Hedge fund billionaire Stanley Druckenmiller is really, really worried about the future of the United States. He is doing an event at Georgetown next week making the case that entitlement spending will form the next mega-financial crisis, and not for the first time.
This kind of quasi-apocalyptic talk is breathtakingly common. His is of a thread with a lot of commentary that suggests that the whole world economy is just a shell game being propped up by profligate government spending and central bank money-printing, that it’s all a scam that will implode soon enough.
It is embedded in the writing of David Stockman, who views the world as being on the precipice of an 80-year central banking bubble that will pop any day now. Hamilton Nolan at Gawker has made an entire side-career out of writing “Bubble Watch” posts.
It is an assumption embedded in a lot more routine prognostication. In the Nexis database, media outlets have mentioned the idea of a bond market bubble 1,172 times in the past year, a stock market bubble 1,030 times, and a “new housing bubble” 598 times. You can add public pensions, emerging market bonds, China, and commodities to the list of asset markets routinely thought of as being ready to burst. Druckenmiller's theory is that the United States is running up against a "demographic bubble."
A lot of this sentiment seems to be rooted more in a psychological stance rather than any clear-headed analysis of the proper valuation of these different markets. Part of it is that we have all been scarred by the last two mega-bubbles, and thus are prone to see new ones wherever we look. Part of it is just that calling bubbles comes at no real cost if you're wrong, and can allow a person to project a certain world-weary cynicism. And part of it is that we have seen some serious inflation in what counts as a bubble.
On the last point first: Lately there has been a tendency to use “X market is a bubble” as a synonym for “X market is currently overvalued.” These are not the same thing at all. Markets rise and fall all the time. Just because a market has recently risen doesn’t make it a bubble, and neither does the fact that a market has recently fallen.
People can choose their own definition, but a bubble is a situation where the price of an asset is bid up beyond what can be justified by its fundamental value, due to human psychology. People see a price rising, expect it to keep rising forever, and thus concoct whatever story they need to make that valuation worthwhile. There’s a big difference between the price correction that happens after a true bubble, and a simple case of reasonable forecasts on the future of the world proving to be off.
For example, in the second quarter of 1999, if you invested $1,000 in the Standard & Poor’s 500 stock index, you were buying shares that would generate only $33 in earnings, at a time you could have instead put the same $1,000 in a Treasury bond paying more like $58. The only way that investment would have made sense would be if U.S. economic growth would continue its torrid late 1990s pace indefinitely; more commonly, investors weren’t thinking very hard about investing in stock at all, but just saw the market rising at a rapid pace and assumed that would continue. That, of course, did not happen, and the S&P has only in the last few months surpassed its March 2000 high.
By contrast, right now, $1,000 invested in the S&P pays out about $60 in earnings, compared to $25 for 10-year Treasury bonds. There are no guarantees that stocks will keep going up. For all we know, corporate profit margins will fall from recent historic highs, or economic growth will disappoint. But there’s no immediately obvious evidence that the market is wildly overvalued.
Similarly, housing prices really were out of whack in 2006, detached from any historical relationship to what it costs to rent a similar house. It was quite clearly driven by homebuyers motivated not by level-headed analysis of the relative benefits of buying vs. renting, but by a self-fulfilling assumption that home prices must always rise.
But a lot has changed since then. Home prices are 30 percent lower than they were in the spring of 2006, as measured by the S&P Case-Shiller 20-city home price index, even after rising a bit over the past year. And rents for similar homes are up 15 percent in that span. Add it all up, and home prices make way, way more sense now than they did then; by Bill McBride’s calculations at Calculated Risk, the ratio of home prices to rents is back at 2000 levels.
Name any of the alleged bubbles right now, and you can tell a similar story. Think that Treasury bonds are overvalued, yielding a mere 2.5 percent for 10 years at their current prices? Well, maybe. But the Fed looks like it’s going to keep short-term interest rates low for a really long time, and there’s not much evidence inflation is brewing, so is it so outlandish?
Emerging markets have experienced an amazing run over the last decades, with both their stock and bond markets experiencing huge inflows. But we’ve also seen many of these countries achieve greater political stability and an ability to pull more of their citizens into the global middle class. If their economies keep growing the way they have in recent years, their markets are if anything undervalued. Of course that growth might not materialize, but the idea isn’t so outlandish as to suggest that betting against Indonesian bonds or Brazilian stocks is a slam-dunk bet.
And finally, there are Druckenmiller’s arguments on Social Security obligations as the trigger of the next global financial crisis. The poster advertising Druckenmiller's speech last week argues that the "true national debt" is more than $200 trillion. What the sponsor seems to be doing is looking at the liabilities side of the balance sheet, but not the asset side. Yes, Social Security and Medicare are on the hook to pay out a lot of money in the future. But they are also on track to collect many trillions in tax revenue in the future.
It’s a little like saying that Bank of America is bankrupt because it has $1.9 trillion in liabilities. That’s a lot of money the bank owes lots of people. But it completely neglects the fact that the bank also has $2.1 trillion in assets on the other side of its balance sheet. Here is my colleague Glenn Kessler with a more detailed accounting of why throwing out why these sorts of numbers — looking only at the government's obligations — is misleading.
Crises are real. And they can be destructive. Policymakers should be on the watch for potential triggers of crises, and thinking deeply about how to avoid bubbles that waste human potential and result in damaging recessions. But when everything is a bubble, and apocalypse is always now, the terms becomes meaningless.