All bubbles are equal, but some bubbles are more equal than others
Columbia University Professor and former Federal Reserve official Frederic Mishkin wrote a much-discussed Op-Ed in the Financial Times yesterday. In it, he asks
Are potential asset-price bubbles always dangerous?
He answers this question with a no, noting that some asset bubbles are more dangerous than others because of their connection to debt and credit. I agree with his delineation and assertion that some asset bubbles are more dangerous than others. But, his conclusion that the non-credit variety of asset bubble — what he calls the “pure irrational exuberance bubble” — is not dangerous is false. This is the same blinkered thinking which led to Nasdaq 5000 and its crash. Experience demonstrates that all asset bubbles are dangerous, some asset bubbles are more dangerous than others. Think Animal Farm: All bubbles are equal, but some bubbles are more equal than others.
The real question Mishkin attempts to answer is whether the Federal Reserve (where he once worked) or any other central bank should target asset prices so as to prevent bubbles from taking form.
Because the second category of bubble does not present the same dangers to the economy as a credit boom bubble, the case for tightening monetary policy to restrain a pure irrational exuberance bubble is much weaker. Asset-price bubbles of this type are hard to identify: after the fact is easy, but beforehand is not. (If policymakers were that smart, why aren’t they rich?) Tightening monetary policy to restrain a bubble that does not materialise will lead to much weaker economic growth than is warranted. Monetary policymakers, just like doctors, need to take a Hippocratic Oath to “do no harm”.
Are we to take this seriously? Even Alan Greenspan is showing more realism in the wake of our latest bubble. This man is outright dangerous. Don’t be fooled; his piece is a plant. We have some serious asset bubbles forming right now and he is looking to give intellectual cover to the watch-the-bubble-and-clean-up-after-the-mess policy we saw on display in the late 1990s. Yves Smith thinks there is a connection between his statement and likely Federal Reserve policy.
What I find interesting is how the Federal Reserve under Greenspan had an explicit policy of targeting asset prices as a means of reflating the economy. Yet, Mishkin is saying they should not target asset prices as a means of deflating the economy. This is what is called monetary policy asymmetry, otherwise known as the Greenspan Put. It’s not about targeting asset prices but looking for excess credit growth, which was certainly on display in the Nasdaq boom as well.
In effect, Mishkin is arguing for us to continue with business as usual. This is one of the more loathsome pieces of prattle I have witnessed since the financial crisis began. I hope no one takes this man seriously. I am ashamed that he is a professor at the business school I attended.
I would be remiss if I didn’t point out his equally absurd piece of research on Iceland’s economy before it collapsed. he wrote a piece called “Financial Stability in Iceland” with Tryggvi Herbertsson which stated:
Our analysis indicates that the sources of financial instability that triggered financial crises in emerging market countries in recent years are just not present in Iceland, so that comparisons of Iceland with emerging market countries are misguided.
No, Mr. Mishkin your analysis is misguided. It was with Iceland and it is here again. See below for a real analysis on Iceland from Willem Buiter and Anne Sibert which we can take seriously.
As I have been saying, you can get wildly different conclusions from two people based on the same facts and largely the same analysis. It goes to philosophical predisposition. What this FT article by Mishkin demonstrates is that no amount of real world evidence of the havoc that bubbles wreak will dissuade these ivory tower ideologues from supporting failed economic policy.
Sources
Not all bubbles present a risk to the economy – Frederic Mishkin, FT
Financial Stability in Iceland (pdf) – Icelandic Chamber of Commerce
The collapse of Iceland’s banks: the predictable end of a non-viable business model – VoxEU
Central Banks Can Do Better Than Just Mopping Up – Caroline Baum, Bloomberg
nothing has changed , all central bankers are incompetent. Bubbles (housing, nasdaq) are autoregulated , sooner or later pop up by themselves. The actual problem is that this new bubble o reflation is really fostered by central banks intentionally on the grounds that economy only needs time to accommodate itself as they consider this a circumstantial and not an structural problem. In the mean time savers as usual are harmed by keeping low artificial interest rates. This kind of bubble will explode once government bonds yields start increasing and ratings downgrading.
“…The country [USA] is already broke, this is only going to accelerate that, we’re heading, the real economic crisis is in front of us, it’s not behind us! Before Barack Obama leaves office there will be a currency crisis, the US dollar will collapse, and prices in this country, for consumer goods, will go ballistic, and so will interest rates. And we’re going to be living in an economy with unemployment closing in on 20%, and double-digit inflation, and double-digit interest rates. This is economic ruin that is coming, and it’s because of the economic policies that you, that you, that you’re wanting Barack Obama to pursue!” [Peter Schiff] “But you are stuck with him, like it or lump it, for the next three years, so are you suggest–you’re, you’re talking as though the US is going to go down the drain under Obama! … What’s the alternative?” [George Negus – SBS Dateline] “But it is! That’s the problem! We continue, we’re continuing–Barack Obama is pursuing the Bush Agenda! That’s unfortunate, and, and Ben Bernanke is doing exactly what Alan Greenspan did! We are repeating all the same mistakes, because none of the politicians want to level with the American public, and tell them the truth about the gigantic hole that their policies have placed us in. We need to go back to a real economy in this country, unfortunately we have been living in a fantasyland, we’ve been living off the productivity and savings of the rest of the world! We are coming, as I said, to a real economic crisis in this country—that’s going to make what happened in 2008, look like, you know, the Roaring-20’s, by comparison.” – Peter Schiff – SBS Dateline, Nov 9th 2009.
Peter the indomitable. His democratic counterpart got slaughtered and ended up just agreeing with most of what he said here. The double-digit inflation + interest may be a way off, but the picture is clear; “debt is bad hokay?
I keep asking myself is any of this new? Didn’t we already know all this? Why are we surprised about asset bubbles and debt growth? I knew of these problems when aged 25 and I’m no economist or financier–debt is a two-edged sword and both sides cut. How surprising.
The only truely unacciountable thing here is that senior experts seem to say they didn’t know. Why this extraordinary blindness? That might be an even more interesting question given the outcome.