The Trouble With Financial Bubbles

The Gold Bubble and the Gold Bugs

NEW HAVEN You might think that we have been living in a post bubble world since the collapse in 2006 of the biggest ever worldwide real estate bubble and the end of a major worldwide stock market bubble the following year. But talk of bubbles keeps reappearing new or continuing housing bubbles in many countries, a new global stock market bubble, a long term bond market bubble in the United States and other countries, an oil price bubble, a gold bubble, and so on.

A new bubble will replace the old one.

The bubbles, not my bubbles, but the financial bubbles.

This is the paradoxical result of the policy response to the financial crisis. Macro liquidity is feeding booms and bubbles but market illiquidity will eventually trigger a bust and collapse.

Angel Foam.

With lots of foam.

A generation later, the sequel to Wall Street to be released next month sees Gekko released from jail and returned to the financial world. His reappearance comes just as the credit bubble fueled by the sub prime mortgage boom is about to burst, triggering the worst financial and economic crisis since the Great Depression.

Because bubbles are essentially social psychological phenomena, they are, by their very nature, difficult to control. Regulatory action since the financial crisis might diminish bubbles in the future.

We've got bubbles going up there, then suds at the top with lumpy tiles.

On one hand, policy must fuel asset bubbles to keep the economy growing. On the other hand, such bubbles inevitably create financial crises when they eventually implode.

Bubble Spotting

Bubble Trouble

Bubbles Forever

But greater wealth for the rich does not necessarily produce much extra spending. It does increase inequality and threaten asset bubbles, which could lead to a new financial crash.

Bubbles in the Broth

What a nice head of foam.

When interest rates rise, as they surely will, the bubbles will burst, the prices of those securities will fall, and anyone holding them will be hurt. To the extent that banks and other highly leveraged financial institutions hold them, the bursting bubbles could cause bankruptcies and financial market breakdown.

For one thing, both were very real.

The cheap credit ushered in by the euro fed an inflationary economic bubble in southern Europe that burst when the financial crisis hit. Credit terms worsened abruptly, and what was left was the thoroughly overpriced rump of economies that had become excessively dependent on foreign financing.

We had the bursting of the tech bubble.

The Great Emerging Market Bubble

America s Education Bubble

Foams end of life

But it was a bubble and a highly leveraged one at that. While periodic bubbles may be unavoidable, and no bubble is without consequences, a highly leveraged bubble tends to cause far more damage, owing to its impact on the real economy and the duration of the deleveraging process.

Another downside risk is that the dollar funded carry trade may unravel, crashing the global asset bubble that it, together with the wave of monetary liquidity, has caused. And, since the carry trade and the wave of liquidity are causing a global asset bubble, some of gold s recent rise is also bubble driven, with herding behavior and momentum trading by investors pushing gold higher and higher.

Letting China s Bubble Burst

Angel Foam never heard of it.

But if financial markets are already frothy now, consider how frothy they will be in 2015, when the Fed starts tightening, and in 2017 (if not later), when the Fed finishes tightening? Last time, interest rates were too low for too long (2001 2004), and the subsequent rate normalization was too slow, inflating huge bubbles in credit, housing, and equity markets.

Israel s Election in a Bubble

As a result, any reform of regulation and supervision will fail to control bubbles and excesses unless several other fundamental aspects of the financial system are changed.

Low interest rates eventually jump started the expansion through a house price bubble that supported a debt financed consumer spending binge and triggered a construction boom. Meanwhile, prolonged low interest rates contributed to a chase for yield in the financial sector that resulted in disregard of credit risk.

Foams Technical Options Committee

And there he was, his face all over soap.

Angel Foam guarantees satisfaction.

How much Angel Foam did you peddle?

They put them in foam, little containers.

Why Small Booms Cause Big Busts

Maybe the word bubble is used too carelessly.

Foam end of useful life issues

Yes, it's beautiful with the foam on the crests of the waves.

Speculative bubbles are the visible manifestation of that temptation. As the bubbles burst and they always do false prosperity is exposed and the defensive tactics of market manipulation become both urgent and seemingly logical.

Angel Foam goes down like liquid gold... and it comes up like slow dynamite... for the man of taste.

Since their collapse in 2007, US households have understandably become fixated on repairing the damage. That means paying down debt and rebuilding savings, leaving consumer demand mired in protracted weakness.