Friday’s WSJ front page article, Bernanke’s Bubble Laboratory, is must reading:

"First came the tech-stock bubble. Then there were bubbles in housing
and credit. Chinese stocks took off like a rocket. Now, as prices soar
on every material from oil to corn, some suggest there’s a bubble in

But how and why do bubbles form? Economists traditionally haven’t
offered much insight. From World War II till the mid-1990s, there
weren’t many U.S. investing manias for them to look at. The study of
bubbles was left to economic historians sifting through musty records
of 17th-century Dutch tulip-bulb prices and the like . . .

Now, the
study of financial bubbles is hot . . . Among their conclusions:

Bubbles emerge at times when investors profoundly
disagree about the significance of a big economic development, such as
the birth of the Internet. Because it’s so much harder to bet on prices
going down than up, the bullish investors dominate.

Once they get going, financial bubbles are marked by huge increases in trading, making them easier to identify.

Manias can persist even though many smart people
suspect a bubble, because no one of them has the firepower to
successfully attack it. Only when skeptical investors act
simultaneously — a moment impossible to predict — does the bubble pop."

Its now at the free section of WSJ.com.


Bernanke’s Bubble Laboratory
Princeton Protégés of Fed Chief Study the Economics of Manias
WSJ, May 16, 2008; Page A1

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  1. farmera commented on May 18

    Through out history, bubbles are driven by excess liquidity. As a country we have total debt (personal, corporate and governmental) that is growing exponentially and is now over 300% of GDP, a record high. THis debt (I define it as excessive debt) will never be repaid. The country has two options, debt revulsion aka depression, or inflation. Bernanke is strongly on the side of inflating away the debt, just ask him. Everything the government is doing is working to keep the debt bubble growing. When you have a government that says debts don’t matter (the Federal debt has close to doubled in the last 8 years), what do you think will happen?

    Bubbles look to me to be the only way the economy can function. Ag is in a bubble now along with energy and other commodities. Bubbles are coming faster and faster, until the big POP, and the music stops.

    The real question to me is not will there be more bubbles, but how to survive the coming
    Big Bang or POP or implosion.

    My investments go along these lines:
    _Foreign stock and bonds
    -Farm land and crops
    -Commodities like gold, platinum and silver
    -A few US stocks like BRK, a few bonds like TIPS and E bonds

    Here’s looking at the coming bubbles.

  2. Andrew commented on May 18

    For bubble formation theory, I’ll suggest Didier Sornette’s “Why Stocks Markets Crash?”

  3. Suge Knight commented on May 18

    “Don’t fight the market”, we’re heading higher, Bernanke will not let the market touch 12,000 again, relax, safe trip to 14,000 on the Dow, Nasdaq will go up another 300 points from here.

    Suge aka “Bernanke’s Boy”


    BR: We appreciate your opinion, “Suge,” but how about some analysis to go with it?

  4. DownSouth commented on May 18

    Fascinating and thought provoking article.

    These were my two favorite insights:

    ☺☺”When a lot of borrowed money is involved — as it often is in a bubble — once prices peak, the speed of their fall is intensified as investors sell urgently to pay down debt. That pattern offers a strong argument, in Mr. Hong’s view, for government to restrain bubbles and the borrowing that fuels them.”


    ☺☺”Today, there’s disagreement over commodity prices: to what extent do they reflect fundamentals like Chinese demand, and to what extent investment mania? Trading points toward a bubble: Daily volume on crude-oil contracts is running 50% above last year. Yet the initial findings of work Mr. Hong has done with Motohiro Yogo of the Wharton School — comparing cash prices and futures prices — suggest that ‘prices for commodities are expensive,’ but not a bubble, Mr. Hong says.”

  5. Phil commented on May 18

    Yes, too much liquidity = bubbles which takes us back to the ‘fiat’ problem.

    As for Bush trying to persuade the Saudis to pump more oil. I think that’s more of a BS PR exercise for the folks back home….. me thinks he doesn’t mind the increasing oil price ….. hmmm …. inflate away uncle Ben.

  6. Jim Haygood commented on May 18

    “Bubbles emerge at times when investors profoundly disagree about the significance of a big economic development, such as the birth of the Internet.” – Justin Lahart

    What a complete load of hogwash. But it’s exactly the sort of self-serving, diversionary smokescreen one would expect from the WSJ, the “lay down Sally” slut of the FIRE sector.

    As “farmera” said above in comment #1, Bubbles are always and everywhere caused by excess liquidity.

    The ludicruous swill from Justin Lahart serves as a perfect example why no serious investor or speculator should be caught dead reading the WSJ, except as a fade.

  7. Winston Munn commented on May 18

    The concept of bubble for me brings to mind the reflexivity theory of George Soros:

    “Reflexivity is, in effect, a two-way feedback mechanism in which reality helps shape the participants’ thinking and the participants’ thinking helps shape reality in an unending process in which thinking and reality may come to approach each other but can never become identical. Knowledge implies a correspondence between statements and facts, thoughts and reality, which is not possible in this situation. The key element is the lack of correspondence, the inherent divergence, between the participants’ views and the actual state of affairs. It is this divergence, which I have called the ‘participant’s bias,’ which provides the clue to understanding the course of events. That, in very general terms, is the gist of my theory of reflexivity.”

    Seems that one could describe a bubble as an extreme in “participant’s bias”, when what is real and what is thought to be real are at maximum divergence.

  8. Juan commented on May 18

    ..the initial findings of work Mr. Hong has done with Motohiro Yogo of the Wharton School — comparing cash prices and futures prices — suggest that ‘prices for commodities are expensive,’ but not a bubble…

    Other studies, oil and sugar markets, have found that causality is unidirectional, from futures to cash.

    Futures markets are financial and open to what I want to call self-fulfilling return seeking reallocation mania which is not manipulation but can result in artificial price.

    Reallocation by long-onlys began late 2003, early 2004, and in my opinion has helped generate a quite incredible bubble in commodities as well as (oft not examined) supporting stories.

  9. Will commented on May 18

    Irrational Exuberance by Robert Shiller is a must read on bubbles.

  10. DL commented on May 18

    Bubbles create great opportunities for nimble traders.

    (Just throw away your copy of Graham and Dodd first).

  11. toon commented on May 18

    When oil hits $300 people will call it a bubble.
    Master world micro economics and trade your way to profit. Bubble or no bubble.

  12. flipper commented on May 19

    Good article indeed. My two cents on Oil – since 96 the volume of barrels traded on 4 most liquid contracts is up
    around 600%.

    In money terms trading is up 37 times. Now that’s only liquid and most traded stuff – crude. Add there explosion in OTC derivatives, much higher products volumes and the figure will go to at least 1000%.

    So, imho the volume criteria for the bubble is in place. As for the price – real prices are at all time high. It’s 1980 all over again, and there was no real supply distruption (may be yet).

    Weak dollar argument is bullshit, dollar has been very veak in 1980 also, the difference in dollar index is not bigger than 10%. Understated inflation – perhaps.

    EM consumption – the idea is that EM will consume at any price? Nonsence.

    If we got for stats such prices brought a demand destruction last time – the oil consumption recovered to 1980 level only in 1989-1990.

    With US going into recession i really can not see how this price tag will be supported for a long time.

    We’ll see.

  13. John Wellman commented on May 19

    I am not a Soros fan. However, his reflexivity concept is intriguing. Unfortunately, the two way feedback loop model does not seem to work to support bubble formation. If the mechanism was two ways, with equal loop velocity, bubble behavior should then reach an equilibrium (similar to a buildup equation) due to proper speculator decisions being executed due to good info, analysis, synthesis then action. Since bubbles pop, the two way feedback loop either has radically divergent loop velocities, or is a positive feedback mechanism. In reality, the same outcome is achieved, irrational bubbles instead of an equilibrium. Emotions take over in the bubble hysteria, thus preventing the feedback loop velocity synchronization.

  14. whitespiral commented on May 19

    Monetary Inflation –> Bubble –> Bust –> More Monetary Inflation –> Next Bubble –> Next Bust –> Yet More Monetary Inflation……………………………

  15. Marco commented on May 19

    “But how and why do bubbles form? Economists traditionally haven’t offered much insight.” No, Keynesian economists haven’t offered much insight. Try reading von Mises, Hayek, Lachmann, von Strigl, Hicks, et al., you ignorant POS before you make such statements. I agree the WSJ really is awful sometimes.

    Whitespiral nails it: “Monetary Inflation –> Bubble –> Bust –> More Monetary Inflation –> Next Bubble –> Next Bust –> Yet More Monetary Inflation……………………………”

    As long as central bankers continue to print fiat money like a bunch of drunken sailors there will be inflation, asset bubbles followed by busts. Period. Full stop. In other words, the Fed can print the economy into trouble, but it can’t print it out of trouble.

  16. flipper commented on May 19

    ow again i am musing about oil buble – but just go to BP site. There is a lot of info porn on energy there.

    Take a look at this –

    page 14. primary energy consumption growth has been sharply decelerating since 2004, and they do not have data for 2007 yet.

    page 15 – china has been decelerating also.

    obviuosly it’s higher prices impact, and the idea that EM consumption will support market at any price is also crap.

    the market will face a demand destruction may be already this year.

  17. David commented on May 19

    There is an excellent book on this subject by Edwin Chancellor called, “Devil Take the Hindmost”.

    Very interesting historical overview of the factors driving speculation during mania/bubble periods (money and credit expansion/availability plays a very key role, as others have already noted).

    A link is available in Barry’s left-hand reading sidebar.

  18. tmorgan commented on May 19

    It is very easy to see why bubbles form – people get more money than they can productively use, but still have to start looking for someplace to make that money “work” for them. Unfortunately, there is a limited supply of real investments to put that money in, so a lot of people enter into a sort of bidding war for the limited commodity (investment). YOu could invest in creating a new business, but that is a lot of work and its a lot easier to just bid on the existing products.

    One of the potential investment types gets more attention than the others (tech stocks, housing, commodities, etc) and the prices start inflating dramatically, even though the actual cost or value of investment is no better than it was before the bubble. That doesn’t matter, the value comes from buying and selling the investment, not the investment itself. No matter how high the price goes, there is always more money with nothing else to do looking to buy its way into that type of investment, and you get … a bubble. It grows until the money dries up (like with housing) or people finally realize they are investing in nothing (like with tech stocks) and the bubble bursts.

    Then all those people who got out in time need to find something to make all that money “work” for them…

    It would all be a comical farce in the rarified strata of high finance, except that the things these people inflate the value of trickles down into the real economy, and people find their 401K’s trashed and their cost to get a home is now 60% of their paycheck.

    And now gasoline takes up 10%-20% of a lot of people’s paychecks, even though the actual cost to produce gasoline hasn’t gone up much at all.

    The solution is to not let the upper strata get more money than it can do anything useful with. Once upon a time they pretended that they would use it to build businesses and create jobs, but I think we all know how that went.

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