I have recently noticed tulips beginning to rise up in my flower beds. Every year, the arrival of spring is forecast by a vanguard of tulips. One of the earliest blooming flowers of the year, the significance of tulips should extend beyond the welcome first splash of spring color.
The tulip is famous to economists for generating one of the first recorded asset bubbles in history. In the Netherlands during the early 1600s, tulip prices were bid to levels that equated to multiple years of earnings for the typical worker of the period. Eventually, the bubble burst and tulip prices collapsed to pre-bubble levels.
While tulips were one of the first known bubbles, they have been followed by many since. Most recently, bubbles inflated and burst in the NASDAQ stock market of the late 1990s, the housing market of the early to mid 2000s and the market for petroleum during 2008. Most of these bubbles share a few key attributes, though none more significant than the liberal use of debt to purchase the asset as an investment.
In some bubbles, government policy exacerbates the situation, as in the case of the housing bubble where the Federal Reserve’s low interest rates made debt cheaper, enabling the buying binge that followed.
Ben Bernanke has been actively defending the second round of quantitative easing, or QE2, a program that features the Federal Reserve crediting banks with reserve deposits in exchange for U.S. government treasuries.
As the Fed essentially issues liabilities to purchase these bonds, it would benefit us all if Bernanke were to stop on his way to work and smell the tulips.
Perhaps, in their history, he would be reminded of the perils of rapid credit expansions and may consider easing back on the quantitative easing.
