Blowing Bubbles

Robert Shiller is something of a self-proclaimed expert on bubbles, having literally written the book on them. Then again, he does seem to have a tendency to declare a bubble in just about any market trading significantly above its historical valuation. His latest insight is that whenever you hear the term "awash in liquidity," that's a very good signal that there's a bubble somewhere nearby.

Meanwhile, David Leonhardt is also on bubble patrol today: apparently when people concentrate on nominal asset prices rather than real asset prices, that "helps create the conditions for a bubble".

Of the two, Shiller makes slightly more sense. When there's lots of money floating around, it's easier to spend it, as anybody who's experienced a significant rise in their checking-account balance will attest. Whether that means we're in the middle of a bubble, however, I'm not sure.

Leonhardt's argument, on the other hand, I find very hard to understand. Yes, if you look at asset prices in nominal rather than real terms, they will seem to be rising more impressively. And the people who are wowed by Dow 14,000 are in fact looking at an asset which isn't nearly as high in real terms as it might seem in nominal terms. But surely what this means is that markets aren't as frothy as they might at first seem.

Both Shiller and Leonhardt conclude the same thing: that stocks are expensive. Which is a bit weird, considering that, relative to everything else, they certainly seem as though they're actually rather cheap.

There has certainly been much more financial-asset inflation in recent years than there has been consumer-price inflation. I'm just not convinced that means we're in a bubble.

My suspicion is that right now there's not enough demand for capital to match the supply of it. Companies don't really need to raise either equity or debt, which means that most equity and debt issuance is the result of financial engineering, and doesn't really reflect the areas of the economy which need the most investment. So a lot of money is essentially chasing its own tail, rather than being extracted from the financial system and injected into the real economy. Is that a bubble?