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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