Over at Econlog, Scott Sumner has an interesting post on bubbles and libertarians. In his post, he asks why libertarians, which generally accept markets as rational, tend to see bubbles everywhere. It’s an interesting post and well worth a read, but I do not agree with him on several items.
But let’s start where I do agree: libertarians do tend to see bubbles everywhere. It’s almost like the libertarian equivalent of the “market failure” argument interventionists use to justify government intervention. Basically, whenever prices do not match what they think the price should be, it’s a bubble (or bubble popping). There may be cases where there are bubbles, but not all swings in price constitute bubbles.
However, I think Scott too quickly dismisses the role of monetary policy in potential bubbles. Interest rates are prices, and when prices are manipulated they send incorrect signals about relative scarcity of resources, which can lead to malinvestment and, in turn, bubbles. To be accurate, the Federal Reserve does not set interest rates; it attempts to influence them through monetary policy but the Fed cannot directly control interest rates. To that end, the effect monetary policy has on bubbles is likely relatively moderate compared to the effect direct price controls (such as price ceilings or floors). But it likely still has an effect.
I think his treatment of markets as always rational is incorrect. Markets are generally rational, absolutely, but they are also just collections of men and men are flawed. It certainly is possible that any given market at any given time could be irrationally priced. Imperfect information, externalities, these things happen. But does this weaken the case for markets and strengthen the case for government intervention, as Scott says? I say no. The same issues that infect markets infect government intervention, but in greater magnitude. Markets needn’t be perfect to be the preferable option. They need only to be better than the other options, and the record on that is crystal clear. In short, I don’t see why recognizing markets as being imperfect necessarily weakens the case for libertarianism (especially as long as markets are allowed to adapt to irrational behavior).
Markets are evolutionary institutions and, over time, they will be rational, but at any given day, any given moment, they could develop bubbles. I do not see anything within this fact that weakens the case for libertarianism or contradicts it.