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Some
people say there are no "bubbles." I disagree with that. I think
there have been situations that were called a bubble, but really weren't. I don't
see any particularly bubbly behavior in 1929, for example. Exuberant, as
befits a time of such dramatic economic expansion, but not bubbly. I think
there was some bubbly behavior in Japan in the late 1980s, but not nearly as
much as most people think. The dot.com and housing/credit events in 2000 and
2007 in the U.S. qualify as bubbles, in my opinion.
Alan
Greenspan had a policy of not trying to spot bubbles before they happen, but
perhaps to deal with the effects afterwards. He has come under criticism for
this, but in the broad, I agree with it. It is useful from a political
standpoint. On the way up, practically by definition, the majority of people
don't think there's a bubble (just think of all the "housing only goes
up" types in 2005, the buyers of CDOs, or the private equity
daredevils), and certainly they don't want anyone to stop the party. On the
way down, after everybody finally gets it, then the Fed has more of a
political mandate to do something. Also, the Do Something that the Fed does at
that point is typically some sort of "easing," which is to say, a
politically welcome event.
So, we
have two problems to begin with. First, it is not so easy to spot a bubble,
since a bubble is, practically by definition, a sort of mass hysteria. Of
course they are very obvious, but the bubble-spotters are always a lonely
minority. Just look at the crap that Peter Schiff took in 2006 and 2007 --
when the housing bubble had already popped! Also, there is the possibility
that one could spot a supposed "bubble," and basically be wrong.
Just think of everyone who thought $40 oil was a "bubble" in 2004.
(I think oil will be headed up again.) Or, everyone who thought that U.S.
stocks were in a bubble in 1986. Second, there is the political issue. Nobody
wants someone like the Fed to step up and end the party, especially when it
holds opinions that are in the minority (as they always are at that point).
To
that we add a third problem, which is: the acts taken to "break the
bubble" are often worse than if the bubble had busted naturally. This
might sound like heresy, but what is a government actually supposed to do to break a
supposed bubble? The typical responses are: higher interest rate targets, and
higher taxes. This, in fact, is precisely what the Japanese government did in
the 1989-1994 period, specifically and overtly to break the supposed bubble
in property. Guess what -- it worked! The situation ended up being much, much
worse than if the property market had simply deflated on its own. I
documented some of the many tax hikes on property in my book. It would be fun
sometime to do a more detailed study of this period. (PhD types -- there's a
nice thesis for you. Send me the results.) Oddly enough, when things were
really falling apart, the government did virtually nothing to fix the
problems it had created, in its efforts to "pop the bubble."
Japan's government was not the only one to do this -- Korea did similar
things a few years back, not to the same extent but the idea was the same. In
other words, be very, very careful when getting the government involved,
because the government, collectively, is intensely stupid.
There
was also a "bubble" in Japanese property in the late 1950s, up to
about 1963. Actually, in terms of price rise, this bull market was much larger
than the bull market of the late 1980s, which is rather teeny by comparison.
In 1960, for example, the urban property price index rose 68%! It powered up
another 45% in 1961. (The largest gains of the late 1980s were about 28% per
annum.) Eventually, a bear market set in, and property prices spent much of
the middle 1960s grinding sideways, even though nominal GDP was growing
15%-25% per year. Here was a case in which the property market was simply
left to work itself out, and guess what -- nothing happened. The economy was
fine. The fact that the Japanese government cut taxes every year during the
1960s, and kept the yen pegged to gold, didn't exactly hurt.
Greenspan,
I believe, is aware of the Japanese case.
Because
of this, I recommend oversight rather than legislation per se as a way for
the government to manage asset markets. The government simply puts an
informal limit on LTVs, neg-ams, volumes of deals being done, or what have
you. The government does
not hike taxes or fool around with the blunt tool of monetary
policy. Which means that the ball is out of Greenspan's court. The Fed
supposedly serves as a banking regulator, but the Fed isn't a branch of the
government (despite acting like one). So, that suggests it's Treasury's job.
Certainly the removal of various limitations on banking activity and leverage
(Glass-Steagall among others) contributed to the present situation. Did the
Fed repeal Glass-Steagall? Or was it Congress? Hmmmm ... don't wait for any
"I'm sorrys" from Congress.
This
brings us to a fourth point, which is: the aftereffects of a bubble are often
overstated. There are several economic events which have been blamed on a
supposed "deflating bubble," but were primarily due to other
causes. The Great Depression, for example, is still conceived by a great many
as a sort of "spiral of doom" touched off by a falling stock
market. Not so. Likewise with Japan, the real problems were dramatic tax
hikes and historically unprecedented monetary deflation. The Asia Crisis was
primarily a currency event. The present situation in the U.S. actually is,
mostly, the various effects of a financial bubble (despite some Peak Oilers'
claims otherwise). Whenever there is a major asset market decline -- and
there always is in any major economic event -- it is very easy to point to
that amazing price chart and say "see, it was a bubble!" We know it
was a bubble, because it "busted," i.e. it went down a lot. All the
people who bought at $100 must have been stone nuts, because the stock was later
at $10. Put in such simple terms, we can see this is grossly stupid, but if
you pay attention I think you will sense this line of reasoning is quite
common. The result is that the "bursting bubble" gets lots of
blame, and the other, more important factors are largely ignored. The
"bursting bubble" fills the need for an explanation, so people get
lazy and they stop looking for the real reasons.
This
means that it is not quite so important to prevent bubbles, because they are
not so dangerous as they seem. The exception to this may be when there is
lots of debt involved -- which tends to mean property. If stocks go up and
down, well, who cares really. But, if debt doesn't get paid, there are
consequences.
So,
with all of this in mind, I tend to follow Greenspan: don't worry about it
too much on the upside, and on the downside do a few things to make it
better. These things should be aligned with our basic principle of economic
management, which is:
Low
Taxes
Stable Money
So,
make money more stable and lower taxes. What if the Japanese government did
nothing to "pop" the bubble on the way up -- no huge tax hikes --
and then, on the way down, actually reduced property-related taxes? And fixed
the deflation problem, which actually began in 1985? Much different outcome.
With
that said, sometimes things get really silly, as they most assuredly did in
2004-2007. If it seems that things are really silly, the government can
exercise oversight, such as demanding that brokers and banks reduce leverage
and exposure, or no mortgages with over 90% LTV (70% LTV for commercial) and
fully-amortized only. And quit with the derivaties! The nice thing about this
is that, if the government is completely wrong, typically little harm is
done. So, the risk of being wrong is lessened. The Chinese government makes
regular experiments along these lines.
This
could probably be considered a variant of our Crisis Management principles.
Identify
the Problem
then
Solve the Damn
Problem
January 27, 2008: Crisis Management
So,
you would Identify that there's a potential bubble being driven by super-easy
mortgage credit, for example, and Do Something to solve that, such as
demanding that banks require 80% LTV (and no piggybacks) and full
amortization. This is much better than just carpet-bombing the economy with
tax hikes and interest rate tomfoolery.
* * *
Famine
Watch: Okay, the famine hypothesis is rather farfetched.
Maybe in 2010, but not 2009. Still, when U.S. industrial agriculture is
dependent on heavy machinery from China, potash from Russia, GM seeds from
Monsanto, credit from Citibank, price hedging on the Nymex, and diesel from
Saudi Arabia ... there's a possibility that something could go wrong
somewhere.
It’s
harder for farmers to get credit for next season’s crop, especially
farmers overseas. They need fertilizer, seed, fuel and more. And most farmers
need to borrow money to obtain these essential items. No credit; no crops.
Therefore,
the global credit squeeze might reduce plantings of key grains, even as world
inventories of these grains hover near historic lows. In Russia, for example,
cash-starved banks have cut off funding for the industry. The head of the
Russian Grain Union says, “Many farmers probably won’t be able to
borrow money for the spring sowing.” This is important because Russia
is no lightweight in the grain division. It produces 9% of the world’s
wheat, for instance. No surprise that the United Nations considers Russia a
critical component of the global food supply.
Ironically,
Russia just had its best harvest ever. And still, global grain inventories
remain low. Bloomberg reports that global inventories of corn, wheat and
soybeans are the second lowest they’ve ever been since 1974.
A
number of countries already fear what might happen next year. The Washington
Post Foreign Service in Shanghai reports that China adopted a number of
measures to protect itself from the worsening food crisis: “Among the
most extreme measures [China] took was to impose new export taxes to keep
critical supplies such as grains and fertilizers from leaving the
country.”
These
taxes are extremely high, on the order of 150%-185%. China worries that
richer countries may outbid its own farmers for supplies and weaken
China’s own food supply. One Chinese fertilizer company, which produces
150,000 tons per year, already said that the new taxes mean exporting is no
longer profitable. China was the biggest exporter of certain types of fertilizer.
No longer. That’s a lot of supply off the market.
Fertilizers
are absolutely critical in maintaining (and improving) crop yields. Without
them, we’d produce far less per acre. As a result, in parts of Africa
where people depend on Chinese fertilizers, the food supply problem is now
more acute. China’s export taxes and bans follow those of other grain
producers, including the Ukraine, India, Pakistan and Argentina.
Chris
Mayer: the Crash in Food Supply
Nathan
Lewis
Nathan
Lewis was formerly the chief international economist of a leading economic
forecasting firm. He now works in asset management. Lewis has written for the
Financial Times, the Wall Street Journal Asia, the Japan Times, Pravda, and
other publications. He has appeared on financial television in the United
States, Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada, call
800-567-4797.
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