Friday, November 05, 2010

Is the Fed blowing new bubbles?

The Federal Reserve is beginning a new round of quantitative easing, printing money to buy intermediate- and long-term bonds, thus increasing the money supply and lowering intermediate- and long-term interest rates.

This is different from what the Fed normally does to stimulate the economy. Normally it prints money to buy short-term bonds. But, since short-term interest rates are already near zero, the Fed has to take the riskier action of buying longer-term bonds if it wants to stimulate the economy.

Harvard economics professor Martin Feldstein, President Emeritus of the National Bureau of Economic Research, warns that this is dangerous and may blow new bubbles:
The Federal Reserve’s proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilise the global economy. Although the US economy is weak and the outlook uncertain, QE is not the right remedy.

Under the label of QE, the Fed will buy long-term government bonds, perhaps one trillion dollars or more, adding an equal amount of cash to the economy and to banks’ excess reserves. Expectation of this has lowered long-term interest rates, depressed the dollar’s international value, bid up the price of commodities and farm land and raised share prices.

Like all bubbles, these exaggerated increases can rapidly reverse when interest rates return to normal levels. The greatest danger will then be to leveraged investors, including individuals who bought these assets with borrowed money and banks that hold long-term securities. These risks should be clear after the recent crisis driven by the bursting of asset price bubbles. Although the specific asset prices that are now rising are different from last time, the possibility of damaging declines when bubbles burst is worryingly similar. ...

The truth is there is little more that the Fed can do to raise economic activity. What is required is action by the president and Congress...
It sounds to me like Feldstein is saying The Onion was right.

As for other notable economists' thoughts on the Fed's actions, John Taylor is opposed and Paul Krugman is ambivalent.


  1. So whats the next bubble going to be in?

    First things that come to mind are green energy, & rare earth elements. Thoughts?

  2. Next bubble? GOLD

  3. If the global economy becomes (more) de-stabilized, it won't matter to Arlingtonians. The value of all assets within the borders of Arlington will rise in perpetuity.

  4. Arlington envy - still palpable after all these years...

  5. I think one bubble is likely to be long-term bonds.

    Unlike stocks, bonds, and real estate, gold doesn't provide a cash flow so it's hard to claim there's a bubble based on a P/E ratio. However, rising gold prices definitely have the "walks like a duck, talks like a duck" thing going on.

  6. That is a no on aluminum:
    Aluminum is the most common earth metal, but due to its reactivity it is almost never found in the pure metal state. Aluminum exists as an ore, usually bauxite. Pure aluminum metal was once one of the most sought after and valuable metals on earth. Then disaster struck. two independent discovers, Charles Martin Hall and Paul Heroult found a way to purify aluminum from all the ores where it could be found! This made pure aluminum as common as wood. From the Legacy section on Wikipedia:

    Although aluminium is one of the most commonly occurring elements on Earth, before the invention of the Hall-Héroult process, it was initially found to be exceedingly difficult to extract from its various ores. This made the little available pure aluminium which had been discovered (or refined at great expense) more valuable than gold. Bars of aluminium were exhibited alongside the French crown jewels at the Exposition Universelle of 1855, and Napoleon III was said to have reserved a set of aluminium dinner plates for his most honored guests. Additionally, the pyramidal top to the Washington Monument is made of pure aluminium. At the time of the monument's construction, aluminium was as expensive as silver. Over time, however, the price of the metal has dropped; the invention of the Hall-Héroult process caused the high price of aluminium to permanently collapse.

    Now what do you think happened to all the aluminum jewelry makers? What about the shipping industry and mining for pure aluminum? Gone. Busted. This no doubt had a huge effect on asset prices across the board. Did the world end?

  7. I think there might be a bubble in T-Bills, but hard to tell. I do think there's a bubble in Gold, for sure.

  8. The next bubble would be gold. Though there is no cash flow. The appreciation is definitely needed to be considered. The bubble is for sure.

  9. Gold and even moreso silver (you should be talking about silver, instead of gold -- and that you focus on gold instead of silver is a strong indication you trust the mainstream media) are far away from a bubble.

    Taking a look at historic highs and price inflation since then, gold and silver are far away from their highs.

    Gold and silver are experiencing asset inflation because this is where all the QE2 money is being spent -- on overseas assets. If these are in a bubble, then all assets worldwide are in a bubble. And they are, and it won't pop because the US dollar is on the way out, for good.

    Just ask the World Bank and IMF -- the most powerful corporations on the planet. You ignore them at your own financial peril.

  10. By the way, people were telling me gold and silver were in a bubble a year ago. Also two years ago. And three years ago.

    That was over 100% gains ago for me. Look at the long-term chart of gold. Nothing but up for 10+ years straight.

    Why do you think that is? Dollar dilution and economic instability worldwide? You really think that's going to change?

    I think those who regurgitate the media's "bubble" analysis on precious metals are those who were too trusting of the mainstream media to actually make a purchase and now they are feeling too stupid to actually buy any.

    Go on and buy already. It's not going to do anything but go up in the long term. Just like the last 10 years.

  11. And don't buy gold -- buy SILVER. Forget gold. Silver is making big gains, twice as much. And it's in much shorter supply.

  12. God, gold-bugs are irritating. Want a better investment? How about taking everything you own to Vegas and putting it on "black".

    You don't even have to rationalize it with months of spurious "research".

  13. An entertaining take on the gold madness:

    Fortunately, this psychological distress seems to be mostly limited to sshut-ins and Glen Beck listeners (granted there's a lot of overlap) so I think the overall population is fairly well-insulated.