Letter to WSJ Re: "Bubbles"
Jude Wanniski
December 26, 1996


Letters Editor
The Wall Street Journal
200 Liberty Street
New York,   NY   10281

Dear Editor:

    When the People’s Daily warned against excessive speculation in China’s fledgling stock markets, it induced a sharp selloff in the value of shares, just as Fed Chairman Alan Greenspan’s warning about “irrational exuberance” on Wall Street sparked a downdraft in stocks here at home.

    Your lecture to China on the workings of the capitalistic marketplace, December 19, would have been more effective if, at the same time, you did not feel compelled to defend Greenspan for setting the bad example. Most of us who make our livings by assessing the value of capital assets have warm feelings about Chairman Alan, but these should not restrain us in our complaints when he is wrong. Unless error is recognized and redressed immediately, it tends to accumulate. When it occurs at the level of either the high and mighty Fed or Wall Street Journal, the consequences can be very serious.

    There of course can be irrational exuberance in a market for one or two commodities, or shares of one or two companies, as history points out in the tulip mania and South Sea bubble. This is when information about the supply and demand for the commodity or company can be controlled and manipulated to disguise internal weaknesses. This is why we have rules about insider trading.

    The only kind of “bubble” that can occur in a broad market, such as the New York Stock Exchange, or the Tokyo Stock Exchange, results from misplaced faith in the intelligence of the policymakers whose decisions can affect broad markets. The Wall Street Crash of 1929 was caused by the U.S. Senate’s shift from opposition to support of the Smoot-Hawley Tariff Act, not a sudden outburst of rationality. The Nikkei “bubble” in Tokyo burst when the government changed the tax treatment of capital gains on real property that had been capitalized into stock values.

    The glimpse into Mr. Greenspan’s thinking that global investors received from his remark about irrationality in the market was enough for them to mark down their optimism about the future of policymaking by the world’s most important central bank. It is no cause for permanent alarm, in that the market reaction has already caused Mr. Greenspan to rethink his hypothesis.
    In other words, the value of assets rise worldwide when Mr. Greenspan says wise things that bear upon the dollar’s future value. They fall when he says dumb things. Policymakers in Beijing, who are trying to learn how to be successful capitalists, so admire the United States in general and Mr. Greenspan in particular, that they will tend to parrot his comments, wise and unwise. This is why it is so important that we set a good example.


Jude Wanniski