Bryan Caplan  

The Right Reaction to Bubbles: Easy Come, Easy Go

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First it was the dot-com bubble. Now it's real estate. In ten years, it will be something else. In each case, the price of a major asset goes way up for no good reason, then comes back down. In each case, people freak out. Frankly, I don't see why.

For those of us who live by the prudent rule of buy-and-hold, I see no reason not to simply shrug and say "Easy come, easy go." I understand why gamblers who bought high and sold low are whining, but I don't understand why anyone else listens to them.

Do you?


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COMMENTS (16 to date)
JH writes:

Because nothing important is happening and doom is always interesting to talk about?

And aren't there positive effects for knowing that the world isn't going to hell when you keep hearing that it is?

Gary Rogers writes:

In 10 years it will be something else? As long as the Fed continues to push easy money, we are going to continue to see bubbles popping up in one place or another. I can take this calmly as long as I can be confident that I will have enough to retire on (I am 60 this year). Gold is looking more attractive all the time.

Alan Watson writes:

Assuming that bubbles are the uneven inflationary effects of too-easy money, I think the interesting question is whether we can predict where future bubbles are most likely to appear. Then it would be really easy come (although still risky on the go side).

Bryan, I guess you're right. So it's just a cyclical shock or when some overvalued company reaches it's true nominal value. However, does the Fed have anything to do with bubble creation? Please answer!

Patrick writes:

Actually, the real estate bubble is a follow-on to the dotcom bubble. This was to be completely expected, as Charles Kindelberger predicted it in his book "Manias, Panics and Crashes". Essentially, most large-scale asset bubbles in history have gone on to create real estate bubbles when the initial bubble bursts. See: Dutch Tulip mania, South Sea bubble, etc.

It's a good book if you like reading about this stuff.

Selfreferencing writes:

I second the demand for you to reproduce your view about the relationship between the Fed and the business cycle for the blog.

Bryan Caplan writes:
Christopher Espinal writes:

Bryan, I guess you're right. So it's just a cyclical shock or when some overvalued company reaches it's true nominal value. However, does the Fed have anything to do with bubble creation? Please answer!

I'm not convinced the Fed has the kind of direct role that some of the other comments attribute to it. Vernon Smith has generated bubbles in extremely simple lab experiments, so I don't see why the Fed is supposed to be the Root Cause of bubbles in the real world.

Of course, you could blame the Fed for not tightening monetary policy until bubbles go away, but that's reaching.

Many of these Fed-bubble theories stem from Austrian Business Cycle Theory. My critique is at: http://www.gmu.edu/departments/economics/bcaplan/whyaust.htm, section 3.4

Dan Hill writes:

"I don't understand why anyone else listens to them"

Well we live in a pervasively nannyish culture that's why.

If enough voters chase the latest bubble only to be hurt when it pops there's plenty of political capital in bailing them out. And those voter's don't feel they should be held accountable because hey, everyone was doing it (my parents knocked that excuse out of me round about the fourth grade, so what does that say about the intellectual maturity of the average voter?)

giesen writes:

Why do people "freak out" and not just shrug and move on?

It's dramatic. Have you ever known someone who rapidly came into huge fortunes or rapidly lost huge fortunes and went bankrupt? It's a big deal. It's shocking. And even when people know about the bubble, it usually lasts for longer than they expected, and only after years of their acute skepticism slowly fading into acceptance, does the bubble finally burst at a completely unexpected moment.

Steve Sailer writes:

The dot.com bubble was built more on equity, while the housing bubble was built more on debt, so it's more dangerous. And the sizable dot.com losses were restricted largely to the fairly well-to-do, while home foreclosures are hitting the average and below average masses hard.

Unit writes:

One difference I see is that the internet bubble was in these high risk stock etc...the problem with the current housing bubble is that it was considered to be a safe investment and people were using real estate to leverage other riskier positions.

Mark Wonsil writes:

I think the next bubble is healthcare. I'm amazed at how many people are leaving one sector of the econmy and going into the healthcare field. Of course, a lot depends on what happens with any effort for a public sector union enrollment program, er, I mean a single-payer system.

GU writes:

Why do people listen to them?

Because most people want to believe that there is a way to see high returns with low risk.

SheetWise writes:

It might have something to do with dual-use of capital. As DeSoto pointed out -- most people use their homes to finance small business ventures. So it's not only people who never had any equity in their homes who are being hurt when values drop, it's also people who had substantial equity and leveraged it in other enterprises.

English Professor writes:

I would normally agree with Bryan on this sort of thing (not that my opinion is worth anything, since I'm not an economist), but isn't the main question here a species of moral hazard? As house values drop, many people have negative equity in their homes. Like Bryan I believe that people should simply take the long view and pay off their houses over time. Historically the American default rate on mortgages has been quite low (hence the AAA ratings on all those CDIs); if Americans continue their old behavior, the "crisis" will prove to have been less devastating than many thought. But if Americans walk away from their houses because their debt exceeds their equity, then the crisis may turn out to be serious. To some extent, this is a question of national character.

Also, isn't the problem exacerbated by the labor market? If I lose my job and can't make my monthly payments, I can't just sell my house and move to a place with more opportunity because the amount I owe on my home is greater than the equity. So I can't even get out of debt by selling. This kind of situation might prompt some people to walk away from their debt.

So Bryan's query seems to ignore two fundamental questions: will Americans maintain their older sense of responsibility for their debts, and how will this crisis impact the overall flexibility of the US labor market?

Cached writes:

"Easy Borrow, Not So Easy Foreclose". You can't help but feel sorry and concerned for the once uneducated home gamblers, for now they are the educators. I hope my sorrow for them is payment enough and not too much of my tax dollars.

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