Home > Uncategorized > Bubbles: are they back?

Bubbles: are they back?

from Dean Baker

There has been much greater concern about the danger of asset bubbles ever since the collapse of the housing bubble sank the economy. While it is good that people in policy positions now recognize that bubbles can pose a real danger, it is unfortunate that there still seems very little understanding of the nature of the problem.

First, an economy-threatening bubble does not just sneak up on us. Often the discussion of bubbles implies that we need some complex measuring tools to uncover an economy-threatening bubble that’s lurking in some far corner of the data.

This is absurd on its face. If a bubble is large enough to threaten the economy, it is hard to miss. This was true of both the stock bubble in the 1990s and the housing bubble in the last decade.

At the peak of the stock bubble in 2000, the ratio of stock prices-to-trend corporate profits was more than twice its long-term average. This may have been justified if there was an expectation that profit growth was going to be much faster in the future, but almost no economic analysts projected this speed up.

Higher price-to-earnings ratios could also be justified if stockholders were prepared to accept lower returns on their stock than they had in the past. But there was no evidence this was the case. In fact, most stockholders seemed to expect that the double-digit returns of the recent past would continue.

In the case of the housing bubble, inflation-adjusted house prices had risen by more than 70 percent above their long-term trend. This unprecedented run-up in house prices occurred at a time when rents were essentially moving in step with the overall rate of inflation, suggesting that there was no major shift in the fundamentals of the housing market. Furthermore, vacancy rates were already at record highs even before the bubble burst, providing clear evidence that house prices were not being driven by a shortage of housing.

And, both bubbles were clearly moving the economy. In the case of the stock bubble, investment hit its highest share of GDP since the late early 1980s, as start-ups were taking advantage of sky-high share prices to finance crazy schemes. Also, the wealth generated by the stock bubble led to a surge in consumption that pushed the savings rate to a then-record low.

In the case of the housing bubble, high prices led to a flood of new construction, raising the residential investment share of GDP to almost 6.5 percent, compared to a long period average of less than 4 percent. The wealth created by the housing bubble led to an even larger consumption boom than the stock bubble.

All of this was easy to see from widely available government data sets. It required no more than an Excel spreadsheet to analyze these data. So this was not rocket science, it was basic economic logic and arithmetic.

Should we be concerned about a bubble now? Stock prices and housing prices are both high by historical standards. The ratio of stock prices-to-trend corporate earnings is more than 27-to-1; this compares to a long-term average of 15-to-1.

House prices are also high by historic standards. Inflation-adjusted house prices are still well below their bubble peaks, but are about 40 percent above their long-term average.

In both cases, these markets are high, although in ways that are at least partly explained by the fundamentals of the market. In the case of stock prices, the profit share of GDP is almost 30 percent above its trend level. If this persists, then the ratio of prices-to-earnings is much closer to the long-term average. Of course, a big cut in the corporate tax rate increases the likelihood that a high-profit share in GDP will continue.

Extraordinarily low-interest rates (both real and nominal) also mean that stocks provide a relatively better return compared with alternatives like bonds and short-term deposits. This also would change if interest rates rise substantially, but for now, that doesn’t seem likely.

The run-up in house prices also seems less disconcerting when we consider there has been a parallel run up in rents. While rents have not increased as much as house prices, they have been substantially outpacing the overall rate of inflation for the last five years. Low-interest rates would also help to explain house prices being above long-term trends, as they justify a higher ratio of sales prices-to-rents.

Here also, there is a risk that higher rates could send prices tumbling. This could be an especially bad story for moderate-income homeowners, since the bottom tier of the housing market has seen the largest price increases over the last five years.

But even in a bad story, where for example higher interest rates send both stock and house prices back towards their trend levels, we don’t have to fear an economic collapse and probably not even a recession. The high stock market is not driving investment, which remains very modest despite near record-high after-tax profits. Housing construction has come back from its post-crash lows, but is roughly in line with its long-term average share of GDP.

The loss of trillions of dollars of wealth would be a hit to consumption. Consumption has been unusually high in recent years with the savings rate averaging just 3.6 percent of disposable income in the last year. A more normal savings rate would be closer to 6 percent. But even if the savings rate were to rise to 6 percent over a span of a year or two, it would likely dampen growth rather than cause a recession.

In short, there is little reason to think that the economy is threatened by the risk of collapsing bubbles at the moment. This doesn’t mean that holders of large amounts of Bitcoin or Amazon stock may not have something to worry about, but most of us don’t.

See article on original site

  1. December 19, 2017 at 4:45 pm

    Well Dean, just a few days ago, I got the great news from Social Security, me and some 60 million other recipients. My monthly payment is very close to the average for retired persons, so I’m in the mainstream. Here’s the great news: my benefits went up a dollar! I’m sure to pump that one dollar baby right into the national income flows, and I sure hope that me doing so, along with millions of others, doesn’t cause any bubbles in “retail” or “restaurants.”

    We don’t have the news yet from the calculators what the Medicare B deductible will be for 2018. In 2017 it jumped up to $183 from $166 previous year, which doesn’t sound like a lot, except there have been no significant increases in Social Security payments to offset it.

    Cheers while we ride this great economy into the sunset of our golden years.

    • Risk Analyst
      December 19, 2017 at 6:29 pm

      I heard almost exactly the same story from my relatives except they prefaced it by complaining about local utility rate increases. In the context of bubbles and whether the Fed is about to raise rates, this kind of discussion highlights how blunt an instrument it is to use interest rates for policy. Elsewhere there is a story (Harris) saying rates should not be raised because of potential impact on asset prices. But the population is not uniform, and there are many who have no such investments, are not in the job market and are earning next to nothing on CD rates due to low interest rate policy. Monetary policy has severe redistributive impacts across generations, industries and income groups.

  2. December 19, 2017 at 5:12 pm

    While the economy rides us into its golden years.

  3. Rob Reno
    December 19, 2017 at 5:30 pm

    We are taking our overpriced bubble inflated house (which we paid off) to fund our transition to Canada (where we can buy a whole lot more house and land) and support our children in their emigration away from this “great economy” towards graduate and medical careers.

    • Rob Reno
      December 19, 2017 at 5:33 pm

      “graduate studies and medical careers in Candada.”

  4. December 19, 2017 at 5:49 pm

    I’ve been producing and hosting the Web-accessible Economic Solutions TV series for nine years, and have been trying to figure the present situation out — what with stock buy-backs, P/E ratios, and many other variables. And Dean, your brief analysis makes excellent sense and agrees with why Ray Dalio remains untroubled, too, so long as the Fed doesn’t raise interest rates too steeply. So maybe we’ll invite you to appear on the program, via electronic communication, if you might be willing to consider that.

    Gracchibros, your points are also well taken. Social Security payment changes are keyed to the CPI; and costs of biggest ticket items like housing, health care, and higher education have been escalating at much higher rates than that. Of course, higher education is still not considered an essential consumer cost in the USA, and certain Scandinavian and European countries provide higher education — as with health care — as public services at no direct cost to the individual. Those nations also score highest in world happiness studies, too. So let’s hope that social science findings more and more replace ideologies in America, over time. But the question is, how long will that take — given currently increasing American rigidity, characterized by such things as a recent Pew Research finding that 58% of U.S. Republicans and 32% of Democrats currently believe universities are making no significant contributions to national well-being? Talk about needing education and recovering more reason!

    • December 20, 2017 at 2:32 pm


      Thank you; let me address this to you and to Dean Baker; it may seem a little off topic from a discussion on bubbles and by implication Minsky moments, but I think I can link the two.

      I brought up the reality of Social Security payments being stagnant, but the out of pocket deductible that must be paid by Medicare recipients before the program kicks in keeps going up.

      In Dean’s work on productivity and the minimum wage, I remember him writing in the early part of this decade that had labor’s missing share of productivity gains and inflation both been factored into increases in the minimum wage, it should be now somewhere between $22-$26 per hour. Since the cutting edge progressive proposals are now pointing towards just $15 per hour phased in over a number of years, consider this: a Social Security “bonus” increase of 5%, which would come in around $65 per month, $780 per year, from the baseline of the median recipient getting about $1300 per month. I use the term “bonus” to link to the Bonus Marchers of the 1932 last days of the Hoover Administration , veterans of WWI who had been promised a bonus well pushed into the future…but who marched to demand an advance due to the hard times of the Great Depression. They were gassed and chased out of their DC encampments by the US military.

      Why should SS recipients today get such a “bonus?” Because the calculations leading to the $1300 monthly average are based on one’s earnings, and many were in the workforce like I was from 1972 to the present, and thus because labor’s share of productivity gains contracted, to put it mildly, during this period, and were not made up by increases in the minimum wage until the very current campaign, and Dean is more optimistic than me that he sees Chauncey Gardner “greed shoots” today on wages and productivity gains – are we not due our missing wages from all these poor decades, skimping on labor’s share? These dismal dynamics had a direct impact in keeping our retirement payments down, less than they should have been.

      And isn’t this also a means to counteract bubble formation, to give a small increase to so many who will spend it not on stocks and bonds, but on the necessities that they cannot now reach, and even to meet what the Fed’s own studies revealed, affecting the feelings of so many 40-60% of the population, once of the basic questions of the 2016 election, answered so unhappily for our nation, by those who don’t have the savings to meet a $400 economic emergency?

      So let’s get the new bonus marches started. What do you say, Dean, based on your solid reasoning from just a few years back?

  5. December 20, 2017 at 12:12 pm

    As with roulette or black jack, the thing that separates winners from losers in the bubble is when you cash out. And that’s mostly chance, not skill. And as with roulette and black jack bubble economies are zero-sum games. If you win, someone else must lose. This is a recipe for a profitable casino; not a recipe for a strong and democratic national economy.

  6. December 20, 2017 at 7:14 pm


    Yes, there’s a lot of evidence (such as collected by Thomas Picketty, for example) that a prosperous middle class provides healthy overall demand for goods and services, and also promotes relatively more stabilized economic growth and comparatively lower depression risks. And more valid Social Security payment adjustments, than current ones, would be needed for more viable living standards and macroeconomic well-being.

    Along with professionals like Dean Baker and Ray Dalio, Nouriel Roubini had also predicted the 2008 crash; and his book “Crisis Economics” proposes a number of prescriptions to help reduce economic bubbles via regulations, as well as to promote recovery successes when bubbles do emerge. Additionally, capitalism itself should not be conceived as a monolithic system, where broad-brush cure-alls apply in dealing with its various fluctuations, vacillations, aberrations and caprices. Rather, there are systemic variants such as market, regulated, civic, and even crony. (My WordPress thread, “True or False in Economics?” addresses some of this.)

    Here’s a chart Nick Hanauer presented, which shows more like $44/hour than $22 to $26, if measuring from 1979: http://www.businessinsider.com/nick-hanauer-ted-presentation-about-why-rich-people-arent-job-creators-2012-5?tru=JIB0D#household-income-hasnt-come-close-to-matching-the-overall-economy-11

    Here are a couple other notable presentations, which contrast GDP per capita with median wages: https://aneconomicsense.org/2015/02/13/why-wages-have-stagnated-while-gdp-has-grown-the-proximate-factors/

    Dean Baker:

    What do you think of Roubini’s bubble-dampening and economic recovery approaches? And might you be willing to discuss your own analyses, projections and prescriptions on an Economic Solutions program? I’m thinking of an episode that could be entitled something like, “Current Economic Outlook and Any Needed Steps.” What do you think? For reference, here are a couple previous ES episodes: https://www.youtube.com/watch?v=mDgKdF-oIEw

  7. December 20, 2017 at 7:17 pm

  8. December 20, 2017 at 7:26 pm

    Sorry, folks, I’m having trouble with repeating the same video link, rather than adding a different one. Maybe an administrator could delete the redundant one, and here’s the second video: https://www.youtube.com/watch?v=mDgKdF-oIEw

  9. Rob Reno
    January 8, 2018 at 7:06 pm

    The run-up in house prices also seems less disconcerting when we consider there has been a parallel run up in rents. While rents have not increased as much as house prices, they have been substantially outpacing the overall rate of inflation for the last five years. Low-interest rates would also help to explain house prices being above long-term trends, as they justify a higher ratio of sales prices-to-rents…. But even in a bad story, where for example higher interest rates send both stock and house prices back towards their trend levels, we don’t have to fear an economic collapse and probably not even a recession…. In short, there is little reason to think that the economy is threatened by the risk of collapsing bubbles at the moment. This doesn’t mean that holders of large amounts of Bitcoin or Amazon stock may not have something to worry about, but most of us don’t. ~ Dean Baker
    Over twenty years ago my wife and I purchased a house in a middle class neighborhood consisting of may workers from Boeing and other blue-collar trades. We both worked at Microsoft as software engineers and while we could have afforded to purchase a house near to the Redmond campus if we wanted to take on more debt, we chose to be fiscally conservative and purchase a home that only required one income to sustain it. As we watched the run-up to the 2007-2008 Financial crisis caused by the housing bubble and reckless banks and financiers, we were repeatedly contacted by the Big Banks “contingent” workers (third party mortgage brokers feeding the banks refinanced secondary mortgages etc.). My background before I went into software engineering was business/accounting/finance. We well knew we were in a bubble and that the escalating housing prices were unsupported by any real material value underlying them. So one day, for giggles and kicks, we invited one young lady who cold called us to come and flip her charts for us. She sat down at our dinner table and proceeded to flip through cartoonish charts repeating the mantra of how much we could save on our monthly payments if we only switched from our 30 year fixed to one of the banks predatory subprime products. Not a word was said about the inherent risk of such predatory financing. I asked the young women, “Which one of these products do you have?”, and she naively informed me how she too was saving money with one of these subprime-debt-traps. The young women clearly had no idea what kind of toxic time bomb she was selling. One of fellow co-workers actually went and got his mortgage broker license so he could cash in on this rising bubble (he paid dearly for swallowing he speculative bait in the long run). We watched foreclosure signs pop up in our neighborhood for our neighbors that drank this toxic Kool-Aid. I had to ask myself, how many working poor and middle class family wage earners were scammed into switching from an affordable 30 year fixed mortgage (albeit times may have been tight, but they still could manage) into accepting one of these predatory subprime products simple because they were not financially savvy enough to realize that the short-term incremental saving in monthly payments was outweighed by the risk they were unknowingly taking on?

    Skip ahead to today. Our house is paid off and over years since the 2007-2008 Financial Crisis we have watched the homes in our neighborhood go from owner owned to investor owned. I know some of these investors because I am kind of chatty guy and I approach them when they are working on their homes between renters. Many of these homes look like shit and are hardly maintained, yet are commanding huge rents. One of these investors has a home that is the exact mirror image of our floor plan and rents it out for almost $3,000 per month and that doesn’t include deposits etc. Naturally few family-wage earners could afford that kind of rent unless both are working, so mostly these homes are filled by young people unrelated sharing the rent. Sometimes multigenerational families pool resources so they can afford these huge rents. In fact, just this morning while walking my dog I met one of those neighbors who is in just such a situation. She informed me they could no longer afford to pay the rent demanded by the investment company because it was constantly going up (along with pet deposits and other such deposits), so they were moving farther away from where they work to areas more plagued by poor schools and high crime; they have no choice. It is easy to spot the investor-owned homes; they are the ones with the shitty paint jobs, falling down gutters, overgrown lawns, trash in the yards and otherwise slumlord like appearances. Just the other day I got one of those predatory investment buyers letters (WeBuyHouseFastBullshit.com) describing a litany of reasons why I should sell my house to them (they know we paid off our house recently); including a list of every possible life crisis a homeowner might find themselves in). With the sky rocketing housing prices in the Seattle are we get a few doctors purchasing houses; our new neighbor across the street is one. But she is having second thoughts already now. It doesn’t take long to see the gradual rot; we are now very careful how much investment we make in home improvement and we ourselves no longer intend on staying.

    Forgive me Dean if your confidence looks a lot like a Greenspan Put. We’re just not feeling it.

    • Rob Reno
      January 8, 2018 at 7:15 pm

      The good news is (if we manage to execute fast enough) is that the escalating housing prices mean we potentially can make a huge profit if our timing is right when we cash out and fund our move to Canada where we will create another startup.

    • Risk Analyst
      January 8, 2018 at 8:47 pm

      There is significant downside risk. The frameworks that you and Dean rely on are right out of the neoclassical finance textbook of looking at a dividend discount model (references to interest rates and rent) and comparables (prices versus trend comments). So when discussing economics in abstract we look to heterodox theory, but when doing serious finance that matters for us personally we fall back on neoclassical? You might want to incorporate expectations and animal spirits here in addition to non-heterogeneous agents. The wreckage of the previous recession is still a fear factor and recession may cause a Fisherian downward spiral that could be quite vicious with investors cashing out to avoid memories of 10 years ago or stories from their parents. There could be a bit of a razor’s edge to these prices. In addition, much of the price increases in Western urban Canada are due to Asian money flooding in for various reasons, and such a one-factor explanation can reverse itself quickly. I am not forecasting such adverse scenarios, but I do believe that there is a heightened risk that a plain vanilla slowdown or recession, when it comes, may be a bit different this time.

      • Rob Reno
        January 8, 2018 at 9:45 pm

        I’m not sure I know enough about economics to even know what framework I rely on Risk Analyst ;-) Yes, I completely agree with “animal spirits” indeed.

        “The wreckage of the previous recession is still a fear factor and recession may cause a Fisherian downward spiral that could be quite vicious with investors cashing out to avoid memories of 10 years ago or stories from their parents.”

        We are fully aware of the inflow of rich Asians driving up the price of housing in Vancouver. I think you are right on that point. Yes, if local community takes appropriate action to stop this influx of wealthy Chinese driving up housing prices, which I think is a wise thing to do, the situation could change. You make a good point.

        I am a home owner, not an investor. My only (laymen) observation is that as investors are purchasing up homes in middle income neighborhoods where I live it is creating a situation where, it seems, we are increasing living in a community of slumlords and should a sudden shock hit the system it may well be catastrophic. Not to mention I don’t thinks this is how to build a strong middle class. Many of those renting are on the low-wage-hump of the Dual Economy. Those who can afford are leaving, which my intuition is leaving more and more debt burdened renters who will slowly be pushed out.

      • Rob Reno
        January 8, 2018 at 9:51 pm

        Correction: “non-community of slumlords.”

      • Rob Reno
        January 8, 2018 at 9:55 pm

        Was it “animal spirits” or “foresight” that kept us from drinking the Kool-Aid of accepting cheaper monthly payments for risky suprime loans? I had friends in Msft who made lots of money speculating this way, and some that lost their homes (and families). They were the cash-rich one’s that bought multiple homes or million dollar homes on these predatory subprime products. Who as acting on “animal” spirits and who was acting rationally?

      • Risk Analyst
        January 8, 2018 at 10:08 pm

        I did not want to go there and so ignored that issue, but since you brought it up I agree there were and are very perverse outcomes in which many (either well educated or risk averse) ended up much worse off than the clueless or gamblers. If you wisely bought a smaller house that either spouse could afford independently, then many others who drank the cool aid as you say ended up making much more money depending on where they bought in the cycle. No one says life is fair, but then money is a very poor metric for measuring success, respectability or happiness.

  10. Rob Reno
    January 8, 2018 at 11:17 pm

    “No one says life is fair, but then money is a very poor metric for measuring success, respectability or happiness.” Completely agree ;-) Especially with the ‘metric’ part! Thanks for being brave enough to speak honestly.

  11. Rob Reno
    March 13, 2018 at 6:15 pm

    Are we still in the sweet zone Dean? Does a despotic demagogue taking us on the path to global conflict (a distinct possibility given the new SOS) figure in anywhere in the bubble analysis?


    • Craig
      March 13, 2018 at 6:39 pm

      Yes, all the more urgent that we implement a 50% discount at the point of retail sale (the point of retail sale for a home is the builder so a $200k home would then cost only $100k thus effectively integrating price deflation into the economy. And if we were smart enough and honest enough to confront the fact that private finance is a destabilizing, illegitimate, post retail sale and thus completely parasitical flow of additional costs we could thus make finance a public utility that could be added to retail sale you could reduce that to $50k.

      Monetary Gifting is the new paradigm that will save financially dominated profit making systems from its own cost inflationary collapse.

      • Rob Reno
        March 13, 2018 at 7:35 pm

        While I commend your idealism Craig I cannot help but note your ideas are impractical and therefore render your enthusiasm useless in solving real-world economic problems. Simply repeating yourself endlessly, dismissing legitimate questions of how one gets from the less than ideal to the ideal in a real world, renders you merely an intellectual parrot. In time no one takes you seriously as you are incapable of thinking outside your own minds “paradigm” long enough to render it practical within the world we find ourselves. Material wealth flows in certain channels and the ability to recognize those channels and work within the pragmatic real-world structures we find ourselves is the only way we incrementally advance towards the ideal—assuming it is a good one and worthy of our striving. Utopian solutions seldom in history have turned out well. It might serve you to consider why that is? No doubt, you will retort I do not understand, as that seems your position of last resort when challenged with the lack of pragmatic specifics of how one advances from the less than ideal to the ideal. Alas we live in a less than ideal world and no matter how much wishful thinking we engage in we must work out our ideals with and among our fellows, and that inevitably means social compromise.

      • Craig
        March 13, 2018 at 9:50 pm

        Utopias are not real. However, Wisdom (the integration of opposing truths) is also the best integration of the practical and the ideal. If we can over night create a Federal Reserve that backs finance when it takes leave of its moorings like it did leading up to the GFC, then with an intelligently lead mass movement of self interested constituencies we can just as easily implement a discount rebate policy and a balancing monetary authority to fund it.

        There’s nothing impractical about that, and all it really takes is for one to act out the discount/rebate policy in one’s mind or with two other people until one sees how real its effects actually are. Some times lingering orthodoxies and current paradigms die only with repetitive efforts…but when the benefits finally hit you….it’s called the breakthrough AKA paradigm change.

        Finally, compromise with a dominant force when a solution is actually available is not only stupid, its completely unethical. Please consider that truth.

      • Rob Reno
        March 13, 2018 at 10:48 pm

        You operate in a world comprised of Craig, making up your own definitions divorced from common sense. Your simplistic definition of wisdom is less than wise. You must have a very wise mouse your pocket, because if you really believe you and your mouse (clearly you foolishly think the rest of the world is going to suddenly wake up and join you and your pocket mouse) can overnight create your ideal world (you grossly oversimplify and stereotype “paradigm change”) you are as naïve as Don Quixote chasing windmills. Science, knowledge, leads to fact consciousness; religion, experience, leads to value consciousness; philosophy, wisdom, leads to co-ordinate consciousness; yet you ignore the fact that social change is evolutionary—it takes time. This shows you have failed to evolve wisdom capable of co-ordinate consciousness. The search for wisdom is philosophy (the love of wisdom). No social ideal is achieved without the cooperation of one’s fellows. Unless you intend to create a commune of like-minded idealists, your idealism remains divorced from pragmatism, which means if fails the test of wisdom-coordination. But don’t mind me, keep right on chasing windmills ;-)

      • Craig
        March 14, 2018 at 12:20 am

        Ad hominem? That was a curious combination of agreement with what I say and then turning around and disagreeing with the same thing. And by the way you apparently missed that I said we needed a mass movement, of the aware and self interested not some assumed commune of wide eyed idealists, to get the imminently workable policies I post here implemented.

        Economists and pundits need to focus more on the temporal universe effects of policies implemented in a breakthrough time and place instead of going on and on in erudite ways about their hobby horse theories and telling those who are anything but wet behind the ears that they are naive.

        I know you’re well intentioned like everyone else here and I should have ignored the critique. Pardon.

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