Project Syndicate
* (http://www.project-syndicate.org/on-deck) _Robert J. Shiller_
(http://www.project-syndicate.org/contributor/robert-j--shiller)
Robert J. Shiller is Professor of Economics at Yale University and the
co-creator of the Case-Shiller Index of US house prices. He is the author of
Irrational Exuberance, the second edition …
July 17, 2013
_Bubbles Forever_
(http://www.project-syndicate.org/commentary/the-never-ending-struggle-with-speculative-bubbles-by-robert-j--shiller)
* NEW HAVEN – You might think that we have been living in a
post-bubble world since the collapse in 2006 of the biggest-ever worldwide
real-estate bubble and the end of a major worldwide stock-market bubble the
following year. But talk of bubbles keeps reappearing – new or continuing
housing
bubbles in many countries, a new global stock-market bubble, a long-term
bond-market bubble in the United States and other countries, an oil-price
bubble, a gold bubble, and so on.
<
Nevertheless, I was not expecting a bubble story when I visited Colombia
last month. But, once again, people there told me about an ongoing
real-estate bubble, and my driver showed me around the seaside resort town of
Cartagena, pointing out, with a tone of amazement, several homes that had
recently sold for millions of dollars.
Banco de la República, Colombia’s central bank, maintains a _home price
index_ (http://www.banrep.gov.co/en/node/29371) for three main cities –
Bogotá, Medellín, and Cali. The index has risen _69% in real
(inflation-adjusted) terms since 2004_
(http://obiee.banrep.gov.co/analytics/saw.dll?Go&Path=/shared/Consulta%20Series%20Estadisticas%20desde%20Excel/1.%20Home%20Price%20I
ndex%20-%20HPI/1.1%20Annual%20Data/1.1.1%20Nominal%20and%20real%20annual%20s
eries%20-%20three%20major%20cities&Options=rdf&NQ) , with most of the
increase coming after 2007. That rate of price growth recalls the US
experience,
with the S&P/Case-Shiller Ten-City Home Price Index for the US _rising
131% in real terms from its bottom in 1997 to its peak in 2006_
(http://www.housingviews.com/2011/09/08/inflation-adjusted-home-prices/real-spcs/)
.
raises the question: just what is a speculative bubble? The Oxford English
Dictionary defines a bubble as “anything fragile, unsubstantial, empty, or
worthless; a deceptive show. From 17th c. onwards often applied to
delusive commercial or financial schemes.” The problem is that words like
“show”
and “scheme” suggest a deliberate creation, rather than a widespread
social phenomenon that is not directed by any impresario.
the word bubble is used too carelessly.
Fama certainly thinks so. Fama, the most important proponent of the _“
efficient markets hypothesis,”_
(http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.1970.tb00518.x/full)
denies that bubbles exist. As he put it in a
_2010 interview_
(http://www.newyorker.com/online/blogs/johncassidy/2010/01/interview-with-eugene-fama.html)
with John Cassidy for The New Yorker, “I
don’t even know what a bubble means. These words have become popular. I don’
t think they have any meaning.”
In the second edition of my book Irrational Exuberance, I tried to give a
better definition of a bubble. A “speculative bubble,” I wrote then, is “a
situation in which news of price increases spurs investor enthusiasm,
which spreads by psychological contagion from person to person, in the process
amplifying stories that might justify the price increase.” This attracts “
a larger and larger class of investors, who, despite doubts about the real
value of the investment, are drawn to it partly through envy of others’
successes and partly through a gambler’s excitement.”
seems to be the core of the meaning of the word as it is most consistently
used. Implicit in this definition is a suggestion about why it is so
difficult for “smart money” to profit by betting against bubbles: the
psychological contagion promotes a mindset that justifies the price increases,
so
that participation in the bubble might be called almost rational. But it is
not rational.
The story in every country is different, reflecting its own news, which
does not always jibe with news in other countries. For example, the current
story in Colombia appears to be that the country’s government, now under the
well-regarded management of President Juan Manuel Santos, has brought down
inflation and interest rates to developed-country levels, while all but
eliminating the threat posed by the FARC rebels, thereby injecting new
vitality into the Colombian economy. That is a good enough story to drive a
housing bubble.
Because bubbles are essentially social-psychological phenomena, they are,
by their very nature, difficult to control. Regulatory action since the
financial crisis might diminish bubbles in the future. But public fear of
bubbles may also enhance psychological contagion, fueling even more
self-fulfilling prophecies.
problem with the word bubble is that it creates a mental picture of an
expanding soap bubble, which is destined to pop suddenly and irrevocably. But
speculative bubbles are not so easily ended; indeed, they may deflate
somewhat, as the story changes, and then reflate.
It would seem more accurate to refer to these episodes as speculative
epidemics. We know from influenza that a new epidemic can suddenly appear just
as an older one is fading, if a new form of the virus appears, or if some
environmental factor increases the contagion rate. Similarly, a new
speculative bubble can appear anywhere if a new story about the economy
appears,
and if it has enough narrative strength to spark a new contagion of investor
thinking.
This is what happened in the bull market of the 1920’s in the US, with the
peak in 1929. We have distorted that history by thinking of bubbles as a
period of dramatic price growth, followed by a sudden turning point and a
major and definitive crash. In fact, a major boom in real stock prices in the
US after “Black Tuesday” brought them halfway back to 1929 levels by
1930. This was followed by a second crash, another boom from 1932 to 1937, and
a third crash.
Speculative bubbles do not end like a short story, novel, or play. There
is no final denouement that brings all the strands of a narrative into an
impressive final conclusion. In the real world, we never know when the story
is over.
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