It’s Official – Asset Bubbles Are Back
We have had a lot of mentions of “BUBBLES” in the headlines for the past week which started with Larry Summers at the IMF and Nobel laureate Paul Krugman who came out immediately to endorse Summer’s manifesto that “we may be an economy that needs bubbles just to achieve something near full employment.” http://krugman.blogs.nytimes.com/2013/11/16/secular-stagnation-coalmines-bubbles-and-larry-summers/?_r=0
This led to the WSJ post if Asset Bubbles Are The Only Way To Growth http://blogs.wsj.com/moneybeat/2013/11/18/asset-bubbles-as-the-only-road-to-growth/ .
As far as irrational human behaviour goes, “an asset buyer is willing to pay a price above fundamentals because, in addition to the asset, the buyer obtains an option to sell the asset to other traders who have more optimistic beliefs about its future value.”
And from a Chicago Fed Paper published in 2012,”every stock market bubble of the past 200 years, excepting bubbles in war years, occurred during years of low inflation. Early in an economic boom, the natural rate of interest is often quite high. Most interest rate rules, however, do not include a time-varying natural rate of interest. Accordingly, if the natural rate is high and inflation is low, the central bank may set its target interest rate too low, and the bubble is further fueled.
The purpose of QE now is to encourage investment, consumption and boost employment. The trouble with QE now is that wealth is concentrated in the hands of a few and they are not going to consume or employ or do any of that except try their utmost to preserve their wealth.
Equity markets misvaluations are good for the investors because it encourages the company to make rational decisions on productive investment through raising funds, i.e. if stock prices are too high – to raise stock and if prices are too low – to buy back stock. As a result, shareholder value is increased. http://www.bloomberg.com/news/2013-11-19/krugman-and-summers-want-to-keep-finance-fun.html
If we read this in the context of the wealthy few who own the stock and trying to preserve their wealth, and behavioural economics that “Our brains are simply not designed to deal with the complexities involved in global markets. And the result is often times a highly irrational set of decisions”, rational decisions are hard to come by. http://pragcap.com/asset-bubbles-causes-consequences-and-policy-options
The conclusion as drawn by the WSJ blog post is that wages and incomes will have to rise to justify the higher asset prices or the prices will have to fall. Or subscribe to the idea that future growth will justify the valuations (optimism).
Or if prices are inflate further, our debt burdens will be reduced !That is a great way to look at it except that it means the rich will get richer and we will never have the same level playing field again.
Like my favourite question to my son, do you want 10 dollars and Coca Cola at 1 dollar or do you want a 100 dollars and Coca Cola at 20 dollars ?
His first answer initially was the 100 dollars. But thinking through it, 10 dollars makes more sense. And it is the same for most of us lemmings out here.
Awareness is a good thing.
So far, I have not read any big wigs coming out to promote the idea of a higher stock market. They have all been strangely silent and even Warren Buffet has retreated into blue chips in his latest decision to buy Exxon. Critics have swelled in their ranks starting with Fortress, Blackstone, Drukenmiller, Marc Faber and gang, Carl Icahn is the latest to come out yesterday on Reuters to call for a market revaluation/correction.
Its been 5 years since QE. I think even the most addled brains are also starting to awake from the pipe dream and want their 10 dollars back for the 1 dollar Coca Cola. And Summers may be right that a great bubble will not be enough to produce enough aggregate demand even with artificial stimulus, leaving us with only stagnation in our faces.