During the first presidential debate last Tuesday, Republican presidential nominee Donald J. Trump once again warned his audience of 85 million people that the U.S. stock market is in a bubble.
As Trump put it:
â??Believe me, we are in a bubble right now, and the only thing that looks good is the stock market. But if you raise interest rates even a little bit, that’s going to come crashing down. We are in a big, fat, ugly bubble.â?
As with anything Donald Trump says, mainstream Wall Street analysts immediately dismissed it as absurd.
Still, could â??The Donaldâ? be right?
Just What is a ‘Bubble’?
Over the weekend, I re-read John Kenneth Galbraith’ â??A Short History of Financial Euphoriaâ? published in 1990.
Galbraith, a Harvard professor, was arguably the most famous economist of his day, a leading public intellectual in the 1960s and 1970s, who later in his life wrote several books about the nature of financial mania.
Writing after both Michael Milken and Donald Trump had gone famously bankrupt in the Go Go 1980s (he mentions the size of Trumpâ??s ego repeatedly in the book), Galbraith breaks down the elements of financial mania as follows:
- Some artifact or development becomes new and desirable. Whether itâ??s Tulips in Holland in 1636, real estate in Florida in the 1920s or junk bonds in the 1980s, something ends up capturing investorsâ?? fancy.
- The price of the object of speculation goes up. What you buy today is worth more tomorrow.
- This increase in price and the prospect of future increases attracts new buyers in a self-reinforcing process.
- There are two types of participants in the mania: The first type expects prices to go up, and stay high indefinitely. Anyone who disagrees with this belief is roundly criticized as either defective or old-fashioned — much like Warren Buffett was at the height of the dotcom boom.
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