Today, I was discussing the skyrocketing stock market in the backdrop of near-depression macroeconomics and macro social problems. I said, like everyone else, that it could be a sign of financial bubble – a really big one. I was taken aback by a response, because all things that take me “aback” are the ones that make me think.
The response I got was: “well, maybe not a bubble; the jury’s still out on that, but something is definitely wrong.”
I’ve lived through every bubble in history (more on that in a minute), So what, exactly, is a bubble?. There’s the Economist’s version, and the Wall Streeter’s version; keeping in mind that most people trading on Wall Street are not actually Economists.
1) The Economics version: An economic cycle characterized by rapid expansion and contraction.
2) The Wall St Version: Security prices rise above their true value, and will do so until free-fall.
Here’s an interesting chart tracking the history of bubbles, which I will base my NEW definition on:
Bubbles haven’t really existed in history. Cycles clearly have existed, but we don’t really see anything that looks like a bubble until 1988. Then it takes off from there, getting into Bubble-icious territory in the late 1990s.
So going back to the Dot Com days let me define a bubble as this: when something (a company, stock, or product) is said to have value, when it’s really worthless. The housing bubble was about CDOs on worthless loans. The Dot Com bubble was a “pump-n-dump” scheme to pump up Internet stock on companies that never produced a single product or service.
It’s hard to have value when you have, well, nothing of value.
What does Wall Street have of value today? Cold hard cash; mountains of it! Remember – M2 (red) is the money the banks are taking in. M2V (blue) is how quickly that money is leaving the banks for the general economy:
We see a liquidity trap, but who can argue that cash isn’t worth something? Well, Adam Smith for one, who said that idle money is wasted money, since it doesn’t have utility value. Even his “Name That Shall Not Be Spoken” (Fredrich Hayek) said that banks sitting on money is stupid.
I suppose we won’t know if Wall Street is really having a bubble until after it bursts, leaving everyone in a smoking pile of economic rubble.
Regardless of whether or not there’s a bubble, right now, the stock market is the ONLY thing in the economy that’s up; and for Wall Street, it’s Bubble-icious!