Sloppy reasoning at the Financial Times

I have a visceral dislike of this sort of column:

We haven’t learnt as much as we should have over the past few years. But the one thing that is surely clear to all by now must be this: bubbles always pop. And so it is with this one.

It’s possible that bubbles always burst, although I greatly doubt it.  But it absurd to argue that we’ve learned that from the last few years.  Take the 6 major English-speaking economies (The US, Britain, Canada, Australia, Ireland, New Zealand.)  All have experienced bubble-type rises in house prices, and yet only two saw the bubbles burst.  The same is true in continental Europe, where there were many bubbles that haven’t burst.  And Asia.  And there are many major metro areas in the US that experienced sharp real house price gains in earlier decades, which are still holding up (San Francisco, San Jose, Manhattan, etc.)

Here’s more sloppy reasoning:

The other thing we have probably learnt is that when housing bubbles pop, economies crumble. Is that happening in China yet?

Again, this is simply false.  The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed.  Only after NGDP collapsed in late 2008 was there a sharp decline in the economy.  Unemployment was 4.9% in April 2008.

And comparisons with China are crazy on all sorts of levels.  China is a poor, fast-growing economy with very high trend NGDP growth.  That means there is little risk of the zero rate trap that has allegedly thrown our monetary policy off course.  China may “collapse” (although I doubt they’d experience more than an ordinary recession) but it won’t be because of any housing bubble bursting, if in fact there is a housing bubble.

One thing that readers need to keep in mind is that past predictions of Chinese bubbles bursting haven’t just been wrong, they’ve been spectacularly wrong, indeed laughably wrong.  I recall that when I visited Shanghai in 2001 many people were talking about a commercial real estate bubble in Pudong.  That was 2001!!  Today those predictions sound about like someone who claimed Las Vegas was overbuilt when the second big casino opened in the early post-war period.  Eventually China will probably become overbuilt.  But if the Chinese government keeps expanding NGDP at a healthy rate, and keeps reforming their economy, the most they have to fear is an occasional recession.

People also need to realize that bubble forecasters are never embarrassed by their false predictions.  They don’t believe they are ever wrong, because if the bubble hasn’t burst yet, it eventually will.  So they put no time limit on their predictions.  Of course if one waits long enough any highly volatile market will have a dip.  That’s what it means to be “highly volatile”–indeed it’s a prediction of the EMH.

Their other trick is to make predictions all over the map, hoping that at least one prediction comes true.  Back in 2003 The Economist made a whole bunch of bubble predictions for developed country housing markets.  The vast majority proved wrong, indeed far off base.  Later they did an advertisement for their magazine bragging that these predictions were right.  Most readers are too lazy to check, and having heard a lot about bursting bubbles in the US, Ireland and Spain, just assumed the ad was correct.  But I am not too lazy to check, and I have a long memory.


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40 Responses to “Sloppy reasoning at the Financial Times”

  1. Gravatar of Benjamin Cole Benjamin Cole
    1. August 2012 at 00:41

    Yes, bubbles always pop unless they don’t in which case they are called secular rallies.

    BTW, constantly overlooked in the USA is that the commercial property market suffered a nearly identical price and volume downfall as the residential market.

    The commercial market is dominated by institutional buyers and sellers, and received no FNMA and Freddie help.

    Gee, do you suppose there could have been a common denominator? Lack of demand, perhaps? I am just guessing.

  2. Gravatar of Saturos Saturos
    1. August 2012 at 05:55

    Another excellent post by Scott Sumner. (Well Ben, since you didn’t this time…)

  3. Gravatar of JSeydl JSeydl
    1. August 2012 at 06:12

    “Again, this is simply false. The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed. Only after NGDP collapsed in late 2008 was there a sharp decline in the economy. Unemployment was 4.9% in April 2008.”

    False. Again, it was when the collapse in home prices pushed the majority of homeowners into a negative equity position that the housing bust had real effects on the economy. This fact can been seen in the following chart: http://img818.imageshack.us/img818/7448/negativeequitygap.png

    Homeowners stopped spending and started saving when they realized that their mortgages were worth more than their homes. It’s unclear how a noncollapse in NGDP would have changed this — or which way the causality runs here.

  4. Gravatar of Morgan Warstler Morgan Warstler
    1. August 2012 at 06:23

    Think how many more bubbles we could pop! if if we didn’t try and inflate out of them.

    There is much joy in creating terror amongst those who are left without a chair when the music stops.

    Technology and thus humanity better evolves when only had core entrepreneurs are willing to shave their bodies and get into the pool.

  5. Gravatar of dwb dwb
    1. August 2012 at 07:14

    i am sort of immune to sloppy reasoning from the press. If it were not for sloppy reasoning, there would be no reasoning at all, and they would have nothing to write about. “Nothing to See Here” is just not a headliner.

    Now, sloppy reasoning from economists who should know better, that’s a different story.

  6. Gravatar of Wadolowski Wadolowski
    1. August 2012 at 07:35

    @ssumner

    Prof. Sumner you said:
    “But it absurd to argue that we’ve learned that from the last few years. Take the 6 major English-speaking economies (The US, Britain, Canada, Australia, Ireland, New Zealand.) All have experienced bubble-type rises in house prices, and yet only two saw the bubbles burst.”

    Maybe it’s not theirs Minsky moment yet. Maybe they can go with real interest rates lower:

    http://research.stlouisfed.org/fred2/graph/?g=8WP

    Like the US did.

  7. Gravatar of J.V. Dubois J.V. Dubois
    1. August 2012 at 07:39

    I wholeheartedly agree. Plus there is another horrible mistake in FT analysis: they act as if there is no bubble today. When in fact nowadays we experience one of the largest and most devastating bubbles in the last few decades. If we define a bubble as something that people are willing to buy something mostly on the basis that other people are willing to buy it as well, then we are currently experiencing a huge bubble in one of the pure “bubbly” things out there – money.

    When people were hoarding houses in curious places or when they were hoarding shares of everything that had “internet” or “e” in the name, we could at least have a benefit of doubt: what if this is not a bubble but healthy growth based on sound fundaments? And when bubble popped, we were still left with something. Some people could live in larger houses, people can now use communication infrastructure and other products created in anticipation of the boom for internet commercialization for the fraction of expected price. And we can move on.

    But we all know that there nothing good can come from a fact that people are engaged in money hoarding scare bubble.

    PS: I reckon there are many South Africans out there offended that you did not count them among major English speaking countries.

  8. Gravatar of ssumner ssumner
    1. August 2012 at 08:04

    Ben, Good point.

    Thanks Saturos.

    JSeydl, If NGDP doesn’t fall then the drop in spending in one area is offset by more spending in another.

    Wadoloski. And that’s why the bubble proponents are NEVER, EVER, wrong. If it hasn’t happened yet, then in will certainly happen eventually. But of course that’s not what this post was about. It’s about the fact checkers at the FT being asleep, most bubbles haven’t burst yet.

    JV, Sorry, I was thinking about developed economies. I realize there are lots of developing countries that speak English.

    Yes, money is a good example. My fear is that it won’t end up being a bubble, but will stay high, as in Japan.

  9. Gravatar of JSeydl JSeydl
    1. August 2012 at 08:20

    “If NGDP doesn’t fall then the drop in spending in one area is offset by more spending in another.”

    Why would businesses invest more after seeing the demand for their products plummet? It would be great if the collapse in home prices somehow weakened the dollar, boosting exports; but that can’t happen when the US’s major trading partners fix their exchange rates to the dollar. The only other area that could offset a collapse in consumer spending is the government sector; but you continuously decry fiscal stimulus.

    In other words, it’s not enough to just say, “If NGDP doesn’t fall then the drop in spending in one area is offset by more spending in another.” You have to explain, specifically, which sectors will pick up the slack and why.

  10. Gravatar of Wadolowski Wadolowski
    1. August 2012 at 08:25

    @ssumner

    Prof. you said:
    ” If it hasn’t happened yet, then in will certainly happen eventually. ”

    But that is a very easy question to answer. So when the debt-financed home price will fall in Canada/Australia you will admit that the “bubble burst”? And there are speculators in the world.

  11. Gravatar of Wadolowski Wadolowski
    1. August 2012 at 08:34

    @ssumner

    And if you could find time to take a look at these questions from the previous post.

    http://tinyurl.com/canh9oz

  12. Gravatar of Doug M Doug M
    1. August 2012 at 08:42

    When someone says “there is a bubble” they cannot definitively say when it will pop, or even if it will pop, but what they are suggesting is that there is a greater potential for a significant price move that you might not currently appreciate.

    An economy is a complex system with feedback loops that both dampen and reinforce trends. Rescources prefferences can quickly and sharply change. These changin preffences create large price swings and localized shortages or gults of existing resources. Uncertainty is not normally distributed.

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. August 2012 at 08:46

    Not everyone in journalism is incapable or reasoning;

    http://blogs.telegraph.co.uk/finance/timworstall/100019212/of-course-there-are-empty-olympic-seats-our-victorian-government-is-arresting-anyone-who-tries-to-sell-them/

    But, then, Tim had the benefit of a sci.econ education.

  14. Gravatar of Bill Ellis Bill Ellis
    1. August 2012 at 08:55

    JSeydl

    “If NGDP doesn’t fall then the drop in spending in one area is offset by more spending in another.”…

    …Is axiomatic.

    Your objections to this statement by Scott don’t make sense to me. But I do share your curiosity about “which way the causality runs here”.

  15. Gravatar of JSeydl JSeydl
    1. August 2012 at 09:01

    Bill Ellis,

    It’s axiomatic provided that the plunge in consumer spending is offset by one or more of I+G+Nx. I want to know, from Scott, how this expected to work out following the collapse of an $8 trillion residential real estate bubble. My guess is that Scott is going to talk up the I effect — from the expectational effect that returning to trend NGDP will have on business investment — but that’s a tough case to make when more than a quarter of homeowners are underwater…

  16. Gravatar of Aeon221 Aeon221
    1. August 2012 at 09:02

    @JSeydl: because aggregate income is driven up by the increase in inflation (or the increase in people hired) and because housing debt maintenance as a percentage of income drops thanks to inflation.

    So businesses invest/spend/hire more because consumers have more money to spend in aggregate.

  17. Gravatar of Wadolowski Wadolowski
    1. August 2012 at 09:21

    @dwb

    You written:

    http://tinyurl.com/c7rs5u4

    “So guess the answer to your question is yes, no, maybe, depending on future economic activity. ”

    As I understand your stance is that private debt and the change in private debt doesn’t matter. And influence nothing.

    Is this your stance to public debt as well (and the change in it = deficit).

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. August 2012 at 09:30

    The Spanish have words for it;

    http://rsocial.elmundo.orbyt.es/epaper/xml_epaper/El%20Mundo/30_07_2012/pla_11014_Madrid/xml_arts/art_10351378.xml?SHARE=6C23C0F29C6C4F158F7CA6264B486305C7EE8722BBAC123DB409B0E7F378B09ED7AE65F05E593A356762CF7E87139EA99693B32BD492BB3B749855BD470F024181C22EA334F2B847CB1BE9B40E7BB708E033BAD8F30D7D65B04B330914F97F39

    Which are; leave the Euro and re-establish the Peseta. It would be like going off the gold standard in the 1930s. He even quotes St. Milton;

    ‘Como enseñó Milton Friedman, es más fácil, más rápido y menos doloroso para recuperar la competitividad y el crecimiento modificar un solo precio, el tipo de cambio, que toda la estructura de precios relativos de una economía.’

    Roughly; it’s easier, quicker and less painful to modify one price–the exchange rate–than all other sticky prices in Euros.

  19. Gravatar of dwb dwb
    1. August 2012 at 09:43

    @Wadolowski
    matter for what??

    anyway, why are you asking me, im nobody?

  20. Gravatar of Major_Freedom Major_Freedom
    1. August 2012 at 09:59

    Bubbles by definition pop. It’s why we say bubbles instead of, say, secular growth, or sustainable boom, or something else.

    The problem is that it is impossible to know ex ante that an industry level bubble is indeed a bubble. One can at best only make an educated guess. So ex ante, bubbles and sustainable booms appear in such a way that they cannot be strictly distinguished. Only ex post can we know that something was a bubble.

  21. Gravatar of Philo Philo
    1. August 2012 at 10:12

    “It’s possible that bubbles always burst, although I greatly doubt it.” I thought it was true by definition that bubbles burst: If something doesn’t burst, it wasn’t a bubble.

  22. Gravatar of Major_Freedom Major_Freedom
    1. August 2012 at 10:56

    ssumner:

    The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed. Only after NGDP collapsed in late 2008 was there a sharp decline in the economy. Unemployment was 4.9% in April 2008.

    This remains a false claim. Saying it over and over again won’t make it true.

    Employment started to fall at the beginning of 2008:

    http://research.stlouisfed.org/fredgraph.png?g=99A

    The same data zoomed out:

    http://research.stlouisfed.org/fredgraph.png?g=99z

    We can see that employment growth had negative convexity going back to early 2004. While the rate of employment growth was positive, the size of the rate of growth was declining towards zero. The economy was not “doing just fine January 2006 to April 2008”. The economy had been weakening for years prior.

    By late 2008 and early 2009, employment growth convexity turned positive again, and by early 2010, employment growth was positive.

    The major changes explained above seem to coincide not with NGDP, but with changes in the fed funds rate, which the Fed changes by way of changing monetary inflation into the banking system.

    ——————————–

    That’s what it means to be “highly volatile”-indeed it’s a prediction of the EMH.

    EMH does not predict market trends. It just tells us that markets are informationally efficent. It is an a priori theory of the market. It isn’t something that predicts what market trends will actually look like over time. Even if all market statistics and indicators measured against money grew at 5% every single year, EMH proponents would still be viewing the market from that lens.

  23. Gravatar of Doug M Doug M
    1. August 2012 at 11:00

    Singular bubbles pop. One bubble is unstable. Many bubbles is foam. Foam is stable.

  24. Gravatar of Mike Sax Mike Sax
    1. August 2012 at 12:50

    “The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed. Only after NGDP collapsed in late 2008 was there a sharp decline in the economy. Unemployment was 4.9% in April 2008.

    However, to the extent that you believe the market is a forward indicator, it was predicting a recession way back in 2007.

    The U.S equity market topped in July, 2007-and retraced in October,due to Fed cuts to the FF rate. You can literally trace the day that the 5 year bull market ended and the year and a half bear market begun.

    It was the day that Angelo Mozillo-the head of CountryWide Financial-gave that conference call where he said that he didn’t see the housing market coming baxk to 2009 at best.

    This totally spooked the markets and the Dow fell the next day 400 points. The bear market lasted from that day in July until March 9, 2009. We saw the Dow drop from over 1400 to 6500.

    This suggests to me that even if superficaly the real economy still looked ok in April, 2008, the fundamentals were trashed and the market knew this.

    Again, this makes sense if you believe the market is a forward indicator-makes sense to me.

    Otherwise you’d have to say the market was wrong to predict a recession but then just happened to be right because Bernanke and company goofed in late 2008.

  25. Gravatar of Lorenzo from Oz Lorenzo from Oz
    1. August 2012 at 16:24

    Explaining why there was a downturn in 2008 is simple. Explaining why there was such a dramatically abnormal downturn in 2008 is a different matter. To have a minor downturn takes a central bank which does not cope with a negative demand or supply shock. To have a dramatically abnormal downturn takes two or more central banks driving down NGDP.

  26. Gravatar of Luke Luke
    1. August 2012 at 18:00

    The English speaking countries where the apparent bubble hasn’t burst all have implemented restrictions on housing development. In Australia, New Zealand and Britain the restrictions are particular severe. The question becomes whether the rising house prices are an appropriate response to an artificially created shortage or an over reaction to these restrictions.

  27. Gravatar of JSeydl: Economics / Art / Adventure » Blog Archive » Scott Sumner Wants The Fed To Maintain Bubble-Inflated Home Prices JSeydl: Economics / Art / Adventure » Blog Archive » Scott Sumner Wants The Fed To Maintain Bubble-Inflated Home Prices
    1. August 2012 at 18:55

    […] the only logical conclusion we can draw from a recent post by Scott Sumner, in which Scott writes: “The US economy did fine during January 2006 to April […]

  28. Gravatar of Saturos Saturos
    2. August 2012 at 03:11

    This is interesting: http://www.economist.com/blogs/analects/2012/08/chinese-property

  29. Gravatar of W. Peden W. Peden
    2. August 2012 at 04:42

    And if a “bubble” never pops, then it gets attributed to some exogenous factor. To explain why someone gets it wrong does not mean that they were right all along.

    Not coincidentally, you don’t find “recovery predictions” anything like the same attention or props. We can compare this with things like web bot-

    http://en.wikipedia.org/wiki/Web_Bot

    “What interests me more than the bot’s accuracy (of which I’m skeptical), is the relentless negativity of its projections. According to the bot, the future is always bleak and steadily worsening.”

    “Economic gurus” who make a lot of capital out of “predicting bubbles bursting” operate on the same reason, even if they have to take a hike (perhaps literally, like Steve Keen) while waiting.

    IF microeconomic (and non-economic) information is (a) dispersed and (b) important to the course of general and business-specific trade cycles, then all of these grand predictions are in the realm of cargo-cult science. In that respect, I’m fully on board with the Enlightened Austrians i.e. those that don’t go gaga about the alleged predictive power of Peter Schiff or von Mises.

  30. Gravatar of Major_Freedom Major_Freedom
    2. August 2012 at 05:45

    W. Peden:

    To explain why someone gets it wrong does not mean that they were right all along.

    You don’t say?

  31. Gravatar of W. Peden W. Peden
    2. August 2012 at 06:11

    Major Freedom,

    You’d think it was obvious, but I’ve seen people dismiss wrong predictions on the basis of statements like “Ah, but Steve Keen couldn’t have known that Rudd would subsidise the Australian housing market. So you can’t really say that he was wrong.”

    Malthusians are the worst at this.

  32. Gravatar of RebelEconomist RebelEconomist
    2. August 2012 at 06:21

    There was a lot worse in that article than the remarks about bubbles. Like this section: “China has long been printing money to buy dollars and keep its exchange rate pegged. In a normal environment, this would have led to inflation. But that’s not what happened. To prevent it the government set the interest rate on deposit accounts very low in order to make real interest rates…negative. That helped keep consumption low…and inflation down.” It does not do the FT much credit.

    I must say though, Scott, that the rubbish you write about events in late 2008 causing the downturn runs the FT article close. It was obvious that the US was heading for a financial crisis from early 2007 at least, with HSBC’s problems at Household, with BNP Paribas freezing some of its funds in August because it could not value the assets, followed by the run on Northern Rock in September, by which time TED spreads were showing the breakdown of interbank lending. The processes that led to the economic slowdown were already well in train by late 2008, and the only people predicting recovery were those trying to talk one up, like investors with bad assets and central bankers. Your view is like watching someone fall out of a window and saying they were doing fine until they hit the ground.

  33. Gravatar of Greg Ransom Greg Ransom
    2. August 2012 at 07:39

    “The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed. Only after NGDP collapsed in late 2008 was there a sharp decline in the economy.”

    These were directly connected events.

    And the recession began in 2007.

    If you wont’ be serious, people won’t take you seriously Scott.

  34. Gravatar of Vivian Darkbloom Vivian Darkbloom
    2. August 2012 at 09:04

    “If you wont’ be serious, people won’t take you seriously Scott.”

    That admonition is unfair. The title to the last post was:

    “It doesn’t matter what I think”.

    But, I’m not being serious.

  35. Gravatar of Tom Tom
    3. August 2012 at 11:28

    The US economy did fine during January 2006 to April 2008 while the housing bubble collapsed.
    Count me as another who disagrees, strongly, with this statement.
    Because how much money somebody has is based, to a huge extent, on the Net Worth. And when the house bubble popped, the Net Worth started dropping … but most folks “didn’t realize” it because the official unemployment rate was fine.
    Thanks for great Net Worth chart, JSedyl

    That official unemployment rate is also false — it doesn’t include the 10 million or so illegals, all of whom were were working at 2006, but were the first to lose their unofficial and uncounted jobs.
    Thanks for nice Employment Chart
    http://research.stlouisfed.org/fredgraph.png?g=99z

    Add 10 million to the 129-139 million, maybe a quarter directly in construction and the rest in related and community jobs (like barbers for the illegals). Their unemployment started dropping in 2006, and kept dropping to the current level of 5? (3? 1?) million.

    Scott, I fully agree with you that NGDP would be far far better. Your repetition of this is, rightly, a fun little joke.
    But you insist that the homeowner loss of $8 tril in Net Worth, starting in 2006, had no significant effect because the GDP didn’t start dropping until 2008. And then you insist that the entire problem is tight Fed money.

    But in monetary fact, which YOU should be promoting and noting, whenever Net Worth falls, “money” that people “have” is automatically tighter.

    There has never been such a huge loss of Net Worth money in a 4 year period in the US. That is a big factor in why AD is so weak, and why Fed low interest rates are not enough to increase AD.

    But you don’t include Net Worth in your model – do any? No model without Net Worth will adequately explain the US economy 2000 – 2015.

  36. Gravatar of Macro_Man Macro_Man
    6. August 2012 at 05:39

    JSeydl,

    Check the facts, the U.S. economy did relatively well despite the housing sector being in recession from early 2006 to early 2008. One sector (housing) of the economy can be in recession while the others are not.

    http://macromarketmusings.blogspot.com/2011/12/what-really-caused-crisis.html

  37. Gravatar of ssumner ssumner
    7. August 2012 at 17:53

    Thanks everyone. If you don’t like my U-rate numbers for 2006/08, check out RGDP growth between 2006:1 and 2008:2

  38. Gravatar of RebelEconomist RebelEconomist
    7. August 2012 at 23:49

    According to BBC news this morning, today marks the 5th anniversary of the beginning of the financial crisis.

    For the purposes of your argument at least, Scott, you seem to have forgotten the idea of lags. What economic activity did during the onset of the financial crisis is irrelevant if there is a sizable lag between financial and economic activity, and it seems to me that there must be. Essentially, finance is all about trading postponed consumption so it seems quite reasonable to expect that it takes time for, say, business investment to slow after a seizure of the interbank lending market. How many days of wholesale market turmoil before bank treasurers conclude that they need to retain liquidity? How many days before this causes bank senior management to revise lending targets? How long before this begins to affect the approach of loan managers in provincial bank branches? How long is the lag between a loan being agreed and drawn? How many days after a loan is drawn before investment activity actually starts?

    In fact, I would put the question the other way round – how could anyone think that it was possible that economic activity would not slow after such unprecedented financial events as those of five years ago (the run on Northern Rock was perhaps the most shocking event to the British public).

  39. Gravatar of JSeydl JSeydl
    8. August 2012 at 08:30

    Thx, Macro_Man. But I have checked the facts (many times). Negative equity and delinquency rates were rising well before NGDP growth started to slow. The US economy was going down in late-2008 whether or not the Fed had been targeting NGDP; because there were no offsetting mechanisms available. That the MM crowd thinks we can just ignore $8 trillion housing bubbles so long as the Fed targets NGDP baffles the mind.

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