Mark Thornton: Is the Bust Here?–Mises Weekends

What Mark Thornton looks at to determine the top of a bubble is potentially occurring:


  1. The bullishness in the market versus the bearishness in the market. Until recently bullishness was at an all-time high, and bearishness was at an all-time low. Cash that mutual funds hold, for example, were at an all-time low. In January the bearishness was at an all-time high. These are contrary indicators.


  1. There are a lot of margin loans. Increases are a very bullish indicator and probably in a bubble and headed for a crash. Once it starts crashing, people pay back the margin loan. Typically at the bottom of a crash you see very low levels of margin debt. This is a typical scenario: buying high and selling low.


  1. In this time frame when things have started to happen but we do not know where they are going, look at the small-cap stock index—Russell 2000 Index—which deals with small corporations. Small corporations do not have the muscle recipe corporations do. If there is real risk coming into the economy, people tend to bail out of small-cap companies because they are more vulnerable. Currently, small-cap stocks have fallen 10 percent in the market.


  1. Oil prices, which is a great indicator of where the economy is and where it is going. It is the master resource in the world. It is a fairly accurate gauge of the fundamentals of demand and things like that. Oil has fallen 10 percent in the market.


  1. Looking at commodities is a very useful way to look at bubbles. It is sort of a long-term element in commodity price relations. For example, oil prices are related to fertilizer prices. And fertilizer prices are related to grain prices. And grain prices are related to cattle prices. And that takes place over a period of time. So if one market is jiggled a little bit, it filters through to the fertilizer, to the grains, to the meats, and so forth. And Austrians do not like overall price indexes because they mask some of the real futures and functions of what’s going on in the economy, but if you break down commodity price indexes, for example, you can see the flow of these materials over time and the workings of everything before it becomes consumer goods. So we love that kind of thing.


  1. The crypto-market. Previously they were a completely separate matter. But now we have seen a bubble in the cryptos. Thus, crypto currencies are being integrated in the wider macro economy. Institutionally, bitcoin has become a part of the actual market where you can buy futures. You can buy these things independently of bitcoin itself.


  1. I do look at the VIX (The symbol for the Chicago Board of Options Exchange’s volatility index, and what we have seen is the financial crisis for VIX as a measure of volatility has been on a downward path to record lows. And you know, you would like to be able to say okay to the record low, that means that we are going to get more volatility in the future, and eventually that will happen. But as an investment vehicle, you can be completely out of the money by the time anything does happen. So it is probably something we should keep our eye on, but in terms of investing it is an incredibly tricky vehicle to try to make money off of.

Jeff Deist:

I am not sure our critics really believe that price inflation limiting stocks, houses, whatever it might be, is a monetary phenomenon. I think they just project that. In other words, as Krugman would say, as long as interest rates are kept low, no amount of QE will be harmful. This seems like magic to an average person. Describe how our critics would see this.


Mark Thornton:

Well, it’s a puzzle to me as well. I mean I have a difficult time understanding why so many people can’t even understand a very simple theory like the Austrian Business Cycle Theory. But Keynesians believe that everything is based on psychology. Other mainstream economics believe that everything is the result of some random technological shock. Austrians incorporate both of those things, except we provide an economic cause. That’s one of the things that nobody else does. We provide an economic cause of the business cycle, which is artificially manipulated interest rates. For mainstream economists, other than the Keynesians, it is just random shocks that you cannot do anything about and that you cannot anticipate, so you don’t hear Chicago economists saying anything about the business cycle until after the fact. Keynesian economists will typically start out their explanation for a boom-bust cycle, or a crash in the marketplace, you know, for whatever reason this happened, and then as a result the psychology went down and then people stopped investing and then people stopped buying, so they give you a description, but for the causes for whatever reason. That’s a quote from Krugman from the previous cycle going back, and you can hear a lot of the economists from the Keynesian school who would say that for whatever reason this happened, mystery, and that set off a series of changes in the economy which put us into a recession.


But if it’s true, at least in the minds of someone like Paul Krugman, that you can create obviously bank reserve and give all of these commercial banks hundreds of millions of dollars, trillions of dollars actually, and use the new reserves of the Fed, and as long as they are not sort of actively out there leveraging on that to create a bunch of new loans in the economy, then no harm will come of it. Well then, what was the point? In other words, has QE just been a sort of cronyist capitalization of commercial banks who found themselves in trouble? Yes. Basically the answer to that is yes. The Fed took all of these risky assets off of the hands of the banks and gave them reserves, which are not risks. There is no risk associated with it. So they re-traded the balance sheets of the banks and gave the banks a dependable source of income by paying them interest on the excess reserves. And through that and other means, basically, they stabilized the balance sheets of the banks as they existed back then. Of course, they created a very bad balance sheet at the Fed at the same time.


You know, if interest rates go up, and they have gone up a little bit, and the yield curve is flattened, which is another bad sign, you know, the Fed’s balance sheets will look awful. The interest rate on government bonds increases from where they are now to maybe four or five percent, that’s going to make their balance sheet look bad, and when the real estate market tanks, all of their mortgage-backed securities are going to start looking really bad as well.. You can delay things, you can transfer problems around, but the Fed has no magic wand for turning bad investments into good investment and turning government debt and making it disappear.


And even if they could, that really a good thing for the economy? Or is that just another bad thing for the economy? Adding problems to the existing problems?