5 Misconceptions About Economic Bubbles And People Who Warn About Them



 

TBR-Jesse Colombo , Forbes Contributor; I'm an economic analyst who is warning of dangerous post-2009 bubbles. Opinions expressed by Forbes Contributors are their own.
 

In my experience with warning about economic bubbles - both last decade's U.S. housing bubble and post-2009 bubbles - I have come across a significant number of misconceptions about bubbles and people who warn about them. The public's belief in these misconceptions is strongest when bubbles are in the final stage of their inflation, which is when excessive greed, euphoria, and delusional thinking take over. People who are caught up in a bubble gravitate to these misconceptions because they justify and confirm their beliefs while trivializing the warnings of skeptics.
Here are five common misconceptions about bubbles and people who warn about them:
1) Early bubble warnings are wrong
This is one that I find particularly irritating, and it's one of the most common. This misconception assumes that skeptics who warn that a bubble is forming years before it pops are wrong or bad forecasters for doing so, even if they are right in the end. This argument makes little sense to me because I believe that bubbles need to be warned about as early as possible to help prevent their inflation and the ensuing damage that occurs when they pop. In addition, early bubble warnings give the individuals who take heed time to prepare for an economic crisis or to limit their exposure to the bubble.
Major, economy-destroying bubbles typically take at least several years to form and can be spotted early on in their development. For example, the reckless debt buildup and asset price inflation that occurred during last decade's housing and credit bubble was identifiable as early as 2002 to 2004, even though it took until 2007 and 2008 to cause a crisis. People who believe that early bubble warnings are wrong are basically implying that the U.S. housing and credit bubble only became a bubble immediately before it popped.

2) Bubble warnings are immediate "sell" signals
This misconception is closely related to the first one, and is a common argument that is used as an attempt to discredit people who warn about bubbles. This fallacy assumes that people who warn about an economic bubble are also calling the bubble's top at the same time. By extension, this fallacy implies that the person making the warning is saying to sell the asset in question immediately and often go short. Though someone who is warning about a bubble may be doing it to inform the public and to prevent a crisis, they often get criticized for "missing the rally" as the bubble inflates.
This argument is wrong because people who warn about a bubble may also realize that the bubble is likely to inflate for several more years, creating gains for anyone holding the asset until the bubble pops. For example, in early-2012, I warned that the global economy could be on the verge of a massive new bubble that would create the illusion of an economic recovery (or what I call a "Bubblecovery") and a bull market in many financial assets. Though I was fully aware that the new bubble could continue to inflate for years, I still believed that it was important to try to fight or prevent it.

3) Bubble skeptics are "permabears"
This belief assumes that people who are aware of a bubble or warning about it cannot acknowledge or trade shorter-term bullish signals in the asset that is inflating. On the contrary, I frequently spot bullish tactical signals in stocks and other assets that I believe are experiencing a bubble that will end disastrously. Analysts and traders who use "trend-following" trading systems can capture gains during a bubble even if they are skeptical of the long-term fundamentals behind the trend. Of course, actually taking advantage of these bullish signals may present a moral dilemma for someone who is warning about a bubble.

4) A global, system-wide bubble cannot happen
For the last few years, I've been warning about numerous post-2009 economic bubbles that are forming in China, emerging economies, Canada, Australia, U.S. stocks, global bonds, tech startups, and more. Common criticisms that are leveled at me and other like-minded skeptics include, "you call everything a bubble!" and "there's a bubble in people calling bubbles."
The problem with these criticisms is that they imply that national economies and individual assets exist in a vacuum instead of being highly interconnected due to globalization. We now live in the era of the global economy rather than national economies (as was the case in the 20th century and earlier), so the possibility of a truly global bubble economy is not far-fetched at all.

How can a global economic bubble form? It's quite simple, really. For the past seven years since the Global Financial Crisis, major central banks around the world have held their interest rates at record low levels (as I discussed here) while flooding the global financial system with over $10 trillion worth of liquidity in the form of QE. These highly stimulative conditions have helped to inflate the valuations of assets such as equities, bonds, commodities, and property. Ultra-low borrowing costs have enabled a borrowing spree by governments, corporations, and households alike in many countries - particularly those that were least affected by the Global Financial Crisis.

5) Strong economic growth means that there is no bubble
This one is downright laughable, but is a fallacy made frequently by so-called "sophisticated" economists, business and political leaders, and financial journalists. The idea behind this fallacy is that a booming economy that is creating jobs and corporate earnings growth is on a sustainable path and, therefore, not experiencing a bubble. This argument is being made about the current U.S. economic recovery. Here is the problem with this logic: economists were saying the exact same thing about the U.S. economy in 2005, 2006, and 2007, which were the prime housing and credit bubble years.

intellectual property of Jesse Colombo