The Federal Reserve’s Most Important Product
[courtesy Google Images]
For example, if the housing market goes into a “bubble,” most homes in that market will be selling for prices that seem unreasonably high. If tech stocks go into a “bubble,” virtually all of the individual stocks in that particular market will be selling for unreasonably high prices.
Bubbles can occur in a particular nation’s bond, stock, housing, and commodity markets. All bubbles share a single common denominator: they’re significantly over-priced.
But when we say “over-priced,” we necessarily mean “over-priced” in relation to something else. What’s that “something else”? It’s the free market. Bubbles are over-priced in relation to the prices that would normally exist in the free market.
For example, suppose the real estate market is in a “bubble”. Prices for homes could be ridiculously high. A house that should sell for $250,000 on the free market, is nevertheless selling for $1 million. That’s a bubble. Motivated by greed, people nevertheless buy that home for $1 million believing that the bubble will continue to expand and the price of the $1 million home will soon go even higher to, $1.5 or even $2 million.
The important point to grasp is that when stock, bond, commodity and home markets become “bubbles” they’re over-priced in relation to a true, free market.
Any free market is capable of over-reacting so as to produce excessively high or low prices. But generally speaking, when a particular free market produces irrationally high or low prices, the more astute members of that market will sense the irrational price and reverse course so as to produce a good profit. Free markets tend to correct their excesses in a more-or-less timely manner.
But a true “bubble” will persist long after the free market might’ve cause a price correction.
Why?
Because a true “bubble” isn’t caused by mere forces of supply and demand in a free market. A “bubble” is caused by influences from outside of the free market. These outside forces cause a market to be artificially stimulated, manipulated and controlled in way that defy and overcome the true forces supply or demand.
What’s the source of outside forces?
It might be a very wealthy corporation. It might be conspiracy of individuals bent on cornering a market. But in this day and age, when you see a “bubble,” you see the result of legislation, policies and/or regulations that’ve been imposed by government and/or the central bank.
Bubbles exist in the un-free, manipulated markets. Manipulated by whom? Government and central banks like the Federal Reserve.
How long will “bubbles” last and continue to grow? Until the government and/or Federal Reserve change policy or run out of sufficient fiat currency to continue to inflate the “bubble”.
(What’s the Federal Reserve’s favorite song? “I’m Forever Blowing Bubbles.”)