There Are Bubbles, And Then There Are BubblesI wanted to cut out the "key bit" but Krugman writes so beautifully and makes every word count. So I ended up excising the whole thing! If you don't read Krugman regularly, you should. He both writes articles for the NY Times as well as blog posts that elaborate themes which the space limitations of a newspaper require they be left out. Monitor this site and you will get all his postings and his articles.
On the whole, I find it amazing and distressing that fear of new bubbles is playing such a large role in current policy discussion, leading too many prominent economists to recommend raising interest rates in the face of a hugely depressed economy. Even if you believe that excessively low policy rates were a key reason for the housing bubble — which I don’t — the idea that we should be raising rates now brings to mind the old joke about the motorist who runs over a pedestrian, then tries to fix the damage by backing up, and running over the pedestrian a second time.
Beyond that, I think we need to bear in mind that while bubbles are in general a bad thing, just how bad depends a lot on the context — in particular, whether the inflation of the bubble has been accompanied by a big increase in leverage on the part of those buying the inflated assets.
Consider the stock bubble of the late 1990s. It was crazy, and when it popped U.S. households suffered a capital loss of about $5 trillion. This was bad, and helped cause a recession. But it never rose to the level of economic catastrophe.
Then came the housing bubble, after which households suffered a capital loss of about $8 billion trillion [hey, a few zeroes more or less ... ]. Yes, they also suffered a big loss as stocks plunged — but that was because the housing bust, unlike the stock bust, had a huge impact on the financial system and the economy as a whole.
What was the difference? First, a lot of financial institutions — which are highly leveraged — were holding securities whose value was highly sensitive to the state of the housing market. There was nothing comparable in the case of stocks. So the housing bust undermined the financial system in a way the stock bust never did.
Second, households also leveraged themselves up in the housing boom, in a way they for the most part didn’t with stocks (yes, there were people buying dotcoms on margin, but they were not typical). So the housing bust created a balance-sheet crisis for the household sector in a way that the dotcom bust didn’t.
The moral for right now is that even if you believe that there are bubbles inflating or about to inflate, they’re only a big concern if they are leading to leveraged positions for key players. The alleged carry trade bubble sorta kinda mighta have met that criterion, although I never found the warnings all that persuasive. But other stuff — bubbles in BRIC equities, or gold, or whatever, don’t make the grade.
Anyway, my point is not so much about current events as a more general observation: the bubbles we should fear are those that lead to leverage, and set us up for a Minsky moment.
The above post is typical of Krugman. He points out the false beliefs of pundits who are media stars. Sadly, too many people with access to the media don't really know what they are talking about and keep making mistakes and misleading people. Poor Paul Krugman is like the little engine that could. For years he keeps telling people truths they don't want to hear. I'm hoping someday Krugman, like the little engine, will actually succeed in his goal.