They Should've Seen Those Things Coming

More than any other period in the current era, historians are sure to remember the last few years as a time when, "Yeah, they really should've seen those things coming".

Of course it's much easier to see some things after the fact. Two cases in point came over the weekend on the subjects of inflation and asset bubbles.

Ben Bernanke spoke at Stanford University on Friday and commented on the relationship between globalization and domestic inflation.

In the major industrial economies over the past decade or so, import prices--particularly the prices of imported manufactured goods--have generally risen at a slower rate than other consumer prices, slowing overall inflation. The slower growth in import prices reflects to some extent rapid productivity gains in the production of manufactures, an important component of trade.
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On the other hand, not all aspects of globalization and trade reduce inflation. For example, globalization has been associated with strong growth in some large emerging-market economies, notably China and India, and this growth likely has contributed to recent increases in the prices of energy and other commodities.
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Accordingly, in the past several years, the effect of growth in developing economies on commodity prices has been a source of upward pressure on inflation in the United States and other industrial economies.

When the offsetting effects of globalization on the prices of manufactured imports and on energy and commodity prices are considered together, there seems to be little basis for concluding that globalization overall has significantly reduced inflation in the United States in recent years; indeed, the opposite may be true.

In many cases it's not just a slower rate of growth for imports. When quality adjustments are taken into consideration, there have been outright declines in prices for many imported goods, notably the price of televisions over the last ten years.

Compare the above price trend to buying movie tickets or other domestic services that do not benefit from falling import prices and a completely different picture emerges.

Combine the prices of television sets and movie tickets and you get benign inflation - the norm for most of the last two decades.

This was key to Alan Greenspan's tenure at the Federal Reserve where easy money policies were carried out amid an environment of low inflation. He commented many times on this subject, here is one example from just two years ago.

Over the past two decades, inflation has fallen notably, virtually worldwide, as has economic volatility. Although a complete understanding of the reasons remains elusive, globalization and innovation would appear to be essential elements of any paradigm capable of explaining the events of the past ten years. If this is indeed the case, because the extent of globalization and the speed of innovation are limited, the current apparent rapid pace of structural shift cannot continue indefinitely.

Someone really should have figured out that if exporting nations with cheap labor and fixed currency exchange rates continue to depress prices in the U.S., that eventually the demands of this global growth on natural resources might become a problem.

Ben Bernanke now grasps this present day reality, but the former Fed Chairman seems to have been blithely unaware.

The second example of how a little foresight might have mitigated a set of problems (problems that only get worse with each passing day) comes from Justin Lahart in this morning's Wall Street Journal. Justin writes($) about the most recent asset bubble and how it's a lot like the last asset bubble.

Seven years after the stock-market bubble busted, the troubles in the housing market look strikingly familiar. In fact, everything is going according to the textbook -- the textbook in this case being Charles Kindleberger's 1978 classic, "Manias, Panics, and Crashes."

Mr. Kindleberger found speculative bubbles tended to follow similar patterns. First, there is some "displacement" -- such as the development of the Internet or a prolonged period of ultralow interest rates -- that radically improves the outlook for some area of the economy. People take advantage of the opportunity, fueling a boom that is fed by progressively easier access to cash. At the height of the bubble, there's "pure speculation"; assets are bought to quickly sell them again at a higher price -- day-trading in 2000, condo-flipping more recently, tulips long ago.
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As Mr. Kindleberger showed, financial shenanigans in housing are coming to light. A jump in "early defaults," where borrowers stop paying shortly after taking out their mortgage, stems in part from questionable lending practices.
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In early 2004, then-Fed Chairman Alan Greenspan said he thought "we don't have to worry much about the emergence of bubbles for a while because it takes a number of years for the trauma of the collapse to wear off." Back then, of course, the Fed's ultralow interest rates were helping to feed the housing boom.

Mr. Kindleberger documented that bubbles frequently come not long after the previous bust. The 1800s included repeated bubbles in canal and rail securities in the U.S. and abroad. Housing wasn't the only place where low rates bred an easy money culture. Emerging-market stocks and bonds, corporate debt and buyouts come to mind.

Anyone with just a little common sense would have realized that the U.S. real estate market had already detached from its fundamentals two or three years ago. Like most manias, when prices are going up, many people stop asking questions.

Easy money policies, enabled by benign inflation which was in part a result of globalization, have led to the most recent asset bubble and a large part of the blame rests squarely with the former Fed chairman.

He really should've seen those things coming.