The Trouble with Asset Bubbles: If You Stop Pumping, They Pop

The trouble with inflating asset bubbles is that you have to keep inflating them or they pop. Unfortunately for the bubble-blowing central banks, asset bubbles are a double-bind: you cannot inflate assets forever. At some unpredictable point, the risk and moral hazard that are part and parcel of all asset bubbles trigger an avalanche of selling that pops the bubble.

This is another facet of The Fed’s Double-Bind: if you stop pumping asset bubbles, they pop as participants realize the music has stopped, and if you keep pumping them, they expand to super-nova criticality and implode.

There are several dynamics at play in this double-bind.

1. The process of inflating a bubble (for example, the current bubbles in stocks and real estate) requires pushing investors and speculators alike into risky asset classes. This puts the market at increasing risk as everyone is pushed to one side of the boat.

2. Those on the other side of the boat (i.e. shorts) are slowly but surely eradicated as the pumping keeps inflating the bubble. When the bubble finally bursts, there are no shorts left to cover, i.e. buy stocks at lower prices to reap their profits.

3. As the bubble continues to expand, the money available to enter the market and keep prices rising declines. The very success of the pumping process strips the markets of new sources of new money, leading to a point where normal selling exceeds new-money buying and the bubble collapses.

4. Money pumping by central banks and governments follows a curve of diminishing return. One analogy is insulin insensitivity: as the systemic distortions build, markets become increasingly insensitive to money pumping. Authorities respond to this intrinsic process of increasing insensitivity by pumping even more money into the system.

But as with insulin insensitivity, at some point the system loses all sensitivity to money pumping: no matter how much money central authorities inject, the markets refuse to go higher. At this point, the stick-slip nature of bubbles manifests and modest selling triggers a collapse as participants all rush for the exits. Buyers have vanished and there is no longer a bid at any price.

5. Having pumped the assets higher with ever-greater injections of speculative risk and pumping, central banks and states have exhausted their ability to re-inflate assets as they collapse.

This growing insensitivity to money pumping is visible in the stock market’s response to each new QE program: each market advance is of shorter duration, and each rise is less robust than the last one.

This degradation of response to pumping has forced the Fed to pursue a policy of infinite QE, with no time or pumping limits.

The idea that authorities can massage their pumping to keep asset bubbles inflated at a permanently high plateau is currently being tested. The Fed is implicitly suggesting that it can adjust the expectations/policy dials with such control that it can keep the bubble inflating essentially for years to come.

Systems cannot be controlled once risk and moral hazard have been raised to levels where instability is an intrinsic feature of the system. Those who actually believe the Fed can keep asset bubbles inflated at a permanently high plateau will discover their error in dramatic fashion, as the bigger the bubble, the more violent the implosion.

This is the super-nova nature of asset bubbles: if you try to deflate the bubble slowly, it implodes, but if you keep inflating the bubble it eventually implodes from its internal extremes.


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  • diogenes

    And when they pop you get some hireling like Chuck Schumer of New York to threaten a corrupt congress and president with riots in the streets to “persuade” them to pump them back up, insuring that 99% of citizens will pay twice as much for shelter forever. Because that’s how democracy works. In America.

  • The thing about investing is like a pyramid scheme, only those that got in early can expect to make the biggest gains for very little risk.

    The only Investment I’d recommend would relate to an off the grid self sustaining property….with perhaps an internet connection.

  • ICFubar

    Notice that as each bubble depicted pops it settles back to the point of nominal GDP or price reality. But the steeper and higher the rise the deeper and harder the fall. The ‘central bank bubble’ is not quite as high but damn near as the ‘housing bubble’ on the growth index above nominal GDP if we want to gauge what the eventual fall may look like, soft or hard landing or spread over what time length, if it were to occur at this point in time.

    • diogenes

      The last bubble didn’t deflate because the same corrupt “two”-party government that enabled its inflation and saw to it that none of the criminals who inflated it were prosecuted, kept it pumped full of funny money (TARP etc.) so that 99% of Americans today pay twice as much for shelter to the 1% who own and operate America for their own criminal benefit..

      • ICFubar

        As you point out the actual working population that actually creates all wealth is getting the dirty end of the stick. Those that own the money and credit creation business, the unrevealed preferred share owners of banks, and their entourage of corporations that control means of production are sucking the working population dry. If we don’t get a better deal then we need to shut their system down and institute one that will see the working classes get that better deal in perpetuity. This by taking ownership of the money-credit creation business. The transfer of wealth to the rentier class since the housing bubble was purposely inflated and then deflated is unprecedented. Houses stand empty while good people live on the streets, in tents and in their cars. This shearing of the flock has been repeated endlessly ever since privatization of the money supply was allowed. “At some point the people will have to go to war with the bankers.”

        “I set to work to read the Act of Parliament by which the Bank of England was created.
        [in 1694] The investors knew what they were about. Their design was to mortgage by degrees the whole of the country…lands…houses….property…labour. The scheme has produced what the world has never seen before…. starvation in the midst of abundance”
        William Cobett in ‘The Political Register’ July 14, 1810.

  • diogenes

    For an inside view of the bubble that popped in 2008-2009, the criminals who ran it, went scot free, and moved on to bigger things — the Treasury Department, the Fed — see Charles Ferguson, Predator Nation.

  • Greg Burton

    We’ve seen this before, many times over millennia. So, do we go down this hell-hole again, back to the dark ages ruled by the Satanic oligarchy, with a boot stomping our faces forever? Or do we learn from history, have an ‘apocalypse light’ versus an ‘apocalypse dark’?