Paul Krugman earlier this month wrote a column in the New York Times denying that there is a bond bubble and expressing strong skepticism that there is a stock bubble. He reasoned:
Bubbles can be bad for your financial health — and bad for the health of the economy, too. The dot-com bubble of the late 1990s left behind many vacant buildings and many more failed dreams. When the housing bubble of the next decade burst, the result was the greatest economic crisis since the 1930s — a crisis from which we have yet to emerge.
So when people talk about bubbles, you should listen carefully and evaluate their claims….
And there’s a lot of bubble talk out there right now. Much of it is about an alleged bond bubble that is supposedly keeping bond prices unrealistically high and interest rates — which move in the opposite direction from bond prices — unrealistically low. But the rising Dow has raised fears of a stock bubble, too.
So do we have a major bond and/or stock bubble? On bonds, I’d say definitely not. On stocks, probably not, although I’m not as certain.
What is a bubble, anyway? Surprisingly, there’s no standard definition. But I’d define it as a situation in which asset prices appear to be based on implausible or inconsistent views about the future. Dot-com prices in 1999 made sense only if you believed that many companies would all turn out to be a Microsoft; housing prices in 2006 only made sense if you believed that home prices could keep rising much faster than buyers’ incomes for years to come.
This is presumably Krugman’s way of saying that a bubble is defined as a period of unsustainable growth. That’s the definition I’ll use in my comments below. He goes on to ask whether there is “anything comparable going on in today’s bond market”, answering in the negative because a bond bubble would mean, when it burst, that interest rates would rise, and
it’s hard to see why the Fed should raise rates until unemployment falls a lot and/or inflation surges, and there’s no hint in the data that anything like that is going to happen for years to come.
Which, as I’ve already pointed out in a previous post, could just as well mean that there are hints in the data that in years ahead something like that is going to happen. Krugman elsewhere cites a Congressional Budget Office (CBO) report showing a decrease in the deficit from the same time last year, but turning to his own source, one can read:
In CBO’s baseline projections, deficits continue to shrink over the next few years, falling to 2.4 percent of GDP by 2015. Deficits are projected to increase later in the coming decade, however, because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance, and growing interest payments on federal debt. As a result, federal debt held by the public is projected to remain historically high relative to the size of the economy for the next decade. By 2023, if current laws remain in place, debt will equal 77 percent of GDP and be on an upward path….
Krugman returned to the CBO outlook in a post last week titled “About That Debt Crisis? Never Mind”, in which he remarked:
OK, another toe dipped in reality. The new CBO numbers are out, and they scream “debt crisis? What debt crisis?”
Um… Here’s how the CBO report unambiguously answers the question Krugman is here suggesting is begged by the very same CBO report:
Such high and rising debt later in the coming decade would have serious negative consequences: When interest rates return to higher (more typical) levels, federal spending on interest payments would increase substantially.
Moreover, because federal borrowing reduces national saving, over time the capital stock would be smaller and total wages would be lower than they would be if the debt was reduced. In addition, lawmakers would have less flexibility than they would have if debt levels were lower to use tax and spending policy to respond to unexpected challenges. Finally, a large debt increases the risk of a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.
Ohhhhh, you mean thaaat debt crisis….
Robert P. Murphy comments on the CBO’s numbers:
So that means the Fed will monetize 84% of the Treasury’s deficit this fiscal year. And it’s not chump change, the deficit is still over half a trillion dollars.
But never mind all that. Krugman continues:
Why, then, all the talk of a bond bubble? Partly it reflects the correct observation that interest rates are very low by historical standards. What you need to bear in mind, however, is that the economy is also in especially terrible shape by historical standards — once-in-three-generations terrible. The usual rules about what constitutes a reasonable level of interest rates don’t apply.
Krugman cannot understand that interest rates are a price and that the only “reasonable level” for them is the one determined by the free market and economic law of supply and demand (i.e., if rates of savings are high, banks will lend at lower interest thus spurring investment in longer-term projects to meet the future demand from the present deferred consumption; and if savings rates are low, interest rates will rise to encourage deposits to be able to have more reserves to loan out). He thinks, rather, that the government should engage in price fixing. He thinks that a small group of people making decisions behind closed doors in a board room at the Federal Reserve know better than the free market where interest rates should be. Or, at least, he thinks he knows better than the free market where rates should be. He might not think quite so highly of the good folks over at the Fed…
Krugman continues in his column:
O.K., what about stocks? Major stock indexes are now higher than they were at the end of the 1990s, which can sound ominous. It sounds a lot less ominous, however, when you learn that corporate profits — which are, after all, what stocks are shares in — are more than two-and-a-half times higher than they were when the 1990s bubble burst. Also, with bond yields so low, you would expect investors to move into stocks, driving their prices higher. All in all, the case for significant bubbles in stocks or, especially, bonds is weak.
Why, you would “expect” investors to behave this way. Let us concede that point. This most surely is to be expected. Yes, indeed. Which is precisely why many are making the case that there is a stock bubble.
Krugman seems to think a bubble is also defined as something one cannot possibly “expect”. Therefore, if a certain behavior of the market can be expected, then it can’t possibly be a bubble. But let us return to our own definition, a period of unsustainable growth. Now, granted, I could be misinterpreting him. But if that isn’t the logic behind his argument here, what is? (I’m all ears if anyone has any other explanation. You can leave them in the comments.)
Expected, indeed. Here’s Ron Paul, for example:
Although many were up in arms when the Fed said it would buy $600 billion in government debt outright for the previous round, QE2, all seems quiet about the magnitude of QE3 because it doesn’t come with huge up-front total price tag. But by year’s end the Fed’s balance sheet could hit $4 trillion.
With no recovery in sight, where’s all this money going? It is creating bubbles. Bubbles in the housing sector, the stock market, and government debt.
The stock market has been hitting record highs for the past two months as investors seek to capitalize on the Fed’s easy money. After all, as long as the Fed keeps the spigot open, nominal profits are there for the taking. But this is a house of cards. Eventually, just like in 2008-2009, the market will discipline the bad actions of the Fed and seek to find the real normal.
And here’s Peter Schiff explaining that blowing more air into a bubble isn’t a recovery:
So why should we listen to the likes of Ron Paul and Peter Schiff over Nobel-Prize winning economist Paul Krugman?
Well, there’s at least one good reason I can think of. While Ron Paul and Peter Schiff were both warning, following the bursting of the dot-com bubble, that the Federal Reserve’s policy of maintaining artificially low interest rates would create a housing bubble that would precipitate a financial crisis, Paul Krugman was advocating that the Fed lower interest rates to create a housing bubble.
For extensive documentation on that, see my book Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis.
What about the dot-com bubble? Well, Krugman’s record isn’t so hot there, either. He couldn’t see it coming when it was staring him in the face. In January 2000, Krugman puzzled over the cause of the sudden dive in stock prices, but he assured his readers that the economy was fundamentally sound and that this dip was merely a signal of a “merely terrific” rather than “incredible” economy and that it had no place to go but up. In February 2000, he was “not entirely convinced” that the NASDAQ was in a bubble, once again suggesting that the economy had nowhere to go but up. Even as the dot-com bubble burst and the NASDAQ began to plummet, Krugman could still write that “the U.S. economy has cheerfully broken all the old limits” with “almost every fresh economic statistic” being “a cause for celebration.” He said that “growth will have to slow” but would continue.
His record on previous bubbles does not exactly inspire confidence in Krugman’s assessment of the current situation.
He concludes his column by brushing aside fears of another bubble in either bonds or stocks:
For one important subtext of all the recent bubble rhetoric is the demand that Mr. Bernanke and his colleagues stop trying to fight mass unemployment, that they must cease and desist their efforts to boost the economy or dire consequences will follow. In fact, however, there isn’t any case for believing that we face any broad bubble problem, let alone that worrying about hypothetical bubbles should take precedence over the task of getting Americans back to work. Mr. Bernanke should brush aside the babbling barons of bubbleism, and get on with doing his job.
Don’t listen to those babbling barons of bubbleism who warned of a stock bubble in the tech sector while I was praising how wonderful the economy was, and how it would continue on an upward path of sustainable growth. Never mind those babbling idiots who warned that the policy I was advocating would lead to a bust.
It’s the same theme at Krugman’s blog, where he recently ridiculed the idea that “the I-see-bubbles crowd” has “The Truth — namely, that those crazy central banks are flooding the world with liquidity, driving asset prices to crazy levels, and it will all end in terrible grief.”
What, exactly, is Krugman denying here? That central banks are running the printing presses (i.e, “quantitative easing”)? He couldn’t possibly be denying that. Or that the excess credit from all this monetary inflation might find its way into the stock market or otherwise drive up asset prices to crazy levels? Gosh, it’s not as though that’s ever happened before. Or that the bursting of a bubble would mean more terrible economic grief? Inconceivable!
Sarcasm aside, what is it he is trying to suggest is perfectly obvious silliness here? Perhaps I’m being unimaginative in being able to come up with only those three possibilities? (Feel free to help me out, here.)
Krugman comments that
Short-term interest rates are near zero because the economy is so depressed, and will stay that way for a long time. Long-term rates are low because people, rightly, expect short-term rates to stay low for a long time.
Interest rates are so low “because the economy is so depressed”? Actually, that does make sense — if what he means by that is rates are so low because the Federal Reserve is monetizing 84% of the government’s deficit in order to try to spur a “recovery” to get us out of the depressed economy. But then, if that’s what he means, it doesn’t exactly make a very convincing argument for his case. Does it?
And why would people expect rates to stay low? Isn’t it because the Fed has promised to keep them low until this policy produces a recovery? (The Fed is like the Little Engine That Could. “I think I can make a recovery by printing more money. I think I can, I think I can, I think I can…”) What is it Krugman is saying here, exactly, that is supposed to convince us that there are no bubbles and no debt crisis?
He next shows us this graph:
Does this shout “bubble” to you?
Um… Definitely maybe? Shall we extend that to get a glimpse at the bigger picture?
So, let’s see… Okay, that’s the NASDAQ bubble right there, and, ah… Yup, okay, that must be he housing bubble right there and… Gosh… Let’s see, does that look like it could be another bubble right there after that…? Naaawwwww! It couldn’t be! Man, obviously not! Pshaw! Only an idiot could look at a graph like that and think there could be another bubble in there at the end! Why, you’d have to be a babbling baron of bubbleism to see what obviously could not possibly really be there!
Krugman next adds:
Now, there are some real puzzles here. Why have profits been so strong in a weak economy? Why, with profits so high, don’t businesses find reason to invest more (equipment investment is actually fairly strong, but construction remains weak)…. But these seem to be real-side puzzles, not monetary/financial puzzles. I don’t see anything in the data that has the “signature” of what you’d expect if the big problem was that Ben Bernanke is flooding the market with artificial liquidity that has nowhere to go.
Is there really any puzzle here? Don’t guys like Ron Paul and Peter Schiff once again have it pretty much figured out what’s going on? Is it really any mystery how excess credit from monetary inflation could find its way into stocks or other assets, driving up prices with unsustainable growth? Krugman’s inability to understand the problem is illustrated in another post, where he states:
We’ve responded to much lower levels of debt by ensuring that the economy functions far below potential, millions of people who want to work can’t find jobs, and many people see all their hopes for the future slipping away.
See, in Krugman’s view, the problem is not that a bubble occurred in which perceived growth was in reality unsustainable, nor the solution that a restructuring of the economy be allowed to occur to correct the malinvestment resulting from the Fed’s money printing; no, rather everything before the crash was fine, and our wise government overlords must just instead keep doing more of the same thing that caused the bubble in the first place in order to prevent such a liquidation of malinvestment and recreate the conditions that existed during the bubble.
He makes this point himself rather explicitly in a recent New York Review of Books essay. In it, he writes:
In the beginning was the bubble. There have been many, many books about the excesses of the boom years—in fact, too many books. For as we’ll see, the urge to dwell on the lurid details of the boom, rather than trying to understand the dynamics of the slump, is a recurrent problem for economics and economic policy. For now, suffice it to say that by the beginning of 2008 both America and Europe were poised for a fall. They had become excessively dependent on an overheated housing market, their households were too deep in debt, their financial sectors were undercapitalized and overextended.
… [British economist John Maynard Keynes’s masterwork, The General Theory of Employment, Interest and Money, is noteworthy—and revolutionary—for saying almost nothing about what happens in economic booms. Pre-Keynesian business cycle theorists loved to dwell on the lurid excesses that take place in good times, while having relatively little to say about exactly why these give rise to bad times or what you should do when they do. Keynes reversed this priority; almost all his focus was on how economies stay depressed, and what can be done to make them less depressed.
I’d argue that Keynes was overwhelmingly right in his approach, but there’s no question that it’s an approach many people find deeply unsatisfying as an emotional matter. And so we shouldn’t find it surprising that many popular interpretations of our current troubles return, whether the authors know it or not, to the instinctive, pre-Keynesian style of dwelling on the excesses of the boom rather than on the failures of the slump.
So, you see? Anyone who would “dwell” on barbaric points of view is just clinging with an emotional attachment onto the ancient ways. Anyone who could think that busts could be prevented by not creating an unsustainable boom in the first place is living in the dark ages, you see, and in this new age of enlightenment, the wiser men among us understand that focusing on what caused the boom is an utter waste of time, because what we really must do is turn our attention rather towards the bust, and do more of what we were doing during those excellent boom years to bring those good times back once again.
David Stockman’s The Great Deformation should be seen in this light. It’s an immensely long rant against excesses of various kinds, all of which, in Stockman’s vision, have culminated in our present crisis. History, to Stockman’s eyes, is a series of “sprees”: a “spree of unsustainable borrowing,” a “spree of interest rate repression,” a “spree of destructive financial engineering,” and, again and again, a “money-printing spree.”
And if you aren’t convinced yet that you shouldn’t read Stockman’s book, please understand that “Stockman’s book isn’t important” and “consists basically of standard goldbug bombast.” Standard goldbug bombast from a babbling baron of bubbleism, I tell you!
Kidding aside, it’s on my list. For Krugman to take such time to make such a remarkably intellectual argument why not to bother reading it as this , it must be really good. Buy it here.
Update (5/21): I’m not the only one who thinks the emperor has no clothes. Robert P. Murphy makes the same observation as me about Krugman’s graph that was supposed to make us all skeptical of a stock bubble, right down to using the same FRED graph. Great minds think alike, you know.