The Fear
(or a bubble in money)

Roubini says there's a bond bubble which will have a disasterous correction. Nick Rowe explains the "bond bubble" in plain English and points out it's bad but not for the reasons Roubini says.

A bubble in house prices is a bad thing. It will cause over-investment in building new houses, under-investment in other things, and under-consumption. A bubble in bond prices is a much worse thing. It will cause under-investment in everything, and under-consumption in everything, because it causes under-employment of everything. That's because bonds and money are close substitutes. A bubble in bonds causes a bubble in money. And a bubble in money can cause a bubble in bonds. Or perhaps they are just different aspects of the same bubble, in both money and bonds.

It's not the bubble in bonds per se that is the big problem. If there were only a bubble in bonds, and no bubble in money, it would be no worse than a bubble in houses. It might lead to the wrong mix of real investment and consumption (presumably too little real investment and too much consumption, due to a wealth effect). It's when a bubble in bonds spills over into a bubble in money, the medium of exchange, that we get a big problem. An excess demand for the medium of exchange is what causes, and is the only thing that can cause, a general glut of all goods. And that causes employment and output to fall, and both consumption and investment to fall.

That's why we should be worried about the bond bubble.

If the US and world economy returned immediately to long-run equilibrium, and expected and actual inflation increased to target, the price of US government bonds would immediately fall. And people who held bonds would suffer a large loss when the bubble burst. But perhaps it won't return to long-run equilibrium for a long time. That is what holders of bonds must be forecasting, because if they are right in this forecast, their decisions to hold bonds at current prices are rational.

And maybe they are right. Who am I to know better? But, like all bubbles, the beliefs that sustain the bond bubble are, at least partly, self-fulfilling. The bond bubble, and the associated money bubble, create the general glut, and prevent the economy returning to long-run equilibrium. And the belief that the economy will not return soon to long-run equilibrium is what sustains the bond bubble.

We need to burst the bond bubble. Bursting the bond bubble will help the economy recover more quickly.

(via Andy Harless, via DeLong)

But maybe he agrees with Roubini? In the comment section Rowe is asked

Or alternatively, why the old-fashioned Keynesian idea of liquidity preference -- which is all that excess bond demand amounts to -- is usefully re-labeled as a bubble?

and he responds:

Precisely because the people who are now saying that bonds are not a bubble, might be lead to rethink their position, and think that in some important sense, the demand for bonds and money is too high, and that the thing we ought to be doing is worrying about this, and bursting that bubble, not propping it up. Rhetorical? Sure.

Someone else in the comments writes along the lines of what DeLong has written

The bubble in bond prices exists only in crazy minds of fixed income traders. Shut them down and get to something more productive and worth talking about. Any bond of US government will pay 100 at maturity with coupons which were fixed at issue date.

Yes the government's debt costs will go up if rates rise, but the United States is not Greece.

Rowe links to Daniel Gross's "The Bubble that Isn't." So I don't think he agrees with Dr. Doom.