Bubble Bath

There's an editorial in today's NYT on drug prices, and I didn't have to wait for my dead-trees copy and coffee to find out about it. Saw it on Adam Feuerstein's Twitter feed. No, as I've said, I'm not a twit, but AF side-posts a feed on some of his regular posts.

What's being missed in all this is calling bubbles, which aren't there. Bubbles happen when moolah is sent to a sector for bad reasons, from other sectors. What's been happening since the Dot Bomb is different. The Housing Boom, and now the Market Boom, are the result of a secular decline in the return to real investment. When The Masters of The World can't conjure up ways to spend profits on plant and equipment in their companies, at any return, they look to The Damn Gummint to provide them with Treasuries at hefty risk-free interest. The problem is that Treasury doesn't do that. The bonds are auctioned, with a nominal interest rate (coupon), but the (monetary) demand for the instruments determines the actual return. This is the global opportunity cost of real investment in the private sector. When all that retained earnings (and global savings excess, to boot) chases Treasuries, the interest rate plummets, and the Masters look elsewhere for 10% risk-free. That's how they found US residential mortgages. Stable returns over decades, nearly risk free. The problem, of course, was that not enough working Americans (qualified for enough mortgages) existed to soak up the moolah. Unlike Treasury, Americans (on their own) couldn't create instruments out of thin air; they didn't walk into CountryWide and tell the brokers how to make a sub-prime Alt-A and such. The mortgage companies, thence banks, did that in order to do their patriotic duty by creating mortgages out of thin air. Well, with the help of fictitious incomes and such.

The justification of the QE was to send a tsunami of moolah at Treasuries, and thus hold down the opportunity cost of real investment to such a low level that The Masters of The World would have no choice but to buy plant and equipment, increase supply of output, thus employing loyal Americans. And a virtuous cycle would ensue. Classic supply side, or pump priming as it was once called, economics. Pushing a string.

Didn't happen because The Masters of The World refused to take the bait. They can't, or won't, make real investment. With home mortgages off the table, mostly, Mr. Market looks the best of a bad lot. And there's the advantage of getting the return in the form of capital gains. Less tax for the 1%. Everybody wins.