“How Concerned Are You About A Bubble?

For The International Economy magazine, Summer Issue, 2021

Financial markets are indeed experiencing bubbles, spurred in part by easy money. Eventually, the bubbles will end.  A bursting could have severe adverse consequences for the real economy, as in 1929 or 2008; but fortunately, that outcome is not guaranteed.

Asset prices are high by historical standards. For example, Shiller’s ratio of US stock prices to cyclically adjusted earnings is above 37, as of June 2021.  It has been above 30 only twice before: 1929 and 2000.

A high P/E ratio need not imply that prices have overshot the present discounted value of future earnings, particularly during a time of innovation.  But the concern is that investors are innovating egregious bubble behavior.

Consider four recent examples:

1. Crypto currencies. Bitcoin’s price surged six-fold from October 2020 to April 2021.
2. The GameStop bubble. The video-game retailer’s stock price increased 18-fold in January 2021.
3. The entire phenomenon of NFTs (Non-Fungible Tokens) is a mystery.
4. The boom in SPACs (Special Purpose Acquisition Company). Their very definition calls to mind a notorious company prospectus in London’s South Seas bubble in the year 1720: “an undertaking of great advantage; but nobody to know what it is.”