Several asset markets have adjusted downwards since Mr. Bernanke gave his interpretation of the course of future monetary policy last Wednesday at the close of the latest meeting of the Federal Reserve's Open Market Committee meeting. On Tuesday evening, June 18 the Standard & Poor's 500 stock index closed at 1,652. Friday, June 21, the S&P 500 index closed at 1,593, a decline of 3.6 percent. And, S&P 500 stock index was down by more than 20 points at the opening of the market this morning.
The yield on the 10-year U.S. Treasury bond, which closed on Tuesday at 2.33 percent, rose to 2.53 percent at the close on Friday, a rise of 8.6 percent. Of course, as the yield on these securities rise, the prices of the securities fall.
Commodities prices fell during the same time period. The Dow Jones/UBS index fell 3.6 percent during this period and the S&P GSCI index fell 4.1 percent at the same time. Furthermore, there has been a sell-off of stocks in emerging markets. And there are other examples. Have all these markets been subject to credit bubbles as the Federal Reserve has pumped billions and billions of dollars into the economy in order to spur on economic growth?
The speed of the decline in asset prices in these areas at the mere hint of a possible slowdown of purchases of Treasury securities and mortgage-backed securities on the part of the Federal Reserve sure gives some indication that there was a lot of hot air inflating the levels the markets had reached. A way to look at one of these bubbles is to look at the measure of stock market performance created by the economist Robert Shiller, the cyclically adjusted price earnings ratio or CAPE.
For May 2013, Shiller is estimating that the CAPE measure is 23.68. (Shiller's reported June figure is only for a June 3 closing value for the stock market.) One has to go back beyond the financial collapse to find this ratio as high as it is.
This measure is far above the historical average. Shiller argues that CAPE eventually will revert to the historical average of the series, which means that at some time in the future the CAPE measure will fall from its current level to somewhere around 18.
Now, the CAPE value can fall in one of two ways. First, corporate earnings can grow substantially with little or no further change in the S&P 500 index. Situations like this usually happen early in the business cycle as business earnings are expected to pick up as the economy gets stronger. That is, stock prices go up in anticipation of the future rise in profits.
In the second case, stock prices must decline. If the corporate earnings fail to materialize then there must be a re-adjustment in stock prices.
I know that there has been a lot of talk about corporations posting higher profits recently, but these results are just coming from some high profile organizations. According to Shiller's data, corporate earnings have been declining since March 2012 to the latest date available. If one adjusts these figures for price inflation, which Shiller does, the weakness in real corporate earnings is even greater.
According to this analysis, corporate earnings are not rising to support the high levels that stock prices rose to. One could argue that this is evidence that the rise in stock prices was a bubble created by the Federal Reserve and not sustainable by the economic performance of the economy. That is, the mediocre economic growth the United States was experiencing was not sufficient to support the stock prices that had been achieved.
In other words, the stock market prices reached the level they did due to the liquidity being pumped into the economy by the Federal Reserve System. The support to this conclusion is the deflation of stock market prices after Bernanke's announcement relative to the "tapering" of Federal Reserve bond purchases. And this conclusion also applies to the sell-off of assets in other impacted markets.
It seems to me that the inflation of these asset markets with little or no real impacts on the economy represent credit bubbles. I don't know what else you can call them.
It seems to me that even the Chinese understand this. In discussing the latest financial crunch in China, officials cite the fact that problem they faced was not one of an insufficient amount of cash available but that "the money has been put in the wrong place."
It was argued that while some areas of the economy lacked funds, other areas were flush with money and the growth of aggregate money and credit numbers supported this. The problem was that funds were circulating within the "shadow financing " area and not in the primary banking sectors. In other words, the "credit crunch" in the primary banking sectors restricted growth in the real economy, while plenty of money circulated in other markets in the economy.
In recent months, a lot of money in the United States has been circulating around within the financial sectors. This fact has created credit bubbles in certain areas. Money, however, is not circulating around in the real sectors leaving economic growth moderate and employment weak.
What's not to understand about bubbles?