However, speculative bubbles on a scale like these don't form without at least tacit government approval. Popping them before they grow catastrophically large is very easy - there is a variety of tools at the government's disposal that can be used to that end.
That's the political point here: Bubbles don't just happen. They're a political choice.
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
That's the political point here: Bubbles don't just happen. They're a political choice."
They are indeed. There is a tool: land value tax. Otherwise i don't really see how you can prevent land bubbles. When economy grows, land values rise and they should rise. Other means, except LVT, would mean preventing the rise of land value. That would mean lower infrastructure, lower population density etc. Or smaller economy overall. I don't believe that there really is a "variety of tools."
I don't believe that there really is a "variety of tools."
Going from mildest to harshest, the ones I can think of are:
Nothing else.
Restrict credit creation and you restrict bubbles.
Replace secured debt with an alternative form of property investment that works, and bubbles will be history. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
The fallout will be limited, because it won't lead to a general contraction in the money supply, which means that it (probably, and if it's not too big) won't lead to major parts of your economy being without liquidity. And it would change the balanced between creditor and debtor, because when you use equity financing, the creditor takes a haircut along with the debtor, unlike debt financing where the debtor gets wiped out before the creditor is even touched.
But there is nothing in curtailing credit that inherently prevents people from overpaying for an asset in the hope that a greater fool will come along and overpay even more.
You can run a Ponzi scam just fine without formalised credit creation.
Ponzi scams are not necessarily related to bubbles. A Ponzi scam in simple terms consists of paying income out of capital.
JakeS:
The fallout will be limited, because it won't lead to a general contraction in the money supply, which means that it (probably, and if it's not too big) won't lead to major parts of your economy being without liquidity. And it would change the balanced between creditor and debtor, because when you use equity financing, the creditor takes a haircut along with the debtor, unlike debt financing where the debtor gets wiped out before the creditor is even touched.But there is nothing in curtailing credit that inherently prevents people from overpaying for an asset in the hope that a greater fool will come along and overpay even more.
I stand corrected, in that it is indeed possible for assets to be over-priced into a Bubble without credit/leverage. The Dot Com Bubble is an example where leverage played a relatively small role.
Having said that, all Real property bubbles, and most other bubbles eg the Private Equity Bubble now collapsing to give swathes of unemployment, were caused by credit/leverage. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Money markets are inherently and unavoidably Ponzi-ish - stock prices can only increase when people throw money at them, which means more money is entering the system, which means that payouts can appear to increase.
As long as there's some connection to real wealth creation, this can work, for a while, although it's not a healthy way to run things.
As soon as markets switch to speculation and a bubble appears, cash floods in - and then mysteriously disappears as the bubble pops.
Technically a Ponzi scam consists of paying income out of income.
Say ten people each invest £100,000 because they are promised 20% return per year and nothing else happens (ie the £1m is kept under the bed or invested at 0%)
Say the manager takes out the usual hedge fund 2% management fee and 20% of the 20% fake "profits".
At the end of Year One the punters get £200k, and the manager gets 2% of £1m plus 20% of £200k ie £60k.
So £260k is distributed, and all of it is Capital.
Same in Year Two
Same in Year Three
The shit hits the fan at the end of Year Four when it's all gone.
But I cannot see how such a Ponzi scheme (the above being my understanding of a Ponzi scheme) is anything other than paying Income from Capital....
ThatBritGuy:
Money created by credit institutions as interest-bearing debt is arguably as dubiously based as Ponzi schemes, yes.
As long as there's some connection to real wealth creation, this can work, for a while, although it's not a healthy way to run things. As soon as markets switch to speculation and a bubble appears, cash floods in - and then mysteriously disappears as the bubble pops.
I would argue that the key difference lies between
(a) credit creation for the purpose of building new productive assets - where bankers such as Jerome fulfil a valuable role; and
(b) credit creation for the purpose of purchasing existing productive (or hopefully productive) assets, which is where Bubbles and Ponzi schemes come in. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
(b) credit creation for the purpose of purchasing existing productive (or hopefully productive) assets, which is where Bubbles and Ponzi schemes come in.
Surely that should be net credit creation, right?
If I borrow a hundred thousand € to buy stock on the margin, and the dude I buy it from uses that 100k € to re-pay a broker's loan, then Nothing Happens(TM) to the money supply.
The problem is when the dude I buy the stock from rolls over the loan and uses the money to buy other stocks - because then new money is infused into the stock market, which causes stock price inflation (unless a commensurate amount of real value is added to the stock market through IPOs).
I think the difference is more that speculation is - jargon aside - designed to make a quick buck from thin air.
The commodity that's being traded isn't income or ROI, it's faith in possible income which may - speculators hope - be created by the perception of possible profit by other investors.
In other words it's a stampede of greater fools, all of whom hope that they're not the ones buying at the top.
Buying and/or investing in existing assets isn't inherently speculative if it's managed in a sane way, and expectations of returns are reaonsable.
Someone I was talking to recently was regretting that she hadn't spent 20k on an existing cheese deli business which had been doing well on her high street.
There's no bubble there - just a business with an unspectacular but steady turnover and which should, recessions aside, repay an investment in a reasonable time, and then produce a profit.
A bubble would happen if the store became incredibly fashionable and decided to cash in by selling cheese deli futures.
With the right PR, the futures would spiral into the stratosphere and then crash. The buying and selling of cheese would be irrelevant - the actual commodities driving the price of the futures would be hope, optimism, guile, greed and wishful thinking.
That's true, of course: Not all Ponzi scams are related to bubbles. But I'd argue that all bubbles have the characteristic features of a Ponzi scam.
Yes there are bubbles, but they are usually not so serious. IT bubble hurts some investors, but this money is still, after all, gone to some kind of technology and something that is produced (although bad production) and creates capital. Land bubble is the serious one. It just sucks money from the whole economy and produces nothing.
The Great Crash of 1929 happened on the stock market, not in the real estate market. It could have happened in the collectible postage stamp market, for that matter, if only enough people were to buy into the belief that collectible postage stamps were a smart investment.
It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with.
Yes, but when the stock becomes overvalued, it does not hurt the underlying real economy. Overvalued stock even helps investments in true capital.
"The Great Crash of 1929 happened on the stock market, not in the real estate market. "
There are also opinions, that this was also about land market.
"It's just that real estate markets have been politically expedient to create bubbles in for the last couple of decades, because real estate is the asset class that Main Street owns and feels comfortable with."
Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market. What makes real estate (or in fact land market) a whole more serious is that the money gained is economic rent, not lottery money from other gamblers. Just a payment from production to privilege (nothing really happens). These bubbles leave labour and true capital in debt for decades. And take down all the production in the whole economy.
I just add that not all "Main Street" owns Real Estate. I believe that in fact it is quite a selected group that really owns land and takes the "rent" from economy. Of course average Joe likes to see his/hers real estate value grow, but in both cases, it is in the end economic rent they cash in.
And when, as happens at some point in all bubbles, the price of the stock no longer reflects the value of the underlying cash flows
Even without bubbles it's astonishing how rarely stock prices reflect trading fundamentals.
But usually they reflect at least some tenuous approximation of the fundamentals. You don't get a company with a hundred million in assets and liabilities of 90 million with a market cap of two hundred million unless you have a bubble. It might have a market cap of a fifteen million one day and eight million the next, because stockholders can't decide on how to value the hard-to-value bits on the balance sheet. But there are limits to the craziness in normal times.
P/E ratios, for instance, have historically not been all over the place, except in the run-up to a panic.
Overvalued stocks do real damage to the real economy in several ways:
A great depression is a bastard of many fathers, and I would be surprised if persistent stock price inflation didn't also inflate real estate prices. But the major contraction in the money supply and the major contraction in aggregate demand both arose from stock writedowns.
Of course they are comfortable, because land values always rise. As long as there is education, developing infrastructure and population growth. No Einstein is needed to cash in land market.
Face values go up, but inflation-adjusted prices don't necessarily go up. And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy.
Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market. You don't lose market share (or wealth) doing it. But when we talk about "bubbles", land market is always a true "Eldorado" for banks and speculators.
"And even when they do, you won't necessarily be better off buying than renting. That depends on tax codes, interest rates, rents, inflation and a lot of other variables. One such analysis can be found here, courtesy of the always great khanacademy."
If you seek quick profits, of course you never rent anything. In this article is a graph about land and housing prices from last years:
http://www.moneyweek.com/investments/property/house-prices-expect-the-worst.aspx
Not in the long term. But you can't always say the same from a certain stock. Also playing "waiting-game" always wins in the land market.
Only if you can afford to wait that long. Real, inflation-adjusted land prices may easily be higher today in many parts of the US and UK than they will be again within my lifetime.
When prices do a random walk, if you can wait long enough you can recoup any loss of book value. That's just another way of stating the Gambler's Ruin: If you have the (sufficiently) bigger bank, you can't lose unless the game is systemically tilted against you.
But very, very few people in the real world can afford to wait for arbitrarily long lengths of time. As Keynes famously said, "the market can stay irrational longer than you can stay solvent." In other words, even when there is a bias in your favour, you may not always be able to wait long enough to make a profit. Nevermind the case where prices are a random walk.
Real land prices (land values) can only be higher today than tomorrow, if productivity drops, infrastructure gets worse and/or population declines. Market price naturally changes. If you can afford to put money in the bank, you can afford to sit on your land assets. There is only usually just some 1% property tax. Already the average growth in productivity covers that "risk". The problem with Keynes is that he doesn't make the difference between "capital" and "land", even these are very different in nature.
And in fact, housing has, in the US and UK, been grossly overvalued. And that bubble just popped. So prices will go down, and likely stay down for quite a while.
I posted last week, it is easy to see how insane Bubble's Great Land Bubble has been.
BTW:
I would love to see a graph of the annual percentage rise of US real estate versus the annual percentage increase in the US labor force. Bet a doughnut there'd be a strong correlation.
That is the home price index. Look the link to the article i posted above. There is the graph of the actual land prices. (In UK)
Or maybe I'm talking through my hat.
My intimate knowledge of UK land prices, policies, and patterns comes from some friends who, in the late 60s, bought a farm well away from everyone to get away from everyone only to wake-up and find themselves surrounded by housing developments lo these many years later.
Not happy they are.
Wishing to leave, they do.
Be damned if they'll sell out to Yet Another Developer to rape the countryside, they declare.
