Bubbles have been frequent in economic history, and they occur in the laboratories of experimental economics under conditions which -- when first studied in the 1980s -- were considered so transparent that bubbles would not be observed.

We economists were wrong: Even when traders in an asset market know the value of the asset, bubbles form dependably. Bubbles can arise when some agents buy not on fundamental value, but on price trend or momentum. If momentum traders have more liquidity, they can sustain a bubble longer.

But what sparks bubbles? Why does one large asset bubble -- like our dot-com bubble -- do no damage to the financial system while another one leads to its collapse? Key characteristics of housing markets -- momentum trading, liquidity, price-tier movements, and high-margin purchases -- combine to provide a fairly complete, simple description of the housing bubble collapse, and how it engulfed the financial system and then the wider economy.....

Debate rages over the endgame for the Great Recession. The broad consensus of policy makers, financial market participants, business leaders and academics concurs that the world is in the midst of its worst decline since the 1930s. In making that comparison, there is a presumption that another depression is a distinct possibility if immediate steps aren’t taken to contain the downward spiral.

This debate misses the point -- and dangerously so. While I have been as bearish as anyone over the past several years, I would still assign a very low probability to a 1930-style depression for the U.S. and the broader global economy. Monetary and fiscal authorities have made it quite clear that they are prepared to do everything in their power to avoid such an outcome. Ultimately, I suspect they will get their way.

Yet there is a serious and worrisome risk to this policy strategy. By fixating on the anti-depression drill, authorities are failing to address the root cause of the current crisis and recession -- the lethal unwinding of unsustainable global imbalances.

As one leading G-7 official put it to me recently, “In the short term, we need to get the world moving again. Then, over the medium term, we will tackle global imbalances.” This is the essence of the “Depression Foil” -- a single-minded preoccupation with avoiding a 1930s-style collapse at all costs while putting off the requisite heavy lifting for that proverbial next day.....

Those of us who still question whether the world has purged its toxins are reduced to the same tiny band of moaning Druids from early 2007, when we shook our heads in disbelief as the carry trade swept Iceland to fresh madness and bankers laughed off sub-prime rot at Bear Stearns.

We learned then to thicken our skins with walnut juice, lie down in dark rooms, and dissent from Goldman Sachs. Such seclusion is called for once again as Goldman replays its BRIC anthem and raises its oil forecast to $85 a barrel this year, betting that the world will roar back on a tidal wave of liquidity.....

China’s economic comeback is under way, towing along companies from Intel Corp. to Hyundai Motor Co. and starting to make up for weak demand in other major economies.

The world’s third-largest economy grew 7.9 percent in the second quarter from a year earlier after expanding at the slowest pace in almost a decade in the previous three months, the statistics bureau said yesterday. The first acceleration in growth in more than two years came after the government implemented a 4 trillion yuan ($585 billion) stimulus plan and prodded banks to lend more.

China is the only one of the 10 biggest economies that is expanding, highlighting the role the nation may play in easing the worst global recession since the Great Depression. The U.S. economy is still shrinking, five months after Congress agreed to President Barack Obama’s $787 billion stimulus package.....

His policies even have the potential to consign the US to a similar fate as Argentina, which suffered a painful and humiliating slide from first to Third World status last century, the paper says.

There are "troubling similarities" between the US President's actions since taking office and those which in the 1930s sent the US and much of the world spiralling into the worst economic collapse in recorded history, says the new pamphlet, published by the Institute of Economic Affairs.

In particular, the authors, economists Charles Rowley of George Mason University and Nathanael Smith of the Locke Institute, claim that the White House's plans to pour hundreds of billions of dollars of cash into the economy will undermine it in the long run. They say that by employing deficit spending and increased state intervention President Obama will ultimately hamper the long-term growth potential of the US economy and may risk delaying full economic recovery by several years.....

In January 1931, a lawyer named Benjamin Roth, 38 years old, solidly Republican, a solo practitioner in Youngstown, Ohio, decided to start a diary. Realizing that he was “living through an historic thing that will long be remembered” — as he put it in one early entry — he wanted to keep a record for posterity.

Mr. Roth’s diaries have just been published in book form — “The Great Depression: A Diary” — edited by his son Daniel, who worked in his father’s law practice for many years, and James Ledbetter, the editor of The Big Money, a financial site run by Slate. It is an eye-opening read, though not necessarily in the ways you might think.....

Ludwig von Mises was snubbed by economists world-wide as he warned of a credit crisis in the 1920s. We ignore the great Austrian at our peril today.

Mises's ideas on business cycles were spelled out in his 1912 tome "Theorie des Geldes und der Umlaufsmittel" ("The Theory of Money and Credit"). Not surprisingly few people noticed, as it was published only in German and wasn't exactly a beach read at that.

Taking his cue from David Hume and David Ricardo, Mises explained how the banking system was endowed with the singular ability to expand credit and with it the money supply, and how this was magnified by government intervention. Left alone, interest rates would adjust such that only the amount of credit would be used as is voluntarily supplied and demanded. But when credit is force-fed beyond that (call it a credit gavage), grotesque things start to happen.

Government-imposed expansion of bank credit distorts our "time preferences," or our desire for saving versus consumption. Government-imposed interest rates artificially below rates demanded by savers leads to increased borrowing and capital investment beyond what savers will provide. This causes temporarily higher employment, wages and consumption.....

It’s a bit odd that so much fanfare now greets the monthly employment figures from the US. Of course, a sustained upturn in jobs is a necessary ingredient in any economic recovery, and all the more so in one where credit is unlikely to play as large a role in funding consumer spending. But what the bond market really has to think about is where we stand on the road back to full employment. When and by how much the Fed tightens will depend on progress towards that target, since a slightly less-huge output gap doesn’t call for monetary tightening. On that score a couple of quarters of plausible job gains in the first half of the year, won’t take us very far at all.

To appreciate that, it’s necessary to get one’s hands dirty with the actual numbers. First, there’s the unemployment rate itself. At 10%, we’re miles above most recession highs. While today’s readings are below the post-Depression peak of 10.8% set in 1982, we are further from full employment today. Back in ‘82, the full-employment unemployment rate was at least a percentage point higher, due to more women and youth entering the labour market and looking for their first jobs, which tends to involve a longer search. Note that the unemployment rate for prime-age (over 20) males set new post-Depression records during the 2009 recession, eclipsing the 1982 peak by more than half a percent, and that the overall drop in employment was much larger this time (Chart).

And the unemployment rate masks the true extent of labour market slack, as it ignores those working part-time involuntarily, those who gave up looking for work, and the rising prison population (that might otherwise be jobless). Those factors were, of course, also present in the past, but to a lesser extent in the 2001 recession. Data aren’t available further back, but other indicators hint that this shadow unemployment is worse this time, since declines in hours worked and labour force participation were smaller in those earlier downturns. The average duration of unemployment spells is now more than twice prior recession peaks.

The result is that the road to full employment is so long that the Fed needn’t worry about closing the output gap for years to come. The following mental experiment is enlightening. Suppose we add 250,000 jobs per month to employment in the household survey. Care to hazard a guess of when we hit full employment (say, a 5% jobless rate), even assuming that labour force participation only recovers to 66%? Sometime in 2012? 2013? Nope, try mid-2015, or nearly five years from now.

That gives the Fed a long timeframe in which to tighten policy to ward off a wage-push spur to inflation. Which is why there is a lot of nonsense involved in shifting the front end of the US Treasuries curve to make room for more or less tightening in the next year or two on the basis of a given monthly payrolls report.

Our week ahead report is available on Bloomberg at WGEC1 <GO> and online at http://research.cibcwm.com/economic_...d/jan08_10.pdf



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Over the past three years, the United States has been committing the planning fallacy on stilts. The world economy has been slammed by a financial crisis. Countries that are afflicted with these crises typically experience several years of high unemployment. They go deep into debt to end the stagnation, but the turnaround takes a while.

This historical pattern has been universally acknowledged and universally ignored. Instead, leaders in both parties have clung to the analogy that the economy is like a sick patient who can be healed by the right treatment.

The Democrats, besotted by the myth that the New Deal ended the Great Depression, have consistently overestimated their ability to turn the economy around.....

With a small group of credulous millionaires joining him at a White House séance the other day to support the Buffett Rule, the Conjurer-in-Chief called forth the spirit of Ronald Reagan, who the president averred would have supported his magic tax on "millionaires." There have been 43 other presidents of the United States. The last one you would associate with Barack Obama is Ronald Reagan.

But faced with the rather unhappy challenge of mounting a re-election campaign coincident with three years of rampant unemployment and next-to-no growth, little wonder Mr. Obama is looking for help from afar. And so it is that the ghost of a president past is indeed haunting the Obama White House—the ghost of Franklin D. Roosevelt.

FDR ran his first re-election campaign in 1936 when the United States was mired in the Great Depression. Barack Obama is running for the last time amid what he himself immortalized as the Great Recession. No surprise that Mr. Obama in his campaign speeches is channeling the master of Depression-era politics.....