Are We in a New Economic Bubble?
Economic bubbles can be devastating. One day, everything seems normal—prices for a specific asset might seem a little high, but otherwise, the market is stable. The next day, everything collapses. Bubbles are responsible for the dotcom collapse of the early 2000s, as well as the 2008 economic crisis, as well as countless other smaller or more distant economic downturns.
Bubbles, of course, can occur in a variety of settings. They all follow a similar pattern, but that pattern can be applied to multiple different areas. To start, a market seems healthy—or else, there’s some reason to generate customer enthusiasm. Consumers start pouring in and making money as prices start to rise, which leads to even more consumers investing. Eventually, this pushes prices to excessive new heights, presumably far beyond their true intrinsic value.
photo/Gerd Altmann
Then, there’s a turning point; a piece of bad news or a new revelation suddenly sparks fear in investors. People start running, selling off their assets, and prices plummet. People start losing money, panic sets in, and a massive selloff causes prices to sink even further. If the bubble is big enough in a specific market, it can have a ripple effect; for example, the housing market collapse of 2007 and 2008 in the United States ended up traversing to the stock market, and internationally.
Is it possible that we’re on the verge of a new economic bubble, without even realizing it?
Let’s take a look at some of the most prominent areas of the economy.
The Housing Market
The housing market has had a healthy, reliable decade. Prices everywhere have increased, in most places fully recovering from the 2008 downturn. People are more interested in buying and owning homes, and loans are highly available to consumers.
Some local markets have grown to become expensive, to the point where ordinary people can no longer afford to live there—San Francisco comes to mind—but for the most part, prices haven’t far exceeded expectations of growth. Similarly, it’s important to note that the most prominent motivating factors in the previous housing market collapse are no longer an issue.
In the years leading up to 2007, banks were incentivized to give home loans almost indiscriminately, allowing people with bad or questionable credit to get loans for inordinately high amounts. On top of that, these loans were passed off as being more reliable than they truly were—and then they were used to back other securities in a form of derivatives trading. In other words, there was a lot of money riding on these people’s abilities to pay back their inappropriate loans. When a few people defaulted, it created a ripple effect.
We aren’t seeing similar patterns of irresponsibility in the housing market, so even if prices are high (and even if the market might cool next year), it seems unlikely that we’re in a “bubble” on the verge of bursting.
The Stock Market
We can also look to the stock market as a place for a potential bubble to form. In the late 1990s and early 2000s, the root cause for the impending economic downturn was the overestimation of tech stock values; people were hungry for dotcom business stocks, overestimating their earning potential and investing too much money in businesses with lackluster business models.
These days, experts do believe that the stock market is somewhat overpriced; price to earnings ratios are as high as they’ve ever been, especially in the tech sector, where massive companies have enormous future earning potential, but aren’t generating a profit today. There are some warning signs that an economic downturn is in the near future, which could be a manifestation of these overinflated prices “bursting” back down to an appropriate level.
However, today’s stock market is much different than, say, the stock market of 1929 or 2000. Interest rates are at near-record lows, and inflation is pretty much nonexistent. There’s an argument to be made that these economic conditions completely justify the higher-than-historically-average prices we’re seeing in the stock market.
Also, higher prices seem to be spread throughout the market; they aren’t concentrated in a specific sector, nor do they seem to be the direct result of some questionable new law or financial practice.
photo/ screenshot YouTube
The Trouble With Predicting Bubbles
It doesn’t seem like there’s a bubble on the horizon, at least in the real estate market or stock market—but then again, it never seems like there is. If people expected themselves to be on a bubble on the verge of bursting, the bubble would never grow big enough to burst. The measures of the past that could have predicted previous bubbles don’t seem to be telling us anything, but there could always be some unseen, untold variable guiding us toward an economic downturn. Even seasoned economists can’t say for sure.
Author: Anne Johansson
