Bubbles: Seen One, Seen them All
One of the greatest blunders in the history of financial bubbles is not a policy error that inadvertently forces a collapse. Instead the real blunder is celebrating the old theory that some agency can prevent financial setbacks and recessions. In various forms it dates back to the early 1600s. And great expectations have surged this summer -- again. Quite likely part of the usual setup to a contraction.
Bear markets are inevitable and are consequent to a frenzy of speculation. And the next will be very embarrassing to the establishment. Boasts of the past that bad things can be prevented by spending trillions of taxpayers’ money will haunt. Historically, financial dislocations precede the hard times of a recession. Indeed, the original promoters of the Federal Reserve System knew this but believed that the “lender of last resort” would prevent recessions. In the 1960s, this was enhanced by macroeconomists armed with mainframe computer “models.” Recessions were banished. According to the NBER, there has been 18 recessions since the Fed opened its doors in 1914 and seven since the advent of economic “modelling.” Clearly, interventionist theories have not been working. But this summer has seen another enthusiastic endorsement of shopworn theories.
In a rush of enthusiasm, Wall Street bid up stocks on the news of a “Fed-Cut.” And lately, this has not been just a wrong conclusion, it has been a costly embarrassment. In September 2007, the head of Harris Private Bank enthused: “Lowering interest rates will certainly help the stock market. There is no question about it.” And the unquestioning bought the “Fed-Cut” story, providing the final thrust to that bull market, which peaked in the middle of October. As investors became nervous in that fateful December, Harvard’s Greg Mankiw assured that nothing could go wrong. The Fed had, as Mankiw boasted, the “dream team” of economists. Bernanke eventually described 2008 as the “worst financial crisis in history.” Which according to theory was impossible.
The combination of boasting that nothing can go wrong, then describing it as the worst crisis ever and then claiming that had the Fed not acted it would have been even worse, is amazing, amounting to the greatest non-sequitur in history. It seems that intrusive central banking has no means of self-criticism, or even institutional memory. The official “nothing can go wrong” in 2007 was followed some 18 months later by boasts that without the Fed the contraction would have continued. What was impossible could only be saved by the Fed.
And ominously, just six weeks ago, BNY Mellon’s Alicia Levine enthused “So with the rate cut… yes, you buy equities.”
The same advice was the rave with the first cut in 2007. The first such cut has been deadly in the past. Well, they have been based on the same old theory that some official agency will keep the bull market going.
In August 1928, John Moody boasted that nothing could go wrong because the U.S. had a “new” and “scientific” Federal Reserve System, which has been the euphemism for a central bank. He condemned the previous National Banking System.
In 2007, proof against things going wrong was a “dream team” of economists.
At the height of the 1873 Bubble as credit strains appeared, the New York Herald, in praising the National Banking System, boasted that nothing could go wrong, because the U.S. did not have a central bank:
"True, some great event may prick the commercial bubble, and create convulsions; but while the Secretary of the Treasury [the U.S. was at that time between central banks] plays the role of the banker for the entire United States, it is difficult to conceive of any condition of circumstances which he cannot control. Power has been centralized in him to an extent not enjoyed by the Governor of the Bank of England. He can issue the paper representative of gold to the amount of scores of millions."
The contraction in England, which was the senior economy, was such that by 1884 economists began calling it the Great Depression. Intellectuals and markets provide a continuing source of irony. The Great Depression ran from 1873 to 1895 and was still being analyzed as the “Great Depression” until as late as the 1930s, when another one was discovered.
There is an old saying in physics that “If you keep your database short enough it will fit your theory.” A full review of market history from the 1600s concludes that great financial bubbles have had similar setups, climaxes, and contractions. All five from 1720 to 1929 suffered severe liquidity problems in the fall of the year. All cleared their problems in November, except for the 1825 Bubble when pressures ran into Christmas.
So, there is no need to refer to a potential crisis as a “Minsky Moment.” Prof. Hyman Minsky’s research must have been limited, otherwise he would have described how contractions really work, and would not have imagined that regulations could prevent them.
Another popular misconception has been the concept of a “Black Swan” financial disaster. Investopedia writes that it is an “extremely rare” event that can’t be “predicted beforehand”. It has been popularized by Prof. Nassim Taleb with his 2007 book The Black Swan: The Impact of the Highly Improbable.
Not so, all five great financial bubbles have had common characteristics. These include a decade-duration of the stock bull market, declining real long interest rates and deflated gold prices, with real prices for base metals increasing. Action in these has conformed to the recurring pattern. And as these change, it will mark the transition to contraction. Providing a warning, metal prices have reversed. Coming to a bourse near you -- this fall -- the start of another post-bubble contraction, with features common to previous examples.