Bubbles and Semilogarithmic Paper

[ostap]

According to most central bankers, one reason why asset prices should not be considered in the formulation of monetary policy is that it is impossible to determine whether prices are fundamentally justified or are driven by speculation.

This is, of course, nonsense. Most speculative bubbles share several common features, which makes them easy to spot. Among these characteristics are an expansionary monetary policy, high credit growth, financial imbalances, speculative mood, high turnover, media frenzy etc.

Another distinct feature of a speculative bubble is an increasing growth rate. A maturing bubble is often growing faster-than-exponentially. This is easy to understand: as a bubble gets more mature, both the probability of a crash and the expected loss from a crash are increasing. In order to compensate investors for that increasing risk, ex ante returns have to increase, which – ex post – results in an increase in the bubble’s growth rate.

Exponential growth yields a straight line when plotted on a semi-logarithmic chart. Faster-than-exponential growth yields an upward-sloping curve when plotted on a semi-logarithmic chart. The following chart of the Shanghai Stock Market Index shows that the Chinese stock market is probably in bubble territory at least since November 2006. When the bubble will burst and how it will affect other markets is another question.

Maybe it’s not a coincidence that logarithmic paper went out of fashion before today’s central bankers went to school…




Source: www.economicreason.com

[Finster]

Re: Bubbles and Semilogarithmic Paper

Absolutely, Ostap. Asset prices reflect inflation just like any other. They just tend to do so first. As a result, inflation is "fun" in the early stages, people just call it a bull market because it's viewed as positive. Later, as the inflation begins to work its way into the prices of things people buy to consume, it's not so much fun any more. Only then do they apply a perjorative term like "inflation".

Ditto on semi-log charts. In general, most financial series that are restricted to positive values need to be plotted on a log scale to avoid distortion. Only if the series has zero or negative values should linear plots be entertained first.

[Sapiens]

Re: Bubbles and Semilogarithmic Paper

[LEFT]Exponential growth yields a straight line when plotted on a semi-logarithmic chart. Faster-than-exponential growth yields an upward-sloping curve when plotted on a semi-logarithmic chart.

LOL, you made me realize that most economists don't understand these concepts, but Radio Frequency engineers easily do.

Excellent post.

-Sapiens

[Spartacus]

Re: Bubbles and Semilogarithmic Paper

as a bubble gets more mature, both the probability of a crash and the expected loss from a crash are increasing. In order to compensate investors for that increasing risk, ex ante returns have to increase, which – ex post – results in an increase in the bubble’s growth rate.

I've never seen a statement I could disagree with more.

bubbles happen because of perceived LACK of risk in the investment.

The only perceived risk for the majority involved in a bubble is the risk of being left behind, of being permanently locked out by increasing prices.

You saw exactly this thinking (and exactly these words in Realtor(TM) advertising) in the housing bubble.

"investors" demand less real return (dividends in the stock market bubbles, rent in real estate bubbles) and because of the perceived safety, are willing to defer returns for later-to-be-realized capital gains. You don't do this if you are scared and you think the returns could evaporate at any second.

EDIT: I didn't know how stongly to word this, so apologies if I come across like a rabid wolverine on steroids and meth.

[jk]

Re: Bubbles and Semilogarithmic Paper

A maturing bubble is often growing faster-than-exponentially. This is easy to understand: as a bubble gets more mature, both the probability of a crash and the expected loss from a crash are increasing. In order to compensate investors for that increasing risk, ex ante returns have to increase, which – ex post – results in an increase in the bubble’s growth rate.

i agree with spartacus on this - i don't think perceived risk is the issue.

i think this is more easily understood as a population growth dynamic. if a population increases in the absence of predation, it will grow exponentially until it outgrows/exhausts its supply of sustenance. then it will collapse.

[bart]

Re: Bubbles and Semilogarithmic Paper

EDIT: I didn't know how stongly to word this, so apologies if I come across like a rabid wolverine on steroids and meth.

Only myself (and Finster with his log compulsion) are allowed to go there... :eek: ;)

[flow5]

Re: Bubbles and Semilogarithmic Paper

"Asset prices reflect inflation just like any other."

AMEN TO THAT

[flow5]

Re: Bubbles and Semilogarithmic Paper


Lawrence K. Roos, Past President, Federal Reserve Bank of was cited in the WSJ as follows: "I do not believe that the control of money growth ever became the primary priority of the Fed. I think that there was always and still is, a preoccupation with stabilization of interest rates."

Ignore Federal Fund rates, or any interest rates, as a “trigger” to guide open market operations. The money supply can never be managed by any attempt to control the cost of credit.

[flow5]

Re: Bubbles and Semilogarithmic Paper

On May 16, 2000 the fed funds rate was 6.5 percent
On Jun 25, 2003 the fed funds rate was 1.0 percent
On Jun 29, 2006 the fed funds rate was 5.25 percent
As the rate fluctuation of the fed funds rate for the last six year shows, the fed lost control of both interest rates and the money supply:mad:
What will it take to grasp the fact that managing interest rates (in the short run) is antithetical to the non-inflationary management of the money supply -- and that in the longer term, we have not only higher rates of inflation but higher interest rates as well?:confused: