I received a direct message on Twitter asking if I could explain what causes bubbles. Taking cue from Hazlitt, I said that I could do that in less than a dozen Tweets.
In this post I have reproduced the same (with a few edits to increase readability).
- Bubble Tip: There is no boom-bust theory in Micro Economics - ergo free markets are stable. The destabilization factor must come from... outside.
- Bubble Tip: Look for the fuel for speculation... check if real inflation adjusted interest rates are negative!
- Bubble Tip: The fuel for speculation comes when the Central Bank prints "mickey mouse" money out of thin air. [Hint: Printing = Quantitative Easing].
- Bubble Tip: "Mickey mouse" money has to go somewhere... and it fuels a speculative bubble where it does. First movers have an advantage.
- Bubble Tip: With the aid of leverages asset prices can be inflated beyond the wildest imagination. [Hint: Japan in the 80's].
- Bubble Tip: Monetary injections are like a steroid. It turbo-charges activity in interest rate sensitive sectors. [Hint: Nasdaq & Housing].
- Bubble Tip: Look if externally created incentives provide support for the bubble i.e. government policy. [Hint: Freddie & Fannie, The Community Reinvestment Act, Tax beaks on Capital Gains].
- Bubble Tip: Finally look for other tell tale signs - poor economic data, inflation, health of banks, inflation, mania, valuations...
- Bubble Tip: The music has to stop. It will when interest rates start to rise to pre-boom levels. Once it does the bubbles pop.