"This is the key issue. Spotting bubbles is very hard - one person says 'bubble' and another says 'new fundamentals are emerging' ...."See that? That right there? That's number one. That is how you spot bubbles.
The single most reliable way to predict a bubble is when the business press, passing along what mainstream economists are telling them, say that the reason you can believe that we're not in a bubble is that "new fundamentals are emerging," or in other words, "the old rules don't apply any more because (fill in the blank)." Any time you hear that, dump the investment. And any time you hear that, Congress and the Executive Branch need to take emergency fast action to, in the vernacular of finance, "take away the punch bowl at the party."
For one thing, it's never true. The fundamentals of economics haven't changed in 300 or 400 years; no weird new equation or minor change in technology or shift in consumer preferences is going to revise either human nature or basic natural laws. Period.
Secondly, it's one of those things that only ever shows up on page 1 of the Business section of the paper, let alone on the front page, when everybody (including journalists) wants it to be true and there are critics pointing out that what's happening now, whatever it is, violates important laws of finance and can't be sustained. Why would journalists side with the finance industry over impartial observers on the subject of the finance industry? Contrary to what you may have heard, it's not because business-page reporters are being bribed, either with meals or gifts or stock tips or even "access," to say what the finance industry wants; reporters are perfectly willing to pile on when the prevailing wisdom changes. No, reporters report what they do, during a bubble, because "everybody knows" that the finance guys are right and the "pessimists" (read "realists") are wrong, and reporters don't create common wisdom, they ratify it.
But that at that point, reporters have bought into the assumptions underlying the sales pitch for fraudulently inflated products is a symptom of the third reason you can know that when somebody says "new fundamentals are emerging" and they get believed instead of mocked, and it's this: all bubbles are, in effect, pyramid schemes. And all pyramid schemes collapse for the same reason: they run out of suckers. And if the people selling the fraudulently inflated products have gone so far down the economic ladder as to be selling them to newspaper reporters, who are famously not wealthy people, then you know that we're running low on suckers. The only place left to go after them are working-class black Americans and poor rural whites, which is why every 20 years or so since 1870 it's been them left holding the bag when the bubbles collapse.
My high school economics teacher told me a story that I haven't been able to source, but it goes like this: future founding SEC chairman and former gangster Joseph P. Kennedy was one of a tiny handful of investors who dumped all their stocks just hours before the stock market collapse that began the Great Depression, and that aroused entirely plausible suspicion that they somehow had insider knowledge that the market was going to tank. When he was asked how he knew to dump stocks, here's what I'm told he said: on his way into the stock exchange that morning, he'd stopped to get a shoe shine, and the bootblack tried to offer him a "hot stock tip." As he was walking away, he said, it occurred to him that if even street urchins think that they have "hot stock tips," then there are too many fools in the market, and it's about to collapse. As I say, I haven't been able to source the story since then, but even if it's not literally true of J.P. Kennedy, the insight is relevant, and it's because of the other 100% reliable way to spot a bubble that's close to bursting: when the "Greater Fool Theory" catches on all over again.
I've mentioned before that modern economics allegedly begins with the realization that nothing has an innate, "real," absolute value, that "the value of a thing is the price it will bring." But even economists who claim to believe that dearly love their mathematical models that offer various frequently-reliable, long-term-proven ways of calculating the reasonable price of anything. Those models don't all agree, but they often cluster. No item can be "really worth" more than the ultimate customer of it can afford to pay, for example, and no investment can "really be worth" more than the rate of inflation plus a premium based on how risky it is; rules like these are centuries old and never wrong. So early in any bubble, the people who crunch these numbers will point out that the prices that are being paid for whatever the bubble is in are inconsistent with these models, with what they call "the fundamentals." Now, here's the part to pay attention to: when finance guys are asked why the fundamentals are out of whack (because nobody will ever ask them why the prices are out of whack), listen for the moment when the majority of them, and especially the most popular of them, start saying that it doesn't matter what the investment or the item is "really worth" if there will be someone willing to pay even more 3 months from now when you're ready to sell. That argument should always set off alarm bells in your head; the more often you hear it, the more desperate you should be to be out of that market. Because they're admitting that you are a fool to buy it at that price, but reassuring you that 3 months from now there will be an even greater fool willing overpay by even more than you overpaid, and that never works very long.
What Ben Bernanke wants is a simple, quantifiable, mathematical rule that says when the some line on a graph that measures some unambiguous, easily defined number that can be read from the marketplace crosses some hard-and-fast threshold on the graph, that's when we're in a bubble; then and only then should financial regulators demand greater collateral and higher cash reserves, then and only then should the Fed think about cutting off cheap credit. Having defined the problem in this way, he gets away with saying that "nobody can predict" if they're in a bubble or not. And other economists, even economists who don't even like him like Simon Johnson, let him get away with this because they're in the same line of work that he's from, economics, and that's how they want regulation and legislation to work.
But it's not the lack of a mathematical rule that makes stopping fraudulent investment bubbles difficult, it's the lack of political will, and even more so, the lack of popular will. Remember, in December of 1996, even laissez fair Fed Chairman Alan Greenspan correctly identified the bubble in Internet technology stocks, most of which did, in fact, turn out to be one form or another of fraud, by noting that "irrational exuberance" in the pricing of those companies' stocks (meaning a total disconnect from any plausible estimate of their worth) was beginning to take over. He could have cracked down then; he had the legal authority and the official responsibility to do so. Why didn't he? Because as soon as he said that the stock market tanked, hard, and millions of people who were invested in the market called their congressmen and demanded Greenspan's head on a pike, and he was forced to back down and apologize and "clarify his remarks" the very next day. See, here's the thing. Once people start making "guaranteed" returns on investment that are greater than the inflation rate, the last thing they want to hear is that what they're doing is participating in a form of the long Con. They believe that earning return on investment above the inflation rate at no risk is their God-given constitutional right as American investors, no matter how impossible that actually is, and they will always scream bloody murder when anyone "infringes" on that "right," even after the nay-sayers were proven right the last time.
And, well, this is a democracy. People who are deeply invested in a fraudulent investment bubble get to vote, too. If one isn't stopped before it reaches half or more of the voters, half or more of the voters will always and consistently demand that they get given their punchbowl back, demand that the party go on. All you can do, when you see that happening, I guess, is to get out before the inevitable crash.
Unless, of course, we start demanding that our Fed Chairmen be people who know to stop that kind of thing long, long before it gets popular. But where on Earth would we find one of those, let alone an uninterrupted string of them?