Guest Post: Bubbles And Central Banks - Is There A Connection?

Tyler Durden's picture

Submitted by Dr. Frank Shostak, via The Cobden Centre blog,

According to the popular way of thinking, bubbles are an important cause of economic recessions. The main question posed by experts is how one knows when a bubble is forming. It is held that if the central bankers knew the answer to this question they might be able to prevent bubble formations and thus prevent recessions.

On this, at the World Economic Forum in Davos Switzerland on January 27, 2010, Nobel Laureate in Economics Robert Shiller argued that bubbles could be diagnosed using the same methodology psychologists use to diagnose mental illness. Shiller is of the view that a bubble is a form of psychological malfunction. Hence the solution could be to prepare a checklist similar to what psychologists do to determine if someone is suffering from, say, depression. The key identifying points of a typical bubble according to Shiller, are,

  1. Sharp increase in the price of an asset.
  2. Great public excitement about these price increases.
  3. An accompanying media frenzy.
  4. Stories of people earning a lot of money, causing envy among people who aren’t.
  5. Growing interest in the asset class among the general public.
  6. New era “theories” to justify unprecedented price increases.
  7. A decline in lending standards.

What Shiller outlines here are various factors that he holds are observed during the formation of bubbles. To describe a thing is, however, not always sufficient to understand the key factors that caused its emergence. In order to understand the causes one needs to establish a proper definition of the object in question. The purpose of a definition is to present the essence, the distinguishing characteristic of the object we are trying to identify. A definition is meant to tell us what the fundamentals or the origins of a particular entity are. On this, the seven points outlined by Shiller tell us nothing about the origins of a typical bubble. They tell us nothing as to why bubbles are bad for economic growth. All that these points do is to provide a possible description of a bubble. To describe an event, however, is not the same thing as to explain it. Without an understanding of the causes of an event it is not possible to counter its emergence.

Defining bubbles

Now if a price of an asset is the amount of money paid for the asset it follows that for a given amount of a given asset an increase in the price can only come about as a result of an increase in the flow of money to this asset.

The greater the expansion of money is, the higher the increase in the price of an asset is going to be, all other things being equal. We can also say that the greater the expansion of the monetary balloon is, the higher the prices of assets are going to be, all other things being equal. The emergence of a bubble or a monetary balloon need not be always associated with rising prices – for instance if the rate of growth of goods corresponds to the rate of growth of money supply no change in prices will take place.

We suggest that what matters is not whether the emergence of a bubble is associated with price rises but rather with the fact that the emergence of a bubble gives rise to non-productive activities that divert real wealth from wealth generators. The expansion of the money supply, or the monetary balloon, in similarity to a counterfeiter, enables the diversion of real wealth from wealth generating activities to non productive activities.

As the monetary pumping strengthens, the pace of the diversion follows suit. We label various non-productive activities that emerge on the back of the expanding monetary balloon as bubble activities – they were formed by the monetary bubble. Also note that these activities cannot exist without the expansion of money supply that diverts to them real wealth from wealth generating activities.

From this we can infer that the subject matter of bubbles is the expansion of money supply. The key outcome of this expansion is the emergence of non wealth generating activities.

It follows that a bubble is not about strong asset price increases but about the expansion of money supply. In fact, as we have seen, bubbles – i.e. an increase in money supply – can take place without a corresponding increase in prices. Once we have established that an expansion in money supply is what bubbles are all about, we can further infer that the key damage that bubbles generate is by setting non-productive activities, which we have labelled as bubble activities. Furthermore, once it is established that formation of bubbles is about the expansion in money supply, obviously it is the central bank and the fractional reserve banking that are responsible for the formation of bubbles. As a rule, it is the central bank’s monetary pumping that sets in motion an expansion in the monetary balloon.

Hence to prevent the emergence of bubbles one needs to arrest the monetary pumping by the central bank and to curtail the commercial banks’ ability to engage in fractional reserve banking – i.e. in lending out of “thin air”. Once the pace of monetary expansion slows down in response to a tighter central bank stance or in response to commercial banks slowing down on the expansion of lending out of “thin air” this sets in motion the bursting of the bubbles. Remember that a bubble activity cannot fund itself independently of the monetary expansion that diverts to them real wealth from wealth generating activities. (Again bubble activities are non-wealth generating activities).

The so-called economic recession associated with the burst of bubble activities is in fact good news for wealth generators since now more wealth is left at their disposal. (An economic bust, which weakens bubble activities, lays the foundation for a genuine economic growth). Note again that it is the expansion in the monetary balloon that gives rise to bubble activities and not a psychological disposition of individuals in the market place.

Psychology and economics

Psychology was smuggled into economics on the grounds that economics and psychology are inter-related disciplines. However, there is a distinct difference between economics and psychology. Psychology deals with the content of ends. Economics, however, starts with the premise that people are pursuing purposeful conduct. It doesn’t deal with the particular content of various ends.

According to Rothbard,

A man’s ends may be “egoistic” or “altruistic”, “refined” or “vulgar”. They may emphasize the enjoyment of “material goods” and comforts, or they may stress the ascetic life. Economics is not concerned with their content, and its laws apply regardless of the nature of these ends.[1]


Psychology and ethics deal with the content of human ends; they ask, why does the man choose such and such ends, or what ends should men value?[2]

Therefore, economics deals with any given end and with the formal implications of the fact that men have ends and utilize means to attain these ends. Consequently, economics is a separate discipline from psychology. By introducing psychology into economics one obliterates the generality of the theory, and renders it useless. The use of psychology is counterproductive as far as economic analyses are concerned.

Summary and conclusions

Contrary to Shiller, in order to establish that a bubble is forming we don’t need to apply the same methodology employed by psychologists. What we require is the establishment of a correct definition of what bubbles are all about. Once it is done, one discovers that bubbles have nothing to do with some kind psychological malfunction of individuals – they are the result of loose monetary policies of the central bank.

Furthermore, once we observe an increase in the rate of growth of money supply we can confidently say that this sets the platform for bubble activities – for an economic boom.

Conversely, once we observe a decline in the rate of growth of money supply we can confidently say that this lays the foundations for the burst of bubble activities – an economic bust.

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Groundhog Day's picture

Here is an open question to Tyler or anyone on ZH?  If Central Banks are diluting the currency and making the cost of everthing go higher squeezing out the middle class into poverty and depleteing what little savings they have, then why do big corporations which rely on the consumer (70% of GDP and all) stop the banking industry?  I mean wouldn't companies like WMT, TGT, MCD, SBUX, PEP, KO, MO, etc etc do something about it cuz if they don't they are screwed....who will buy all their crap?


Chris Jusset's picture

"Bubbles are the result of loose monetary policies of the central bank."


Very good.  It took you this long to reach the same conclusion that we ZH'ers have know about for 15 years!

sgt_doom's picture

You stole my comment, Good Citizen Chris Jusset!

Indeed, anyone who followed douchetard Shiller, and such idiocy, when simple arithmetical analyses of the Fed's rate making coupled with the so-called real estate/housing bubbles, proves this most obvious point!

Case closed!

Skateboarder's picture

All big corporations are lapdogs of the money changers. Walmart can just as easily be called Goody's tomorrow, with a new family in charge, and nothing would fucking change. Their means of expression are still limited to the medium of exchange, which is ultimately controlled.

sgt_doom's picture

Your question speaks to the profound and militant ignorance so extant today (no offense, and I realize without active participation, which you are now exhibiting, such knowledge isn't forthcoming from the CorporateMedia addled zero-content "news" outlets)!

"..then why do big corporations which rely on the consumer (70% of GDP and all) stop the banking industry?"

Firstly, is the bankster ownership of those corporations, added to the most salient fact that you have repeated, but not understood, a partial numeric figure, i.e., 70% of the GDP is supposed to be consumption, but how many actual Americans make up that 70% figure?

In other words, it IS NOT 70% consumers doing the spending, it has increasingly been a shrinking number of the upper economic echelon in America responsible for that 70% figure, a few short years back it was the upper 20% who made up the vast majority of that 70% figure, while today it is less than the upper 15% of the populace.


This is a repeat of the economic forces behind the political assassinations of the 1960s, which irrevocably altered the arc of progress this nation was on, and why it is in such a mess for the 99% today:

50 Years Ago:  The Kennedy Assassination Revisited

During the last few years, there has been a veritable deluge of books filled with misinformation and disinformation on the assassination of President John F. Kennedy.

Highly unusual is that these money-losing books, from money-losing publishing companies (the majority of them), have a peculiar origin: most of those publishers are owned by a small group of hedge funds, seemingly always involved with ONLY profitable ventures?

More than one person has inquired as to why the JFK murder should matter to us today.

A pithy and pointed response might be: Vietnam War, oil shocks of the 1970s, Iranian hostage situation, NAFTA, GATT, WTO (and China's entrance into that organization, thereof), 9/11, and the recent global economic meltdown.

So, to keep it as short and sweet as possible, let's examine the final actions of the last two US presidents to die in office, FDR and JFK.

It is so very simple to understand the individuals who gave the kill orders that day by examining the tax returns of Allen Dulles and John McCloy (without researching John McCloy's illustrious career, from his time as an attorney for I.G. Farben in Nazi Germany (pre-WWII) and later as chairman of David Rockefeller's Chase Manhattan Bank.

David Rockefeller and his brother Nelson, owned the Warren Commission just as most certainly they owned Dulles and McCloy.

Case closed.

[And the last thing FDR did before he died in office was to give the go ahead to the DOJ to file a lawsuit against the 17 bankers of Wall Street, alleging a criminal conspiracy in corporate ownership, by the banks, dating back to 1915.]

The last action JFK took before he died in office was to support and give the go ahead to Rep. Wright Patman in his congressional investigation into the super-rich (the banksters) hiding their ownership and wealth in foundations and trusts. Note the similarity of actions: hitting the super-rich at their most vulnerable point, where they hide their ownership and wealth!

[Rep. Patman's precursor study was: Tax Exempt Foundations and Charitable Trusts: Their Impact on Our Economy (December 1962) 87th Congress, 2nd Session]

Associated links:

(You might be suspicious of the link below, but all the data has been verified, and you can easily verify it yourself.)

(Information from the above site.)

Congressman Wright Patman, chairman of the House Banking and Currency Committee, proved in 1967 Hearings that 14 Rockefeller foundations held assets of more than $1 billion in Standard Oil stock. Not only did they pay no tax on this stock, but it gave them permanent control over the family owned firm. Rival financiers could not buy control of Standard Oil because its stock was insulated by foundation ownership. As Patman pointed out, the fact that the Rockefellers escaped paying huge sums in taxes gave them an unsurpassed market advantage over other firms which had to pay normal rates of taxation.

The agitation for increased "corporate taxation" adds to Rockefeller's advantage. Patman said, "The Foundations are the best investments the Rockefeller family could have made."

A family member, Senator Nelson Aldrich, shepherded the General Education Board charter through Congress. The Rockefeller Foundation charter proved more difficult. It was a flagrant effort to evade government decrees against the Standard Oil monopoly, but was finally pushed through in 1913 by Sen. Robert F. Wagner of N.Y., setting aside $50 million in Standard Oil of New Jersey stock for "charitable work". The Rockefeller Foundation charter was signed on May 22, 1913. Its incorporators were:

• John D. Rockefeller

• John D.Rockefeller Jr.

• Henry Pratt Judson, of the Lyman and Pratt families, president of University of Chicago

• Simon Flexner, educated at Universitv of Berlin and Univ. of Strasbourg, had served with Rockefeller Institute since 1903 as prof. of medicine

• Starr Jameson, "personal counsel to John D. Rockefeller in his benevolences"

• Jerome D. Greene, secretary of Harvard Corp. 1910-11, banker with Lee Higginson of London, 1912-18, sec. Reparations commission at Paris Peace Conference

• Wickliffe Rose, prof. Peabody College, secretary Peabody Educational Fund, trustee of Slater Fund and General Education Board

• Charles W. Eliot, also of the Lyman family, married Ellen Peabody, educated in Germany, president emeritus of Harvard

An offshoot, the China Medical Board, secured Standard Oil the market for "oil for the lamps of China", and gave the family entree into the highly profitable Asiatic drug trade. The breakthrough was obtained after they financed the rise to power of the Soong family, who created modern China.

The list of officers of the Rockefeller Foundation from 1913-63 reveals a great deal about this organization. The four chairmen of the board have been John D. Rockefeller. Jr. 1917-39; Walter D. Stewart, 1939-50; John Foster Dulles, 1950-52; and John D. Rockefeller 3rd, 1952-63.

Walter D. Stewart served with Bernard Baruch on the War Industries Board in 1918, was with the Federal Reserve Board from 1922-25, and then joined the law firm of Case, Pomery, a Rockefeller firm. He was economic adviser to the Bank of England 1928-30, Special Adviser to Bank for International Settlements 1931, Presidential Council of Economic Advisors for Eisenhower 1953-56, and later president of the Institute for Advanced Study. In this list of legal and financial posts, one is struck by the conspicuous absence of any "charitable" endeavours.

John Foster Dulles, as senior partner of the law firm of Sullivan and Cromwell, carried on the firm's traditional involvement in promoting wars and revolutions. Few Americans know that Sullivan & Cromwell's intrigues made the Panama Canal possible

A 736 page volume, "The Story of Panama, the U.S. House Hearings on Panama in 1913," offers hundreds of pages of documentation proving that William Nelson Cromwell, founder of the firm, and Dulles' mentor, instigated and promoted the Panamanian Revolution for J.P. Morgan and J. & W. Seligman. Morgan subsequently received $40 million in gold from the U.S. Treasury, the largest check it had ever drawn to that time. $35 million of this sum was clear profit.

Groundhog Day's picture


Thanks for all the insight

Winston Smith 2009's picture

"The adequate soundtrack:"

ROTFL. More than just adequate. A nice tune with appropriate lyrics:

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.

Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.

I'm dreaming dreams, I'm scheming schemes,
I'm building castles high.
They're born anew, their days are few,
Just like a sweet butterfly.
And as the daylight is dawning,
They come again in the morning!

I'm forever blowing bubbles,
Pretty bubbles in the air,
They fly so high, nearly reach the sky,
Then like my dreams they fade and die.

Fortune's always hiding,
I've looked everywhere,
I'm forever blowing bubbles,
Pretty bubbles in the air.

BubblesFlo's picture

Here's the hilarious adequate video to accompany the adequate soundtrack:

SillySalesmanQuestion's picture

The FED blows three billion bubbles per day, eighty five billion bubbles per month, over a trillion bubbles a year... That's a lot of bubbles, and Don Ho is singing in the background the whole time.

Seer's picture

Was there central banks during the Tulip Bubble?  And others?

The Fed only abets greed, allowing for over-grabs from the future.  It's human nature.  But yes, they can definitely help create HUGE bubbles (until that is, they lose control over natural capital).

formadesika3's picture

No central banks then. The meme of Progress began to take hold about that time. Everybody suddenly thought they could get rich quick with no effort, which magnified the effects of normal human greed.

A lot of damage has been done with the Progress meme, not just the fallacy of infinite growth. Some bad ideas were slipped in among the good ones, central banking for instance.

Diogenes's picture

Bubbles require an input of money or credit to blow them up. At the time of the Tulip Mania there were large amounts of silver and gold flooding into Europe from Mexico and South America by way of Spain.

Holland being a major shipping and trading nation, got a lot of money out of this boom. The newly rich merchants, traders and ship owners were involved in the tulip trade in a big way, as they were in all other trades.

Many of the most expensive tulip bulbs were traded on credit as well.

The first bubble deliberately blown by a central bank was the Mississippi Bubble in France. It was a scheme to pay off the national debt that got out of hand.

A few years later the Brits tried the same scheme, resulting in the South Seas bubble.

It was the South Seas bubble that gave rise to the terms "bubble company" and "financial bubble".

Seer's picture

Appreciate the additional input.

It pretty much says that we'll find one way or another to create bubbles.

That said, what are bubbles really, if not just an over-amplification of growth, which is not sustainable any way.  I suspect that it's got to do with the timeframe.  It works for you if you are at the top of the pyramid (can get out before it goes) or if it outlasts your time on the planet.

Sufiy's picture

Yellen - There Is No Bubbles... just have a look at Bitcoin:

Peter Schiff: Bitcoin Is Not Gold GLD, GDX

Bitcoin Heist And Jim Rickards On Taper, Janet Yellen and Gold GLD, MUX, TNR.v, GDX

  "In this very interesting episode RT is reporting about the hunger for the FIAT Currencies alternatives and how it is driving the Bitcoin Bubble, but it is not The New Gold or even close to it - as we have written before. New security concerns are reported with the cryptocurremcy and Jim Rickards dissects the Currency War situation in the ECB, BOJ and FED race to the bottom. You will find out why Janet Yellen can not Taper and what is behind the Gold and why Gold Standard is still valuable option even today.    After our yesterday US dollar chart observations it has fallen out of bed so far today - maybe somebody already has received Janet Yellen's testimony for tomorrow's nomination hearing."

puntme's picture

Food and being fat.. is there a connection??

ebworthen's picture
"Guest Post: Bubbles And Central Banks - Is There A Connection?"

Does a bear shit in the woods?

Is the Pope Catholic?


Does the Pope shit on a bear in the woods?  YES there is a connection.  Unwind any bubble and you will find a CB.

ebworthen's picture


What prevents bubbles?


Take away risk and bubbles form.

What do central banks do?  Remove risk and reward bad bets.

You'd think people with PhD's wouldn't need to resort to psycological theory and arcane formulae for simple ideas but...

formadesika3's picture

...but your lying eyes would be playing tricks on you.

The arcane psychological theories and mathematics are designed not to illuminate the simple and sound ideas but to discredit them.

ak_khanna's picture

The main aim of the political class and the central bankers worldwide is to create one bubble after another for the zombie bankers to feed on. The majority of the population who actually work hard to earn their living by engaging in productive work have to pay the price by either loosing a majority of their earnings in the form of taxes, interest on loans or paying the bill for the bailouts.

Flakmeister's picture

Bubbles have always existed, however, Central banks make them easier to form especially if they are in denial....

Bubbles come into existence when when there is a lack of productive assets to invest in....

sgt_doom's picture

Well, historically the first real bubble in America was with the formation of the Federal Reserve System, which required, on the average, less capital reserves on hand at the banks, then they then normally kept on reserve, hence a long-term bubble back in the day.

Diogenes's picture

Bubbles require a large input of money or credit. Find the source of the money and you find the source of the hot air blowing up the bubble.

Bunga Bunga's picture

But but but it's not bubbles, it's booms.

marriedgeordie's picture

STOP STOP STOP STOP!!! Do NOT use the phrase "Nobel prize winner in economics" or anything similar to this. THERE IS NO NOBEL PRIZE IN ECONOMICS! Repeat after me: THERE IS NO NOBEL PRIZE IN ECONOMICS! ZH editors should - no, they MUST - remove any and all references to this from any and all articles published here. Expose this award for what it is - a Swedish central bank award in economics, which has nothing to do with the Nobel family except for using their name "in memory of Alfred Nobel", who is spinning in his grave because of this, and timing the award to make it look like it is legit. The purpose of this site is to expose lies of the powers that be, so let us be consistent in this.

sgt_doom's picture

But there is a Milton Friedman prize for poop, or was that the Thomas Friedman prize?

withglee's picture

It's impossible to read Shostak's stuff without continuously regurgitating. He's Mr. Money Pump. Worse than Keyenes ever could be imagined to be ... and Keynes set the previous standard for ineptitude under power. It's a good thing Shostak has never gotten into a position of power. He has no clue what money is.

moneybots's picture

"Once it is done, one discovers that bubbles have nothing to do with some kind psychological malfunction of individuals – they are the result of loose monetary policies of the central bank."


Alan Greenspan is an individual and had some kind of psychological malfunction that caused him to double down on 1920's FED policy, in an orgy of loose monetary policy.  Bernanke suffers from the same, taking dose after dose of QE and Yellen announced yesterday that she sees no bubble, hears no bubble and FED speak no bubble, exhibiting telltale signs of the same monetary illness.

moneybots's picture

All roads lead to Rome, but the loose monetary policy does result in the malfunction of other individuals.  It was other bankers who created liar loans and securitized sub prime mortgage debt.  Rating agencies gave them AAA, when they weren't deserving.  There was a large cast of characters, including home flippers.

RaceToTheBottom's picture

All of those things would have been survivable, without the leverage and securitization.  Some banks would have gone under, but they deserved to and others would have been more careful going forward.

Leverage and securitization issues propelled the banks way into the TBTF area and convinced banksters that they were above the law...  This is the major reason why the next financial crash will be exponentially larger.

sgt_doom's picture

Most pithy; short, sweet and to the point.

Nothing further need be said . . .

the grateful unemployed's picture

psychology is a scam on the working man

Diogenes's picture

I always sensed mental health was some kind of trick.

Big Johnson's picture

History would suggest that America rebelled for a lot less BS that was placed upon them from their overlords than we are currently experiencing today

khakuda's picture

It's not very hard.  Make money free and keep it free for too long and bubbles will form somewhere eventually.

dadichris's picture

"The Masters of Money are the Root of all Evil"

They got the quote wrong the first time...

BubblesFlo's picture

I think this Sing-A-Long with Ben Bernanke video that I found goes along with this article quite nicely:

orangegeek's picture

central banks plus all other banks create bubbles


right now the banks are parking their clients (aka bag holders, aka lemmings) into longs thereby clearing their own institutional positions


we call these people prop traders


isn't life grand?

RMolineaux's picture

Although it is not identified as such, this article has strong overtones of the "Austrian" school of economics, as promoted by one of its proponents - Ludwig von Mises.  It brought back memories of the course I took from him at NYU in the sixties.  He was a promoter of the notion that economics involved the cold calculations of market participants, and that psychological considerations had no place in it.  By pursuing these notions, von Mises and his followers ignore human nature and the actual experience of economic events.  He would ignore the facts of consumer behavior, propensities, and non-rational decision making.  He would also ignore the natural tendency of entrepreneurs to develop monopolies and oligopolies.  His work was well suited to the de-regulation push of the 80s and 90s.  He was the darling of Wall Street.  This denial of the human dimensions of economics and its rationalization of de-regulation has brought us to the state in which we now find ourselves.


MagicMoney's picture

You never studied Mises, or even read his trademark book Human Action. He says nothing of the sort. He admits that man's decision making isn't infallible. That's the point of profit, and loss. The point of failure. Man being infallible is not even Austrian. You are confusing Austrian theory with that of another school economic thought that has a normative bias.

RMolineaux's picture

You are implying that I slept through a semester of von Mises' lectures.  That was not the case.