The distinction between a bubble and reality can only be perceived after the bubble bursts. So the question is a conceptual dilemma.
Some useful observations can be made about US financial assets at this juncture. US financial assets have been built on debt in the last decade. Debt is not intrinsically objectionable if it is properly collateralized by real assets. Yet as economists know, money is created whenever two parties enter into a mutual debt obligation (Hyman Minsky). The size of the invisible money pool created by financial derivatives is now many times (no one knows how many) the amount of M3. One firm alone (LTCM) commanded open positions of US$1.2 trillion financed by 100-fold leverage. That is the entire daily transactional value of the world's foreign exchange markets. Another hedge fund (Tiger Management) can suffer an asset evaporation (loss) in the amount of US$20 billion in 6 hours by a 10% appreciation of a single currency (yen) against the USD. At year-end 1998, U.S. commercial banks, the leading players in global derivatives markets, reported outstanding derivatives contracts with a notional value of $33 trillion, a measure that has been growing at a compound annual rate of around 20 percent since 1990. Of the $33 trillion outstanding at year-end, only $4 trillion were exchange-traded derivatives; the remainder were off-exchange or over-the-counter (OTC) derivatives. On a loan equivalent basis, a reasonably good measure of such credit exposures, U.S. banks' counterparty exposures on such contracts are estimated to have totaled about $325 billion last December. This amounted to less than 6 percent of banks' total assets. Still, these credit exposures have been growing rapidly, more or less in line with the growth of the notional amounts.
A Bank of International Settlements survey for June 1998 estimated that size of the global OTC market at an aggregate notional value of $70 trillion, a figure that doubtless is closer to $80 trillion today. Once allowance is made for the double-counting of transactions between dealers, U.S. commercial banks' share of this global market was about 25 percent, and U.S. investment banks accounted for another 15 percent. While U.S. firms' 40 percent share exceeded that of dealers from any other country, the OTC markets are truly global markets, with significant market shares held by dealers in Canada, France, Germany, Japan, Switzerland, and the United Kingdom.
This invisible supply of virtual liquidity supports an artificial level of asset value very much detached from fundamentals, and the unbundling of their underlying open private contracts will inevitably cause drastic readjustments in asset prices in the formal markets. The secuitization of debt blurs the all important dividing line between debtor and creditor, and allows an economy to borrow from itself, not just against its future, but against its current and less sophisticated debt. The collateralization of sophisticated debt by less sophisticated debt has characteristics of a bubble. The broad dis-aggregation of risk to maximize transactional surplus (profit) ultimately leads to the socialization of risk (transferring it into systemic) while the privatization of profit (in the name of capital formation) remains a sacred prerequisite. Under the accounting rules of capitalism, capital cannot exist until ownership is specifically assigned. Thus socialization of capital is a self contradiction in terms and must stay off the balance sheets of the system. To own assets, even the government must act as if it is a corporation, i.e. a "person". Public pension fund assets and other forms of collectively owned assets must have the governing characteristics of "private" capital in order to participate in the US economic system. Such assets enjoy no prerogative to invest negatively for the common good because the ultimate definition of the common good is profit. The public owns 80% of the land in America, which makes the US a socialist system by definition, yet that contradicts America's self image, thus public assets are insulated from the capialistic economic system. This formula will lead to the hollowing out of the center - a classic definition of a bubble. Whether or when the bubble will burst depends on government's ability to extend its elasticity which is not unlimited. That is why Greenspan is pushing de-limiting as a solution to runaway circular hedging in his latest speech. To support the market, government need more power and intervention which in turn destroys the market. As is already apparent, the Federal Reserve is reduced to an irrelevant role of explaining the economy rather than directing it. With every passing month, Greenspan sounds more like a lecturer in Econ 101 rather than the central banker of the world's biggest economy.
Another characteristic of a bubble is that no one inside can escape without bursting it or for that matter, has any incentive to. Except that the laws of physics are generally not forgiving. Bubbles will burst by their very nature.
Henry C.K. Liu
Paul Henry Rosenberg wrote:
> Jordan Hayes wrote:
>
> > From dhenwood at panix.com Mon Apr 5 07:20:43 1999
> >
> > >do bubbles always burst?
> >
> > Can't think of one that hasn't ...
> >
> > Well that's a non-starter; since a bubble that hasn't burst always
> > has the potential to burst, this seems a little too smug to me.
> > But there is precedent for things that have appeared "overvalued"
> > continuing to hold that value; California real estate for one.
>
> I live in California, Jordan. Plenty of people have lost money in
> California real estate because it very much IS subject to periodic
> bursts of over-valuation.
>
>
> --
> Paul Rosenberg
> Reason and Democracy
> rad at gte.net
>
> "Let's put the information BACK into the information age!"