Since the financial crisis of 2008, the optimists have been steadily beating the prophets of doom in the battle of the economic narrative, as the stock market continues its years-long bull run and the economy steadily improves. But that doesn't mean the doom-mongers have gone away; indeed, they tend to cite the rising market as evidence that a dangerous bubble is emerging. Yet this fear of bubbles may be precisely what we should be fearing most, since it could upend the progress the economy has made.
Markets are battleground for ideas, where bullish optimists and bearish pessimists fight with differing takes on the past, present, and future, trying to push the market in the direction they desire it to go. This means that economics is particularly vulnerable to self-fulfilling prophecies.
Sometimes markets can fall merely because a handful of traders are acting on a speculative rumor. Other investors then notice that the stock market is falling, and sell their stock. Things can snowball from there, leading to a catastrophic collapse of confidence.
When it comes to the economy at large, the prophets of doom have focused on the Federal Reserve's unprecedented economic stimulus programs, which have backstopped the recovery and tilted the economy upwards. So far, their prophecies of economic malaise haven't become self-fulfilling, but there has been several instances in which their predictions have won the argument — to ruinous effect. That's what recently happened in Sweden, where the central bank hiked rates in the name of "financial stability," only to find itself with rising unemployment and sucked into a Japanese-style deflationary spiral.
It's highly troubling, then, that one of the arch-pessimists has a prominent spot at the Federal Reserve. Richard Fisher, president of the Dallas Fed, has been warning about economic bubbles throughout the bull market, saying that easy money is stoking up a mania on Wall Street. "I fear that we are feeding imbalances similar to those that played a role in the run-up to the financial crisis," he told the Association of Mexican Banks last week.
Fisher's view is a gross oversimplification. Low interest rates and quantitative easing do encourage investment and spending. But that really says nothing about whether the subsequent growth will be productive growth or bubbly growth. Throughout human history — and particularly throughout the last 100 years — economic growth has overwhelmingly been productive. Why should we assume that bubbly growth is now the norm?
Indeed, the real danger is that the Fed will start worrying about stoking bubbles and lose track of its real goals of low unemployment, and low, steady inflation.
What the U.S. could end up with instead is deflation, a crippling cycle that could result in a cascading series of debt defaults and anemic economic growth. Japan has been in the deflationary trap for 20 years, and Sweden, Greece, Spain, France, and Switzerland may be be falling into it, too. That's the kind of future the prophets of doom would have us live in.
