Bubble, Bubble, Toil and Trouble

J.D. Foster / November 05, 2009

Confusing times lead to conflicting concerns. Worries over current deflation run into worries about explosive inflation down the road and now there are growing worries over another global asset price bubble. All of these worries are valid, but the possible return of the asset price bubble is the newest and perhaps most serious in the near term. As with the previous bubble, however, commentators seem to be conflating the causes.

The simple evidence of a bubble begins with the Dow Industrials pushing toward 10,000. Who knows what the right level ought to be, but a 53 percent one year jump strikes many as excessive. Commodity prices are also up significantly – oil has more than doubled in price since February while gold is up 35 percent.

If bubbles are building, what are the causes? One candidate is the huge amount of liquidity the Fed has pumped into credit markets. This is reminiscent of the excess money creation earlier in the decade that contributed massively to the financial crisis. However, while this money creation has been enormous, with excess reserves held at the Fed now almost $1 trillion above normal, almost all remains at the Fed rather than released into the credit system. So money creation poses a threat for future inflation, but pose little risk of current bubble building. (more…)