Finance in the 21st Century
Bubble Spotting
Robert J. Shiller
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NEW HAVEN – People frequently ask me, as someone who has written on market speculation, where the next big speculative bubble is likely to be. Will it be in housing again? Will it be in the stock market?
I don’t know, though I have some hunches. It is impossible for anyone to predict bubbles accurately. In my view, bubbles are social epidemics, fostered by a sort of interpersonal contagion. A bubble forms when the contagion rate goes up for ideas that support a bubble. But contagion rates depend on patterns of thinking, which are difficult to judge.
Big speculative bubbles are rare events. (Little bubbles, in the price of, say, individual stocks, happen all the time, and don’t qualify as an answer to the question.) And, because big bubbles last for many years, predicting them means predicting many years in the future, which is a bit like predicting who will be running the government two elections from now.
But some places appear a little more likely than others to give rise to bubbles. The stock market is the first logical place to look, as it is a highly leveraged investment – and has a history of bubbles. There have been three colossal stock-market bubbles in the last century: the 1920’s, the 1960’s, and the 1990’s. In contrast, there has been only one such bubble in the United States’ housing market in the last hundred years, that of the 2000’s.
We have had a huge rebound from the bottom of the world’s stock markets in 2009. The S&P 500 is up 87% in real terms since March 9 of that year. But, while the history of stock-market prediction is littered with too much failure to try to decide whether the bounceback will continue much longer, it doesn’t look like a bubble, but more like the end of a depression scare. The rise in equity prices has not come with a contagious “new era” story, but rather a “sigh of relief” story.
Likewise, home prices have been booming over the past year or two in several places, notably China, Brazil, and Canada, and prices could still be driven up in many other places. But another housing bubble is not imminent in countries where one just burst. Conservative government policies will probably reduce subsidies to housing, and the current mood in these markets does not seem conducive to a bubble.
A continuation of today’s commodity-price boom seems more likely, for it has more of a “new era” story attached to it. Increasing worries about global warming, and its effects on food prices, or about the cold and snowy winter in the northern hemisphere and its effects on heating fuel prices, are contagious stories. They are even connected to the day’s top story, the revolutions in the Middle East, which, according to some accounts, were triggered by popular discontent over high food prices – and which could themselves trigger further increases in oil prices.
But my favorite dark-horse bubble candidate for the next decade or so is farmland – and not just because there have been stories in recent months of booming farmland prices in the US and the United Kingdom.
Of course, farmland is much less important than other speculative assets. For example, U.S. farmland had a total value of $1.9 trillion in 2010, compared with $16.5 trillion for the US stock market and $16.6 trillion for the US housing market. And large-scale farmland bubbles are quite rare: there was only one in the US in the entire twentieth century, during the great population scare of the 1970’s.
But, farmland, at least in certain places, seems to have the most contagious “new era” story right now. It was recently booming, up 74% in real terms in the US in the decade ending with its price peak, in 2008. And the highly contagious global-warming story paints a scenario of food shortages and shifts in land values in different parts of the world, which might boost investor interest further.
Moreover, people nowadays easily imagine that the housing and farmland markets always move together, because prices in both boomed in recent memory, in the early 2000’s. But, from 1911 to 2010 in the US, the correlation between annual real growth of prices for homes and farmland was only 5%, and the latest data on farm prices have not shown anything like the decline in home prices. By 2010, real farm prices in the US had fallen only 5% from their 2008 peak, compared to the 37% decline in real home prices since their peak in 2006.
The housing-price boom of the 2000’s was little more than a construction-supply bottleneck, an inability to satisfy investment demand fast enough, and was (or in some places will be) eliminated with massive increases in supply. By contrast, there has been no increase in the supply of farmland, and the stories that would support a contagion of enthusiasm for it are in place, just as they were in the 1970’s in the US, when a similar food-price scare generated the century’s only farmland bubble.
Still, we must always bear in mind the difficulty of forecasting bubbles. And, for daring investors, it is not enough to find a bubble to pile into. They must also try to determine when to cash out and put their money elsewhere.
Robert Shiller, Professor of Economics at Yale University and Chief Economist at MacroMarkets LLC, is co-author, with George Akerlof, of Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
For a podcast of this commentary in English, please use this link:
http://media.blubrry.com/ps/media.libsyn.com/media/ps/shiller76.mp3
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tejasmhaskar 10:03 26 Mar 11
Very well written ! I completely agree with you Sir
RandyMiller 05:11 27 Mar 11
The farmland bubble has already started inflating. Land prices are up significantly where I live in Iowa, for instance land that would have sold for $5,000/acre several years ago is now selling for $10,000 or more. "Driven by high commodity prices" is the oft cited rationale. It is following the same pattern as I saw in the 1970's bubble. In the early 70's, soybean and corn prices went through the roof, cash rent prices followed, and land prices soon followed. Grain prices returned to more traditional levels, and shortly thereafter the people who had bid up cash rent and land prices were suffering, calling for a federal bailout.
Since the collapse of the 2008 commodities bubble, corn futures have oscillated between $3.50 and $4.60 per bushel. Starting in the summer of 2010, they started rising, fueled by the speculator herd believing there was a shortage coming. Remember that the 2008 crude oil bubble, and the current oil bubble, were and are based on the herd believing there might be a shortage in the future. EIA reports in 2008 clearly showed there never was a shortage of oil, and the Cushing tank farm is awash in crude oil today. There is no shortage.
What does oil have to do with farmland prices? High oil prices mean high prices for ethanol. A bushel of corn can be converted into 2.7 gallons of ethanol. Ethanol price in June of 2010 was around $1.50/ gallon, and peaked at $2.60 per gallon in early March 2011. Ethanol price drives the price of that "last marginal unit" of corn, so if Ethanol price goes up $1,00 per gallon, corn price should go up $2.70 per gallon (remember, 1 bushel of corn = 2.7 gallons of ethanol). When you factor in the ethanol distiller's subsidy of $.45 per gallon, you see why corn prices have climbed.
If all other corngrower input costs stay the same, and the average acre produces 167 bushels, and farmers can lock in a new crop price of $6.20, compared to $4.20 a year ago, that means the could raise cash rent from the current average in central Iowa from the current $195 per acre by as much as $334 per acre (167 bushels X the $2/bushel price difference.) They won't go nearly that far, because farmers fear a crop failure, and other inputs may go up somewhat. Fertilizer costs might actually be down, because natural gas feedstock prices are down; fuel prices will be up somewhat.
It is reasonable to think that cash rent might go up by 25 percent, perhaps as much as 50 percent. Farmers almost always want to farm more ground than they did the year before, so the demand for ground will drive up the cash rent.
And land prices will follow as long as the purchaser thinks he can make the payments. Farmers will do that by mortgaging the land they have paid off, a common practice in the seventies. They will bid it up because they see even higher cash rent cost coming in the future, and they do not want to reduce the size of their operation because of fear they will not be able to rent the ground they currently farm. So, farmers will drive up land prices because of fear.
And outside investors will drive it up because of irrational exuberance, the rationale that land prices always go up over the long term, and buying a CD at the bank only yields 1 percent interest.
At many farmland auctions, you will see the final two bidders being a farmer with adjacent land, and an outside investor. On that day, the farmer will convince himself he needs that land, and will pay almost anything to get it.
The price of oil will eventually fall back to the cost of that marginal last barrel produced. Ethanol will fall back to more traditional levels. The ethanol distillers subsidy will almost certainly go away, because converting corn to ethanol does drive up food prices. Yields on other investments will climb.
The price of land will fall closer to justifiable levels.
The land price bubble has already started. In 4 of the 8 reporting districts in Iowa, those four being the biggest grain producers, the price in 2010 climbed 17 to 19 percent.
So, professor Shiller is correct except the bubble has already started inflating.
The commodities bubble is doing a lot of damage to livestock farmers and consumers; just look at the price of meat in the store. In 2008, the size of the stock cow herd sunk to 1950 levels, and the high commodity prices have kept ranchers from raising the aggregate size of the her. That means higher beef prices.
In some bubbles, you can liquidate your position as prices fall, and minimize your losses. Unfortunately, in land, as in real estate, it is hard to close out your position on the way down.
The ag department at Iowa State would do a huge service by inviting Professor Shiller to Ames to head a discussion group on land and commodity prices. Invite Tom Vilsack, midwestern Ag bankers and economists. All of this would be done with the idea of leading people to make sensible economic decisions as opposed to using irrational exuberance.
uchrisn 06:26 28 Mar 11
I read the paper linked here, interesting reading. The authors have not really attempted to suggest which country reacted in the best way after their crisis and how, and which country reacted in the worst way and how. I was a little confused about wheter they are for early deleveraging after the crisis like US and Iceland or against it. In any case it is a presentation of the available data and i suppose readers should continue their own research.
By the way Dr. Schiller has online lectures from his Yale courses which are very enjoyable and informative. Thank you Dr. Schiller for sharing the knowledge.
criticaleye 06:59 07 Apr 11
Yes, there were more stock market bubbles than real estate bubbles in the past, but the real estate bubble was enabled by the creation of CDO's and the like, which made it possible for stock market (in the most general sense) to bid-up the real estate.
We may have more real estate bubbles, but not right away. We are not immune because we recently had a bubble but because that bubble has not yet played out.
Alternative 02:36 05 Jun 11
Robert Shiller's attempt to "bubble spotting" is excellent. The importance of spotting forthcoming risks or catastrophes in the financial world can't be overestimated. Thank you prof Shiller for this article.
@Randy Miller: very interesting comment ! But how long will the administration continue to tell people that bio-ethanol is good for the environment? Once people realize that bio-ethanol is just another scam the tide can turn ... And imported bio-ethanols from countries like Brazil are an even bigger menace for the environment ...
REMant 02:31 25 Mar 11
You mean, in the Keynesian view, "bubbles are social epidemics, fostered by a sort of interpersonal contagion."