President Obama’s High Command at the Fed has had the luck which Napoleon looked for in his generals. The exercise of two Yellen puts seems to have delayed the late dangerous stage of asset price inflation to beyond 2016 Election Day.
Growing evidence and diagnostic power supports the view that the asset price inflation disease now afflicting the global economy is a historically rare form albeit also present in the last decade. President Bush, however, did not appoint lucky Fed generals. The Great Panic and Recession arrived before 2008’s Election Day.
The Two Types of Asset-Inflation Disease: Depression vs. Boom
Four episodes of asset price inflation since the mid-1980s (when Paul Volcker abandoned his ‘hard money’ policy) have added importantly to the available data on the asset-price-inflation disease. The hypothesis has become plausible that asset price inflation, always of monetary origin, comes in two distinct types rather than just one.
The first and best known is the boom-type (type A) and includes examples such as 1924-9, 1962-8, 1985-9, 1995-2000. The second is the depression-type (type B) and includes 1934-7, 2003-7, and 2010-?. Type B is comparatively modern, stems from radical monetary experimentation, accompanies continuing economic weakness and has an end phase which can be more deadly than that of type A.
Both types of asset price inflation are characterized essentially by out-of-control money empowering irrational forces in financial markets. The flawed mental processes documented by behavioral finance theorists gain prominence in market price determination and so the signals which guide the invisible hands become highly distorted.
The disease passes through several stages including a late-mid phase when speculative temperatures are already falling sharply in some areas while still rising elsewhere. In the final stage there is a widespread crash across financial markets and the onset of recession. Beyond those common features there are five important differences.
This post was published at Ludwig von Mises Institute on Oct 19, 2016.