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Tuesday, October 4, 2022

Bubble Redux?

Date: Wednesday, September 30, 2009
Author: John Cassidy, The New Yorker

An interesting piece in the Financial Times asks whether the recent revival in the markets amounts to another speculative bubble in the making. “The rally has been achieved with global economic growth barely above zero and unemployment still rising,” John Authers notes. In valuation terms, the U.S. stock market remains well off its historical peak, but other indicators are more favorable to the bubble thesis. With short-term interest rates at or close to zero in many countries, cheap money is fuelling the rise in asset prices. Once again, as in the period from 2003-2006, the Fed is promising to keep interest rates low for an indefinite period.

My own view is that we aren’t in another bubble…yet. This time last year, Wall Street was in a state of panic, and the global economy appeared to be on the brink of another Great Depression. The subsequent coördinated rescue operation, during which Western governments committed about nine trillion dollars of taxpayers’ money in bailouts, stimulus packages, and financial guarantees, prevented the worst from happening, which, surely, justified a big relief rally.

Still, the renewed sightings of exuberance on Wall Street, together with the return of multi-million dollar bonuses for traders and investment bankers, highlight the tensions inherent in our financially driven economy—some of which I write about in the magazine this week. (The article is adapted from my forthcoming book, “How Markets Fail: The Logic of Economic Calamities.”)

Authers reports that many mutual-fund managers appear to be buying stocks, not because they have great faith in the economy but because they fear missing out on the next bull market. He quotes Jeremy Grantham, the veteran bear, as saying: “Fund managers are simply not prepared to take the career risk of being wrong for a little while and losing business.” As Keynes pointed out (and as Brad De Long, Andrei Schleifer, Larry Summers, and Robert Waldmann showed formally), following the herd can be a perfectly rational investment strategy. This is one of the main reasons that markets tend to go to extremes.

But investors aren’t the only ones who pursue strategies that can ultimately prove self-defeating. Policy-makers sometimes do the same thing, and it isn’t too impertinent to ask whether the Fed is on the verge of repeating past errors, particularly those associated with the Artist Formerly Known as Maestro.


“The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance. In the judgment of the Committee, policy accommodation…can be maintained for a considerable period without ultimately stoking inflationary pressures”
—Alan Greenspan, testimony to Congress, July 15, 2003


“The Committee expects that inflation will remain subdued for some time. In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. The Committee…continues to anticipate that economic conditions are likely to warrant except exceptionally low levels of the federal funds rate for an extended period.”
—Statement from the Federal Open Market Committee, September 23, 2009

I don’t wish to be overly critical. After a slow start, the Fed did a good job responding to the financial crisis, and it is justifiably worried about the danger of tightening policy too early. But reviving the infamous “Greenspan Put” is surely not what Bernanke wants to do to begin his second term…