… unfortunately, it also brought mortis:
Just when you thought the central planners had everything squared
away in a tidy little package (the jobless rate is rising? Sell vol. Not
enough iPhone 77.25S are being sold? Sell vol. Ben Bernanke’s voice is
shaking? Sell more vol. The Russell 2000 is up only 1%? Dump all the
vol!), here comes the Harvard-based NBER ( the same people who determine
the start and end of recessions), in conjunction with those economic
wizards from Princeton, with what is actually an interesting paper
discussing the nature of debt (as opposed to equity) bubbles, i.e., “Quiet Bubbles.”In the paper, the authors postulate the following about credit
bubbles (an issue that is obviously quite sensitive in a day and age
when central banks are responsible for the gross monetization of some
80-100% of government debt/deficits):“greater optimism leads to less speculative trading as investors view
the debt as safe and having limited upside. Debt bubbles are hence
quiet—high price comes with low volume. We find the predicted
price-volume relationship of credits over the 2003-2007 credit boom.”Sadly, the authors completely ignore the fact that there are some
several hundred trillion in credit derivatives where the true impact of
credit and interest rate bubble manifests itself, because as far as we
recall when AIG blew up courtesy of a few trillion in CDS the outcome
was far from quiet, not to mention tens of billions of synthetic
structured products (or maybe everyone has forgotten the CDO3s
2006?), as well as one particular entity, the Fed, whose DV01 is now so
large at $2.75 billion, the Fed not only will never unwind, but even
the tiniest rise in rates will force the Fed to monetize even more as
the alternative is a toxic spiral that explodes the Fed’s balance sheet.
In other words, perfectly logical things than anyone with some
practical experience would note but certainly not the Ivory Tower
denizens of Harvard and Princeton.
ZeroHedge goes on to provide the actual set of equations that determine asset bubbles:
Leaving aside the hilarious idea that one can somehow differentiate a non-continuous function using a non-existent variable if one tries hard enough, this has to be one of the better episodes of “first, assume the existence of a can-opener” that I’ve seen in my lifetime.
Here’s a quick overview of how asset bubbles form: they form because of excessive money printing. Full stop. Asset bubbles form because interest rates in the economy are pushed down by central bank interference, pushing them away from the true time-preference rate held by agents in the economy (I dislike drawing a distinction between producers and consumers, as producers are themselves consumers and vice versa). This leads to increasing mispricing of assets in the economy as investments are misallocated and malinvestments begin to emerge- basically, producers invest capital in longer-term projects that require large amounts of said capital in order to bear fruit, and are not easily unwound once entered into. Bubbles collapse when it becomes clear that these malinvestments will never really bear fruit.
Try putting any of that into mathematics, though, and you run immediately into massive problems. How do you even quantify time preference rates? There is not “one” rate of interest in the economy, there are a great many. How do you calculate the “true” value of an asset? I know of at least five different methods of strictly fundamental analysis to do so, and they all give different values. How do you know exactly when to prick a bubble- i.e. what is the ideal “stopping time” in your stochastic equation that denotes the best time for an asset to drop in value? Good luck trying to figure out any of this without going completely cross-eyed.
If it weren’t for the fact that people like these ivory-tower twits hold positions of immense influence and power in today’s credentials-driven economy, this would be merely laughable and mildly irritating instead of actually dangerous.
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In this podcast I talk to Carl Bergstrom of the University of Washington about the mathematics of microbes. Bergstrom is a mathematical biologist who probes the abstract nature of life itself. math