Bubbles are over extrapolation of justified bull markets.
Rising stock prices in a bubble lead to:
- more spending & investment
- raising earnings & valuations
- lower credit spreads & higher leverage
- FOMO
- growth in “shadow banking” (NBFI)
- large ALM mismatches
- more spending & investment
- raising earnings & valuations
- lower credit spreads & higher leverage
- FOMO
- growth in “shadow banking” (NBFI)
- large ALM mismatches
Near the top of the bubble economy is most vulnerable while people feel the wealthiest and most bullish
(Ray Dalio)
(Ray Dalio)
Monetary policy helps inflate the bubble rather than constrain it. Central banks should target debt growth with an eye towards keeping it at sustainable levels.
As the bubble pops falling asset prices decrease equity and collateral values of leveraged speculators which causes lenders to pull back. This forces speculators to sell driving down prices even more.
Lenders run from risky financial institutions leading to a liquidity crisis.
Lenders run from risky financial institutions leading to a liquidity crisis.
Credit problems emerge about half a year before the peak in the economy. As a result the yield curve becomes flatter and people start hoarding cash.
Some part of credit system suffers while others remain robust so it isn’t clear that the economy is suffering.
Some part of credit system suffers while others remain robust so it isn’t clear that the economy is suffering.
In early stages of bubble bursting when stock prices fall and earnings have not yet declined, people mistakingly judge the decline to be a buying opportunity and find stocks cheap in relation to past and expected earnings failing to account for earning downgrades.
