Home > Uncategorized > Anatomy of a bubble

Anatomy of a bubble

from David Ruccio

I’ve been listening to and reading lots of financial pundits over the course of the past week—all of whom use the same lingo (the U.S. economy as the “cleanest shirt in the hamper,” the “deterioration in risk appetite” around the globe, and so on) and try to explain the volatility of the stock markets in terms of economic “fundamentals” (like the slowing of the Chinese economy, the prospect of deflation in Europe, and so on).

Me, I’m much more inclined to think of terms of uncertainty, unknowability, and “shit happens.”

Let’s face it: stock markets are speculative markets, in the sense that individual and institutional investors are always speculating (with the aid of computer programs) about how others view the market in order to make their bets—with fundamental uncertainty, unknowability, and the idea that shit happens. That is, they have hunches, and they have no idea if their hunches are correct until others respond—with the same amount of uncertainty, unknowability, and the idea that shit happens. And then all of them make up stories (using the lingo of the day and often referring to changes in the “fundamentals”) after the fact, to justify whatever actions they took and their advice to others. 

That’s pretty much the view outlined by Robert Shiller. It’s all about stories characterized by uncertainty, unknowability, and shit happens.

In general, bubbles appear to be associated with half-baked popular stories that inspire investor optimism, stories that can neither be proved nor disproved. . .

the proliferation of such stories is a natural part of economic equilibrium. Successful people who value their careers rely on an instinctive sense for what pitch will sell. Who knows what the truth is, anyway?

As time goes on, the stories justifying investor optimism become increasingly shopworn and criticized, and people find themselves doubting them more and more. Even though people are asking themselves if prices are too high, they are slow to take action to sell. When prices make a sudden drop, as they did in recent days, people tend to become fearful, even if there is a subsequent rebound. With the drop they suddenly realize that their views might be shared by other people, and start looking for information that might confirm their belief. Some are driven to sell immediately. Others are slower, but they are all similarly motivated. The result is an irregular but large stock market decline over a year or more. . .

It is entirely plausible that the shaking of investor complacency in recent days will, despite intermittent rebounds, take the market down significantly and within a year or two restore CAPE ratios to historical averages. This would put the S. & P. closer to 1,300 from around 1,900 on Wednesday, and the Dow at 11,000 from around 16,000. They could also fall further; the historical average is not a floor.

Or maybe this could be another 1998. We have no statistical proof. We are in a rare and anxious “just don’t know” situation, where the stock market is inherently risky because of unstable investor psychology.

I would only add one correction: we always “just don’t know”—not just in anxious situations of volatility (such as during the past week), but also in more stable periods. In fact, we don’t even know if we’re in a volatile or stable period (until a new story becomes the common sense that it was volatile or stable) and we certainly don’t know how one becomes the other (from stable to volatile and vice versa).

All we can say, when it comes to bubbles, is: shit happens.


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  1. Finance as warfare
  2. Piketty vs. the classical economic reformers
  3. Incorporating the rentier sectors into a financial model
  4. From the bubble economy to debt deflation and privatization
  5. How economic theory came to ignore the role of debt
  6. The use and abuse of mathematical economics
  7. U.S. “quantitative easing” is fracturing the global economy
  1. August 30, 2015 at 8:41 am

    The macroeconomics concept from Keynes is achieved and uptdated in “Money, how to flip the table off” (Amazon editor). I’ll answer to your text further, because it needs much time to think about it. Thanks. Louis Peretz

  2. August 30, 2015 at 10:30 am

    As a mathematician, this seems reasonable, but I’m not sure what is meant by ‘unstable investor psychology’. Has the psychology changed, or the situation? Take UK house prices. A year or two into a bubble house prices are growing ahead of other asset classes, and they still look affordable. But if house prices continue to forge ahead they will begin to look unaffordable for first-time owner occupiers. Maybe some new buyers (e.g. buy-to-let) will move in, but the situation is clearly not sustainable. Is it that the psychology will change, or that the psychology is fixed and the attitude will change, reflecting the changing circumstances?

    On the other hand, I have seen some stuff that suggests to me that Myers-Briggs ‘sensing-thinking’ types have been doing well in well-paid jobs. Maybe these types have increasing influence, leading to worse bubbles?

    • August 30, 2015 at 1:35 pm

      As I have noticed in my book, bubble can be avoid if you have two moneys inside a country. One usual for people, and an other, special financial one. So, if this one runs through banks, for people using, it will be easy to control its quantity. This software is already made for external currencies. It will be possible to use it for internal moneys. For an exemple, dollar will be used as usual, but Fdollars for only financial money, coming from Stock. It could be converted in dollars to buy every things and houses or load for people. There is not psychology neither mathematics in this software, only statistics. In this case, last crisis never happened. Do you think I can have a patent for this idea ?

  3. Dave Raithel
    August 30, 2015 at 4:19 pm

    I’ve read through the complete essay at the NY Times twice now, and I cannot get the clause “a natural part of economic equilibrium” out of my head. So give me a moment: Maybe others caught Jon Stewart’s (The Daily Show…) sign-off counsel to his fans – Watch out for bullshit. Others may recollect that Stewart was himself a fan of the philosopher Harry Frankfurt, who wrote a book about bullshit. I’m not sure that Shiller’s kind of “explanation” counts as bullshit, but it sure says nothing good about the stock market for social good. So, being irrational and acting in a panic and lemming like behavior is “a natural part” of getting to a better place? There’s gotta be a concept somewhere between “damning with faint praise” and “bullshit.” But it is no term of adoration.

  4. August 30, 2015 at 5:15 pm

    If you look for economics laws, try with the “2 nd principle of thermodynamics”. This is the basic law with which my book proves that Keynes was right. Of course this law is a mechanical one. But he finished his main book (General Theory…) saying that psychology has sommething to do with physical economics theory… As I did. You will never have responses about economics if you don’t know what he says. Good luck

  5. BC
    August 30, 2015 at 6:01 pm

    Bubbles for equities have been characterized historically by achieving or exceeding certain thresholds with respect to market cap to GDP, margin debt to GDP and market cap, and culminating with a terminal log-periodic, super-exponential blow-off trajectory.

    US equities have experienced now three distinct bubbles of unprecedented scale in 15-16 years, including the one today that is likely in the initial phase of bursting, i.e., an “anti-bubble” regime.

    Moreover, US real estate prices have historically been in bubbles when the real median house price reached a threshold above real wages and salaries per capita, which occurred in the late 1970s, late 1980s, mid-2000s, and today since 2013. In fact, the real median house price is as overvalued against real wages and salaries per capita as during the 2005-07 peak prior to the epic housing recession/depression in 2007-11.

    Finally, the S&P 500 has experienced a dozen or so coincident indicators that have simultaneously occurred only twice before in stock market history going back to the early 20th century: 2007 and 1929.

    Excepting the case of record non-financial corporate debt as a share of GDP, similar conditions also prevailed in 2000.

    Therefore, we have unambiguous coincident bubble indicators in stocks and real estate that preceded three of the largest stock market crashes in US history, two of which were deflationary recessions/depressions.

    Fed officials, TBTE bankers, Wall St., and financial media shills consistently claim that there are no bubbles or that it is impossible to recognize bubbles in real time, which is an indication of ignorance, incompetence, or deceit; and clearly it is the latter.

    If deception (or lying by omission, distraction, or otherwise) is the normative approach, then it begs the question of why monetary authorities and their legions of central bank- and Wall St.-employed eCONomists perceive the imperative to lie. Why?

    Why are financial bubbles tacitly encouraged, enabled, sustained, and consistently denied by the Fed as they are inflating to extremes and increasing the risk of financial instability, crashes, and fallout for the rest of the economy?

    What gives the Fed the credibility and legitimacy to promote successive bubbles, consistently deny their existence, and be required to resort to desperate means to “save the world” when the financial markets predictably experience existential crisis as a result of the bubbles?

    The Fed is often described my the Establishment narrative as having a moderating influence on the financial markets and business cycle, intervening in a timely and skillful manner to avoid capitalist “booms and busts”. Are they kidding?

    Since the early 1970s when the post-Bretton Woods fiat petrodollar regime began, the Fed has presided over following “boom-and-bust” phenomena:

    Three commodities bubbles and crashes;

    Four (including today) real estate bubbles in the late 1970s, late 1980s, mid-2000s, and since 2013;

    The US$ crashing 85-90% and 80% in CPI terms against gold;

    Four of the largest stock market bubbles and crashes in history in 1973-75, 1987, 2000-02, and 2007-09, and likely about to be the fifth crash;

    Three of the worst recessions in US history in 1973-75, 1980-82, and 2007-09;

    Continental Illinois collapse, the S&L Crisis, LTCM implosion, and Bear Stearns and Lehman wipeouts;

    Unprecedented private and public debt to wages and GDP, including a record for non-financial corporate debt to wages and GDP;

    Total US public debt to GDP exceeding 100%; and

    Gilded Age-like wealth and income inequality;

    Other than someone who seeks to participate in the deception, how can anyone argue that the Fed does not encourage, facilitate, and rationalize reckless financial risk taking by TBTE banks and Wall St., successive financial bubbles, and financial instability, and then be compelled to print hundreds of billions of dollars of fiat digital debt-money credits for bank reserves to bail out the complicit TBTE banks?

    Following this line of inquiry compels one to scrutinize the self-interests, values, motives, objectives, world view, expectations, and actions of the principal architects, facilitators, and beneficiaries of the elaborate deception. What are they attempting to achieve by constructing and reinforcing such a deceptive narrative? Who wins? Who loses?

    We look with eyes wide shut upon the corrupt, deceptive institution of the Fed, its principal objective being to run political cover for its TBTE banks’ owners’ license to steal via reckless financial speculation and bubbles. The TBTE banks’ managers and owners act with complete confidence that they will not be held accountable for the fraud in which they engage and the instability they create in the process of their legalized theft. And they know that they will be covered by the Fed and the US gov’t they own for losses they incur from their reckless activities.

    Finally, consider the appointment of Yellen (and Bernanke before her) as The Chair of the Fed in the context of the foregoing. She is intended to serve as a “kinder and gentler”, grandmother-like political face as deceptive cover for the TBTE banks’ fraud and theft. How can one critique or scrutinize the Fed when Bubbe Janet is presiding over the TBTE banks’ QE and “forward guidance” (the many little lies we are conditioned to tell ourselves)?

    Surely Bubbe Janet wouldn’t lie to us, would she? But if she is lying, she must be doing so for our benefit, yes?

  6. August 30, 2015 at 6:51 pm

    In my view,
    financial bursting bubbles and car accidents have a lot in common:
    A whole bunch of conditions conspire to make an actual accident more likely.
    Then, additional, timing related matters add up to produce the actual accident.
    Both bursting bubbles and car accidents happens in accordance with natural law.
    And they can both be minimized with appropriate enforced regulations.
    Glass-Steagall comes to mind.

  7. BC
    August 30, 2015 at 11:00 pm

    Helge, yes, but who will enforce such regulations at this point? The predatory rentier and bankster foxes own the chicken coop and hire the foxes to guard it, so to speak.

    The so-called Progressive eCONomists and other public intellectuals and mass-media influentials have been co-opted, intellectually and professionally neutered, and rewarded in many cases for their silence (reluctance to speak up or frame a comprehensive critique).

    We have the likes of Keen, Hudson, Black, Kelton, Wray, et al., espousing various merits of MMT/charlatism and discussing the bankster fraud, regulators complicity, and debilitating aspects of excessive private debt to wages and GDP; but their work is perceived by the rentier top 0.001-1% as naive, irrelevant, and harmless at best to potentially dangerous among some on Wall St. and in DC.

    There is no constituency at present for an alternative to private fiat debt-money created and owned by the owners of the private, gov’t-sponsored hedge funds known as the largest int’l commercial banks and primary dealers of US gov’t debt. They are the definition of non-productive, extractive, parasitic predators with virtually no checks on their reckless activities, apart from themselves.

    In effect, they now possess a virtual perpetual claim on all US labor product, profits, and gov’t receipts for social goods forever. Thus, there can be no growth or real GDP per capita in perpetuity after net flows to the financial sector and its owners.

    The wealth and income inequality that has resulted from the deindustrialization and hyper-financialization (having spread the world over by now) of the economy, society, and political system is obscene and pernicious. The vast majority of the polity cannot take responsibility for self-harm because the process evolved without any semblance of popular mandate or even informed acquiescence of the larger public.

    Rather, the bourgeois professional middle class DID consciously (presumably) acquiesce to, and thus tacitly affirm, enable, and benefit from, the multi-decade-long process of deindustrialization, financialization, militarization, and globalization/empire, resulting in MASSIVE private and public debt to wages and GDP; a record low for labor share to GDP; Gilded Age-like inequality; the elites disengaging from productive economic activity, abandoning the social contract, and becoming increasingly insensitive to the plight of the bottom 90%+; and the top-down moral, ethical, intellectual, and political values of the elites reflecting rentier speculation/gambling, rapaciousness, cynicism, parasitism, and sociopathy.

    • August 31, 2015 at 1:53 am

      The opportunity for change will come when this top heavy system crashes.

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