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Topic: Economics and the stock market
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Reality. Bites.
rabble-rouser
Babbler # 6718
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posted 07 December 2005 02:36 PM
quote:
Originally posted by jrootham:
Yup, it's called a bubble
George: A bubble? A: Yes, a bubble. George: Boy! 
From: Gone for good | Registered: Aug 2004
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Stephen Gordon
rabble-rouser
Babbler # 4600
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posted 07 December 2005 03:02 PM
The 'fundamental' price of an asset depends on peoples' evaluations of the future returns they will generate, and the rate at which those returns are discounted. As peoples' expectations evolve, so will the price.Part of the return on an asset is the capital gain it generates. If you can sell it for a higher price than what you paid for it, then you might buy it, even if it doesn't generate income. A bubble occurs when the price of an asset is (almost) entirely driven by the belief that its price will rise. If everyone believes that its price will rise, they'll pay a higher price. And if more people are willing to pay a higher price, its demand will go up, and the price will rise - thus confirming the original belief. This confirmation provides the basis for another iteration, and so on. Bubbles can be sustained for quite a while, and it may even be rational to ride a bubble, even if you know that it will pop eventually, if you think that you can get out in time.
From: . | Registered: Oct 2003
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up
rabble-rouser
Babbler # 9143
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posted 07 December 2005 10:11 PM
So how over-priced are stocks today compared to an earlier period (say 530 years ago, or whatever year you have come across a number for).So using 19XX (whatever you know 1960, 1975, doesnt matter) valuation systems, today's market is how much larger? How much of the market is bubble from over-heated demand? And do speculation bubbles increase inflation? Whats the relationship there? [ 07 December 2005: Message edited by: up ]
From: other | Registered: May 2005
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Stephen Gordon
rabble-rouser
Babbler # 4600
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posted 07 December 2005 10:22 PM
quote:
Originally posted by up:
So how over-priced are stocks today compared to an earlier period (say 530 years ago, or whatever year you have come across a number for).So using 19XX (whatever you know 1960, 1975, doesnt matter) valuation systems, today's market is how much larger? How much of the market is bubble from over-heated demand?
We really don't know. The asset-pricing literature has yet to reach a consensus. quote:
And do speculation bubbles increase inflation? Whats the relationship there?
Again, it's not clear. There are some - The Economist magazine is probably the best known advocate of this position - who think that bubbles should be attacked by monetary polcy when they occur. It's not a universally-held belief, and I personally don't agree. But it's not a point upon which we can claim there's a broad consensus.
From: . | Registered: Oct 2003
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DrConway
rabble-rouser
Babbler # 490
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posted 08 December 2005 12:46 AM
The partial disconnection of the stock market from the real economy effectively diverts consumer price inflation into asset price inflation, though. If I have, let us say, $500 discretionary income this month, and I choose to regularly deduct some of that money to purchase stock, then that money can't go into the consumer goods sector. If many other people do the same thing, then we are, essentially, buying less material stuff and more assets, and this can drive up the price of assets rather than the price of the material stuff we buy. The inflation hasn't really disappeared; it's just been shifted and it disappears because of the differing regard we give to consumer price inflation and asset inflation (pardon the seeming circularity of the statement, though); asset inflation is generally regarded as benign since it's tied up with perceptions of profitability, whereas consumer price inflation is regarded not as a sign that supply should increase to meet demand, but a bad thing in and of itself. But I digress.  However, to the extent that a bust in the stock market has a ripple effect on consumer demand, and that bubbles have a rather unfortunate side effect of encouraging rampant fraud, scams and rip-offs (say what you will about people who bought into a dot-com on the strength of airy pronouncements from a CEO still in his metaphorical diapers, but unsophisticated entrants into the stock market do not deserve to be fleeced of their life savings), it only makes sense that bubbles should be brought under control as soon as possible. [ 08 December 2005: Message edited by: DrConway ]
From: You shall not side with the great against the powerless. | Registered: May 2001
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