With the S&P 500 and Dow at record highs and the Nasdaq climbing to its highest elevation since the collapse of the tech-stock boom in 2000, it was inevitable that market talk would turn to bursting bubbles and other bad things that can happen when asset prices run too far ahead of the real economy for too long.
What a relief, then, to hear from former U.S. Federal Reserve chief Alan Greenspan that equities are not yet approaching bubble territory. "This does not have the characteristics, as far as I'm concerned, of a stock market bubble," he says in a Bloomberg Television interview scheduled to air this weekend. "It could come out that way, but I don't see it at this stage."
If anyone knows bubbles, it ought to be Mr. Greenspan, considering his influential role in two of the most spectacular and destructive ones in modern times – tech stocks in the 1990s and credit and housing in the 2000s.
Some students of Fed history trace the central bank's current dilemma over monetary stimulus back to Mr. Greenspan's aggressive easing in the wake of the 1987 market crash. That intervention subsequently led to a series of dangerous asset bubbles, even though he later pointed out that the crash damage remained confined to the market.
During his long tenure at the Fed, market pros adopted what became known as the "Greenspan put" – a largely faith-based bet made with confidence that the central bank would ride to the rescue of faltering markets with aggressive interest rate cuts. Today, we have the Bernanke put; and the Yellen put is coming soon to a theatre near you. So money keeps pouring into equities, driving prices to levels that can't be justified by their fundamental value or economic prospects.
In his memoirs, Mr. Greenspan acknowledged how clueless he and his Fed colleagues were about the bull market in the late 1990s and how long it would run. In 1996, he posed his now famous question: "But how do we know when irrational exuberance has unduly escalated asset values?" After a brief hiccup, the irrationality persisted for nearly another four years.
So why the 87-year-old economist thinks that he's become a better bubble spotter in his retirement years is a mystery. By the way, if you're wondering where Janet Yellen, who will take over the Fed helm in a couple of months, stood on the question, she told fellow monetary policy makers in 1996 that any effects from the then year-old stock market boom would be gone by the end of that year.
Some critics have argued that without the various bubbles that began on Mr. Greenspan's watch, U.S. and global growth would have been decidedly tepid in the years leading up to the Great Recession.
"We now know that the economic expansion of 2003-2007 was driven by a bubble," Nobel laureate and New York Times columnist Paul Krugman wrote earlier this month. "You can say the same about the latter part of the 90s expansion; and you can in fact say the same about the later years of the Reagan expansion, which was driven at that point by runaway thrift [savings and loan] institutions and a large bubble in commercial real estate."
Famed economist Larry Summers, who was President Barack Obama's first choice to replace retiring Fed chairman Ben Bernanke, has provocatively argued that the U.S. economy may indeed need repeated bubbles to sustain positive interest rates, strong growth and high employment.
Mr. Greenspan isn't in their camp. But his less-than-stellar forecasting record may mean Mr. Summers' bubble theory of growth will soon be put to the test.