Monday, 23 November 2009

The Next Bubble: Introduction

Bubbles fascinate me. Nowhere else will you find such a variegated proving ground for the vagaries of human psychology, nor such a vivid illustration of the wondrous complexity that is the market. The various tensions on display – between individuals and institutions; between incentives and emotions; between rationality and greed; between the short term and the long run; between macro economics and micro behavior; between fundamentals and technicals – offer limitless scope to the curious observer.

If the study of markets is the study of human nature, then the study of bubbles is the study of markets in microcosm.

My fascination with bubbles will come as no surprise to regular readers of this blog, as evidenced by my choice of subject matter. In recent weeks I have written about bubbles and the rational trader; scale invariance in bubbles; feedback effects in bubbles; the link between asset price bubbles and jobless recoveries; the identification of bubbles; and the stages in the evolution of bubble.

But these essays have been, for the most part, abstract and analytical; they say little about the state of the world today. Not so the next few posts. In the coming week I would like to talk about a bubble that I fear is developing before our eyes. And it’s not a bubble in emerging market stocks or in raw materials; it’s in something much closer to home.

Again, regular readers of this blog will know or have guessed what I’m talking about: I believe that we have recently completed the transition from a boom to bubble in the market for long term US government bonds.

Extraordinary claims require extraordinary evidence. Hence I will take a break from the usual ‘weekly column’ format of this blog, and instead provide a sequence of shorter posts in which I will expound on my thesis in greater detail. Coming up first: background information and necessary conditions.

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