One thing we learned in the 1990s and the 2000s is that there can be asset bubbles in the economy without growth in either money stock variables or increases in consumer (flow expenditure) price inflation. The financial system seems to be flexible enough so that it can leverage up where it wants to even though monetary policy and consumer spending seem to be “in control”. This is the lesson of modern “financial engineering.”

However, the monetary statistics are not benign for most of the time period from January 1961 up to September 2008. During this time period, the monetary base which is supposedly under the control of the Federal Reserve System rose at a compound annual rate of slightly more than 6%. Total credit during this time period rose much more rapidly. Consequently, the United States experienced a period if “credit inflation” that dominated everything going on during this 47 years or so. This secular inflation drove the financial innovation that took place as the whole financial system took on more-and-more leverage and more-and-more risk.

Since September 2008, the Federal Reserve has caused the Monetary Base to increase explosively by more than 130%. However, the banking system is not lending and much of these funds seem to have ended up on the balance sheets of the banking system. Excess reserves in the banking system went from about $2 billion in August 2008 to almost $1.2 trillion in February 2010. Excess reserves for September 2010 averaged slightly below $1 trillion.

Even with all of these excess reserves, the current concern is whether or not the economy will go into a period where prices actually decline. That is, might the United States be headed for a period of deflation?

Everything mentioned above is true. Yet, there is more going on in the economy than just what we see here. In some areas, a lot is going on and in these areas we are seeing lots of upward price movement which leads one to ask whether or not these price movements are bubbles or indications of something else taking place. Certainly, the “bubbles” are not increasing employment, or capacity utilization, or getting the economy going again.

I have written about this before: “Where the Action is: The Bond Market”, I wrote in this post:

“There is a lot of money in the financial markets…in the shadow banking system…and worldwide.
Where is the action taking place?
Well, for one, in the bond market. We have major companies issuing bonds at ridiculously low interest rates.”

Of course we know that government bond prices are inordinately high causing yields to be excessively low. But, this is also true in the market for high-grade corporate debt and for junk bonds. One could certainly argue that there might be “asset bubble” in the bond markets.

Thank you shadow banking system!

And, the cash continues to build up on the balance sheets of “healthy” large corporations. It also appears as if many hedge funds and private equity funds are attracting “large bunches” of new money.

But, capital is almost perfectly mobile in the modern world: it can escape almost everywhere.

Because of this, writers like Martin Wolf have argued that one of the goals of American leadership is to “inflate the world” in order to get United States economic growth going again.

So, are we seeing the results of this?

Well, we might be seeing this flow of capital going into world commodity markets and also into emerging markets. There is the possibility that bubbles may be occurring here.
The movement in commodities seems to be worldwide but repercussions are being felt domestically in the United States. (See “Dilemma Over Pricing: From Cereal to Helicopters, Commodity Costs Exert Pressure”, This article indicates that, year-over-year, corn prices are up by 34%, wheat prices are up 34%, milk is up 32%, copper is up 30%, and oil is up 14%. It is also the case that sugar is up about 50% year-over-year.

The question many companies are facing is, “How can we raise prices to cover these costs when the economy is so weak?” A real dilemma!

Funds are also flowing into emerging markets. All one has to do is watch the stock exchanges in those countries. And, all indications are that large companies are looking to locate in many of these markets or acquire firms in these markets. We are also seeing the hedge funds and private equity funds looking in this direction. (See for example, “Buy-outs set to divide private equity”,

In a world where there is a fluid movement of capital, money is not going to stay at home if the home economy is not strong, structurally. The American economy is having major problems in its economy. Why would “big” money want to invest here? (See, for example, “Globalized Finance: Advantage China”,

The Federal Reserve, and the federal government, may need to change their economic models to include the fact that organizations other than domestically chartered commercial banks can create credit and can cause bubbles to occur anywhere in the world where an opportunity exists.

Modern finance with internationally mobile capital does not seem to exist in the models the leaders of the United States are using. This is one reason for my skepticism of all the new financial reform systems that are being constructed. (See my post “Banking at the Speed of Light”, Money is becoming more and more fluid and hence less and less controllable.

The American banking system may currently be dormant, but there seems to be plenty of money and plenty of action, elsewhere.

Yes, there are bubbles all around.