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fransgeraedts (99.92)

Irrational Exuberance -how to prevent large scale speculation; a challenge to the community

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August 09, 2010 – Comments (6)

Lets begin with a quote from the ever popular Alan Greenspan.

 

Clearly, sustained low inflation implies less uncertainty about the future, and lower risk premiums imply higher prices of stocks and other earning assets. We can see that in the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past. But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. Indeed, the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.

Allan Greenspan, in december 1996(!)

 

Central bankers have studied the crash of 29 and the downward spiral of the economy into the great depression like no other subject. Bernanke is one of the great authorities. But they (and almost all economists) asked the wrong question. All of their intellectual energy has been invested in answering the question what should be done after a great speculative wave in the markets crashes -how to prevent that the economy as a consequence falls into a depression. They forgot to ask the preceding question: how to prevent largescale speculative waves in the first place.

Greenspan in 1996 sensed that there was something going wrong. But he did not know how to act. Even today the lazy mainstream of economic thinking simply maintains that you cannot prevent largescale speculative waves cannot be prevented  -thereby evading the question cowardly.

I think that this question is the most important question in economics today. (1) We are getting ever better in managing capitalism on the macro- meso- and micro-levels. How to prevent large scale speculative waves could be the last big open question  ..with enormous positive consequences if we would find an answer. (2) I suspect that to answer this question we will be forced to integrate into one perspective the two large economic theories of our times (neo-classical and keynesian). That would be a great benefit for economical theory and the politics that go with it. (3) There is a real danger of a third speculative wave in the middledistance. I do no not think that we can withstand another one. If i may use a Dutch metaphore: the dikes will not hold against a third tsunami, the first two have weakened them to much. That makes the question how to prevent a third wave urgent.

I would like therefore to challenge the Caps community to answer this question.

How can large scale speculative waves be prevented?

Alstry, Bullishbabo, Ultralong, Binve, Florida, Deej, Chris, Donner, David from Quatar, Dwot, Sinchi,Abitare, Dragon and all the others that commendably think and write on macro-economic questions....How about it? Ideas? Thoughts? Theories? Suggestions?

 

fransgeraedts

  

6 Comments – Post Your Own

#1) On August 09, 2010 at 12:31 PM, MegaEurope (< 20) wrote:

Tax policy is very important.  Central bankers don't have any control over it though.

I think we should raise the short term capital gains rate and phase out mortgage interest deductions.  (Not just in case of speculative emergency, but permanently.)  But it is probably politically impossible.

If you look at China, a key factor in the property bubble is that most cities did not have property taxes.  Now they are being introduced which should cool the market off quite a bit.

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#2) On August 09, 2010 at 1:51 PM, ChrisGraley (29.85) wrote:

The economy is cyclical, but the beta increases when there is manipulation.

If you artificially make the highs higher, you'll eventually make the lows lower.

Then you have to manipulate even more the next time making the beta even higher and making the next low even worse.

There is not now or will there ever be any such thing as a free lunch (except on my birthday at the local Hooters)

 

 

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#3) On August 09, 2010 at 6:23 PM, MegaEurope (< 20) wrote:

Surprising that this did not attract much discussion.  I guess a lot of the political commenters on CAPS are not interested in talking about realistic reform.

I think identifying the problem as broadly as 'speculation' will not work from a PR standpoint.  Regulators and politicians need to identify specific problems associated with speculation.

A good place to start might be anti-flash-crash measures, designed to protect against "market terrorism".  Who could lobby against that?  But they can lobby against tax hikes very effectively.

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#4) On August 09, 2010 at 7:31 PM, rofgile (99.25) wrote:

fransgeraedts,

 The fractals guy, Mandelbrot has a neat book you should read.  "Misbehavior of the Markets" - its a couple of years old now.

 One of the interesting things he proposes in the book is that bubbles are a natural part of the market system - ie, if you have a market you are guaranteed to have bubbles.  

 You should take a read of that book, best on economics/markets I read this last year.

 -Rof 

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#5) On August 09, 2010 at 7:42 PM, whereaminow (22.93) wrote:

Simple, stop f*cking with interest rates - yeah, I'm looking at you Alan.  You want to stop irrational exuberance, stop pushing drugs (artificially low interest rates are f*cking drugs.)

I don't see what is so hard to figure out.  Tell me please, what is so hard to figure out?  

David in Qatar

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#6) On August 16, 2010 at 1:29 AM, TMFUltraLong (99.95) wrote:

I've been away for the past week clearing my head but don't think I didn't see this thread. 

I have a very simple answer to this question of what can be done to prevent irrational exuberance.....

Nothing! 

Not a darn thing. Irrational exuberance is in and of itself a market wave of speculation driven largely by emotions and emotional trading has increased as the mainstream methods by which anyone can get invested in the market have increased. Remember in 1999 when your cab driver had the next hot IPO that was going to shoot up 200%? Those people are still out there and they will always be out there. I'm not saying we can't respond to things from a macroeconomic perspective, but we have no hope to control speculative waves which will come about every decade or two... that's the nature of the market. 

The Fed will always be responding to economic data which is at least weeks old and that will also negate any chance to truly get a stranglehold on speculative waves. Do you remember the movie Spaceballs... 

Dark Helmet: What the hell am I looking at?! When does this happen in the movie?!Colonel Sandurz: "Now". You're looking at "now", sir. Everything that happens now [indicates himself and Helmet] is happening "now". [Indicates the screen]Dark Helmet: What happened to "then"?Colonel Sandurz: We passed "then".Dark Helmet: When!?Colonel Sandurz: Just now. Were at "now," now.Dark Helmet: Go back to "then"!Colonel Sandurz: When?Dark Helmet: Now!Colonel Sandurz: "Now?"Dark Helmet: Now!Colonel Sandurz: I can't.Dark Helmet: Why!?Colonel Sandurz: We missed it.Dark Helmet: When!?Colonel Sandurz: Just now.Dark Helmet: ... When will "then" be "now"?Colonel Sandurz: Soon.Dark Helmet: [backpedals in shock] How soon? I think that accurately sums up my point about reacting to macroeconomic policy. Who would have ever thought Spaceballs would help me make my point... UltraLong Report this comment

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