
EXTRACT: "For the most vulnerable countries, we must create conditions that enable them to finance their climate-change mitigation" ........ "The results are already there: in two years, following the initiative we took in Paris in the spring of 2021, we have released over $100 billion in special drawing rights (SDRs, the International Monetary Fund’s reserve asset) for vulnerable countries.By activating this “dormant asset,” we are extending 20-year loans at near-zero interest rates to finance climate action and pandemic preparedness in the poorest countries. We have begun to change debt rules to suspend payments for such countries, should a climate shock occur. And we have changed the mandate of multilateral development banks, such as the World Bank, so that they take more risks and mobilize more private money."
Dec 27th 2023
EXTRACT: "....if AI causes truly catastrophic increases in inequality – say, if the top 1% were to receive all pretax income – there might be limits to what tax reforms could accomplish. Consider a country where the top 1% earns 20% of pretax income – roughly the current world average. If, owing to AI, this group eventually received all pretax income, it would need to be taxed at a rate of 80%, with the revenue redistributed as tax credits to the 99%, just to achieve today’s pretax income distribution; funding the government and achieving today’s post-tax income distribution would require an even higher rate. Given that such high rates could discourage work, we would likely have to settle for partial inequality insurance, analogous to having a deductible on a conventional insurance policy to reduce moral hazard."
Dec 21st 2023
EXTRACT: "Shocks are here to stay, and our task is not to predict the next one – although someone always does – but to sharpen our focus on resilience. Staying the course of politically mandated policies while minimizing the inevitable dislocations is easier said than done. But that is no excuse to fall for the myth of being victimized by the unprecedented."
Dec 21st 2023
EXTRACTS: "A new world is indeed emerging. It will be characterized not only by more interdependencies, but also by more insecurity, danger, and war. Stability in international relations will become a foreign concept from a bygone age – one that we did not fully appreciate until it was gone."
Dec 14th 2023
EXTRACT: "Yet one must never forget that Putin is first and foremost an intelligence officer whose dominant trait is suspicion."
Dec 2nd 2023
EXTRACTS: "In a recent commentary for the Financial Times, Martin Wolf trots out the specter of a 'public-debt disaster,' that recurrent staple of bond-market chatter. The essence of his argument is that since debt-to-GDP ratios are high, and eminent authorities are alarmed, 'fiscal crises' in the form of debt defaults or inflation “loom. And that means something must be done.' ----- "If, as Wolf fears, 'real interest rates might be permanently higher than they used to be,' the culprit is monetary policy, and the real risk is not rich-country public-debt defaults or inflation. It is recession, bankruptcies, and unemployment, along with inflation." ---- "Wolf surely knows that the proper remedy is for rich-country central banks to bring interest rates back down. Yet he doesn’t want to say it. He seems to be caught up, possibly against his better judgment, in bond vigilantes’ evergreen campaign against the remnants of the welfare state."
Nov 27th 2023
EXTRACT: "The first Russia, comprising those living in Russia’s two biggest cities, Moscow and Saint Petersburg, can pretend there is no war at all." ---- "Then there is the other Russia, the one you find in small towns and villages scattered across the country’s massive territory. Here, the Ukraine war is a source of patriotic pride,"
Nov 27th 2023
EXTRACTS: "I interviewed Wilders in 2005 " ---- "Frankly, I thought he was a bore, with no political future, and did not quote him in my book. Like most people, I was struck by his rather weird hairstyle. Why would a grown man and member of parliament wish to dye his fine head of dark hair platinum blond?" ----- "His maternal grandmother was partly Indonesian" ----- "Eurasians, or Indos as they were called, were never fully accepted by the Indonesians or their Dutch colonial masters. They were born as outsiders." ---- "Ultra-nationalists often emerge from the periphery – Napoleon from Corsica, Stalin from Georgia, Hitler from Austria." ---- "Henry Brookman founded the far-right Dutch Center Party to oppose immigration, especially Muslim immigration. Brookman, too, had a Eurasian background, as did another right-wing politician, Rita Verdonk, who founded the Proud of the Netherlands Party in 2007." ---- "A politician who might fruitfully be compared to Wilders is former British Home Secretary Suella Braverman. As a child of immigrants – her parents are double outsiders, first as Indians in Africa and then as African-Indians in Britain – her animus toward immigrants and refugees “invading” the United Kingdom may seem puzzling. But in her case, too, a longing to belong may play a part in her politics."
Nov 19th 2023
EXTRACT: "The good news is that the San Francisco summit was indeed an improvement on last year’s meeting. Above all, both sides took the preparations far more seriously this time. It wasn’t just the high-level diplomatic engagement that resumed in the summer, with visits to Beijing by US Secretary of State Antony Blinken, US Treasury Secretary Janet Yellen, US Secretary of Commerce Gina Raimondo, and climate envoy John Kerry. Equally important was identifying in advance the key issues on which the two leaders could cooperate and eventually agree."
Nov 11th 2023
EXTRACT: "It would be naive to hope that the Russian government or US diplomatic outreach would prevent nuclear war in the event of a serious threat to Putin’s political survival. The risk that Russia’s Ukraine misadventure could culminate in nuclear nihilism demands nothing less than a systemic review of America’s options."
Nov 11th 2023
EXTRACT: " Hamas’s barbaric massacre of at least 1,400 Israelis on October 7, and Israel’s subsequent military campaign in Gaza to eradicate the group, has introduced four geopolitical scenarios bearing on the global economy and markets. As is often the case with such shocks, optimism may prove misguided."
Nov 10th 2023
EXTRACT: "The last two years have been catastrophic for investors in US Treasury bonds. By one measure, 2022 was the worst year for such investors since 1788. Bond prices are poised to fall again in 2023, making this the first time in US history that they declined for three consecutive years. But now the “smart money” is jumping back in."
Nov 6th 2023
EXTRACTS: "China’s economic slowdown could lead the CPC to embrace a militant form of Chinese nationalism in an effort to maintain public loyalty. This would spell trouble for Taiwan, the Asia-Pacific region as a whole, and China itself in the long run. Given the threat posed by China’s assertiveness, it is no surprise that Japan is increasing its defense budget and that other countries have decided to follow America’s lead and explore ways to support Asia’s liberal democracies." .... "The difference between China’s and Japan’s economic trajectories raises the question: Can a corrupt Leninist regime outperform a free society? Whatever the answer, China is facing an uphill battle."