Can speculative bubbles occur in the unhampered market? Certainly there would be relatively less, but is there any merit to the notion of so-called positive-feedback loops in the absence of credit expansion? Is it really impossible, in absolute terms, for a speculative bubble to exist without it being financed by credit expansion?
I've searched the forum and have come across a few threads that didn't delve too deeply into this question, so I hope this thread might really dig into it a little more.
I know that some French guy published a book about speculative bubbles that says that Tulipmania was really a result of newly circulating money (forgive me, I haven't gotten around to reading it yet so I don't yet know the specifics), but had the money supply been more stable, could such "irrational" behavior still have occurred?
Assume the total of all prices in an economy are set by a stable supply of money and credit.
Then assume that prices for rubber bands starts to rise.
What will happen to all of the other prices in the economy? I think prices will fall for other goods and services as purchasing power is directed to rubber bands.
What happens to demand as prices increase (rubber bands) and decrease (other goods)?
If you find something evil that wobbles, push it. - Gary North
liberty student: Assume the total of all prices in an economy are set by a stable supply of money and credit. Then assume that prices for rubber bands starts to rise. What will happen to all of the other prices in the economy? I think prices will fall for other goods and services as purchasing power is directed to rubber bands. What happens to demand as prices increase (rubber bands) and decrease (other goods)?
Technically that's definately correct, but in a complex economy this feedback is not quick enough to prevent every speculative bubble. But in a way, every decision that turns out to be wrong ex post is a very tiny bubble. Capitalism is just very good at bursting these bubbles as fast as possible to prevent systemic risk. But there is no reason to believe that therefore ther could never be any bubble.
Of course there could occur some bubbles on a truly free market. Since no single person can know what the future will be like, it is always possible that a large number of market participants will make wrong forecasts and hereby create asset bubbles.
The only difference is that, on the free market, the occurence of a speculative bubble will cause interest rates to rise, since there is an increasing demand for savings, whereas the supply for it has shrunk. That higher interest rate will make the bubble burst before it can become really harmful.
However, in a FRB system like ours, the central bank can keep interest rates down for a long time. During this time, the asset price bubble can grow without any resistance and thereby become a huge threat for the economy.
Yes, but technically no.
Yes in that there may be a rush towards a good that drives the price of that good really high (which is subjective,anyway) compared to the recent price history. But technically no because there is no intrinsic value.
My favorite online shop: www.cafepress.com/libertyphile
Tobbog: Of course there could occur some bubbles on a truly free market. Since no single person can know what the future will be like, it is always possible that a large number of market participants will make wrong forecasts and hereby create asset bubbles. The only difference is that, on the free market, the occurence of a speculative bubble will cause interest rates to rise, since there is an increasing demand for savings, whereas the supply for it has shrunk. That higher interest rate will make the bubble burst before it can become really harmful. However, in a FRB system like ours, the central bank can keep interest rates down for a long time. During this time, the asset price bubble can grow without any resistance and thereby become a huge threat for the economy.
Heh -- I think the protocol is that someone else is supposed to suggest your post as the answer.
What do you mean an increase in the demand of savings? Does that mean people are demanding loans more so that they might be applied to buying more of the bubbly asset? And supply of loans has shrunk because potential loaners have decided to put their money into the bubbly asset?
On a side note, is it fair to say that the flight to gold that's currently going on right now has the qualities of a speculative bubble? As much as I like seeing an increased interest in gold, who's to say that it won't be followed by a debilitating price decline?
Alex M: Can speculative bubbles occur in the unhampered market?
Can speculative bubbles occur in the unhampered market?
Yes, 95% of them occur on the race track.
Alex M:Can speculative bubbles occur in the unhampered market? Certainly there would be relatively less, but is there any merit to the notion of so-called positive-feedback loops in the absence of credit expansion?
Yes, certainly. But the size of the bubble (market size x overvaluation) is constrained buy the money supply. So if the bubble occurs in a tiny sector (e.g. fine art) then the degree of overvaluation can be very high, whereas if its a large sector (housing) then the bubble is far more constrained.
Alex M:could such "irrational" behavior still have occurred?
I don't believe the behavior is so irrational, see here.
"What do you mean an increase in the demand of savings? Does that mean people are demanding loans more so that they might be applied to buying more of the bubbly asset? And supply of loans has shrunk because potential loaners have decided to put their money into the bubbly asset? "
Exactly. You might also say that during times of speculative bubbles, time preference increases which always causes an increase in interest rates.
"On a side note, is it fair to say that the flight to gold that's currently going on right now has the qualities of a speculative bubble? As much as I like seeing an increased interest in gold, who's to say that it won't be followed by a debilitating price decline?"
I think that's hard to predict. The good news is that the gold rush doesn't seem to depend on the FED's printing presses. As far as I see it, most gold bugs speculate on hyper-stagflation (= economic stagnation + inflation). If that will be the case, the gold price is still way too low. If not, we are just experiencing a gold bubble that is doomed to bust.
Tobbog: You might also say that during times of speculative bubbles, time preference increases which always causes an increase in interest rates.
You might also say that during times of speculative bubbles, time preference increases which always causes an increase in interest rates.
Hmmm... I'm mostly familiar with the way Rothbard used the term "time preferences" from Man Economy and State, and I got the impression that time preferences, as the causal force behind interest rate determination, weren't really all that susceptible to changes in market conditions. I think his example of something that might affect time preferences is, for example, a looming feeling of impending doom, perhaps due to nuclear war, which would tend to cause people to want to consume now vs. save for later, since they think they might die before they might reap any benefits from the investment. I guess I'd hesitate to say that time preferences increase during a speculative bubble, since it really just seems like interest rates increase due to, like you said, rising demand and lower supply of savings, in other words, changes in the marketplace. Do I misunderstand the term "time preference"?
Alex M:Can speculative bubbles occur in the unhampered market?
No.
At most, 5% of the population would need to stop complying to bring down the government.
Alex M:I think his example of something that might affect time preferences is, for example, a looming feeling of impending doom, perhaps due to nuclear war, which would tend to cause people to want to consume now vs. save for later, since they think they might die before they might reap any benefits from the investment.
If people fear that they might die in the near future, their time preference will rise of course, but that is by far not the only reason for a change in time preference. During times of speculative bubbles, many people follow Get-Rich-Quick schemes, they become greedy and dumb at the same time. They will plunder their children's college fund and take on huge piles of debt because they think they might get rich by investing in Florida appartments or internet companies or whatever.
Alex M:it really just seems like interest rates increase due to, like you said, rising demand and lower supply of savings, in other words, changes in the marketplace.
I think in theory it's possible, but credit expansion or leverage is usually the driver.
There is one commodity that creates havok, and that is securitized debt. I don't think it has been given the attention it deserves.
MBS, CDO, CDO-squared, etc, purchases were made in the absense of price signals. There was big demand for them, and in order to fill that demand, outrageous methods were used to create the debt to sell. There was a complete decoupling of house prices from the debt instruments, and the instruments were designed to be opaque. Massive fraud ensued.
Excess liquidity and easy credit are behind all bubbles that I can think of.
"Bubbles" would not occur. However, it is possible that financial assets could be mispriced, since some information was not revealed through the price structure. When the new information is revealed, then there would have to be a repricing of the mispriced financial assets.
Mises Community Natural Rights Discussion Group
Like a moving platform under your feet driving you backward, FRB and printing money forces you to keep running ("investing", taking risk) lest your wealth evaporates before your eyes. Rarely does anyone ask why we have to keep "investing" (constantly searching for the next big thing, "asset allocation") just to protect the fruits of our labor (savings). The only risk-free asset is cash, but with it you are GUARANTEED a huge loss under FRB. So the alternative is to "follow" the sloshing of "liquidity", or pay someone (financial services) to advise you of the next liquidity wave so you can "jump" on it in a risky attempt to merely KEEP what you already have. An utter waste of wealth and human effort.
Given the above, there's nothing irrational about jumping onto a large, liquidity-driven, asset trend. It's actually very rational to try to be a beneficiary rather than a victim of a system. Through the above mechanism FRB re-allocates wealth from prudent savers (victims of inflation) to speculative borrowers (liquidity wave-riders, beneficiaries) and is all the more immoral for it. Without it, everyone would be able to KEEP their nest-eggs risk-free, thus the need for jumping on waves would diminish providing much less fodder for bubbles.
Z.
Ludwig von Mises Institute | 518 West Magnolia Avenue | Auburn, Alabama 36832-4528
Phone: 334.321.2100 · Fax: 334.321.2119
contact@Mises.org | webmaster | AOL-IM MainMises
Mises.org sitemap