It's a puzzlement.

• Author: Adams, Tucker Hart
• Position: The ECONOMIST

"It's a puzzlement," sang Yul Brenner in "The King and I," as he tried to understand the differences between East and West. Alan Greenspan chose a different word in testimony before the House Finance Committee more than four years ago. He talked about the "conundrum" of the unanticipated behavior of world bond markets.

Long-term rates were falling, even though the Federal Reserve was increasing short-term rates, flattening and eventually inverting the yield curve (the spread between short and long rates on securities with a similar degree of risk).

Whether we call them puzzlements or conundrums, clearly something odd has been going on in the world economy over the last decade. Take, for example, the dot.com bubble of 10 years ago. Remember when we were being told that the price of technology stocks could only go up, that because technology and the Internet were integral to doing business in a global economy, the industry could only grow?

One of the most basic principles of economic theory is the Law of Downward Sloping Demand. As the price of a good falls, it becomes more affordable and, all other things being equal, people purchase more of it. When the price rises, the opposite occurs as people choose less expensive substitutes. Chicken replaces beef; beer replaces wine.

Back in the "olden days" when I studied economics at the University of Colorado, we learned of one exception to the relationship. During the potato famine in Ireland in the 1800s, potatoes became more and more expensive, but people still increased their purchase of them. What initially seemed to be a conundrum had a logical explanation. Potatoes, although more expensive than they had been, were all people could afford. Gradually they replaced meat, fruits and other vegetables. The Law of Price hadn't been repealed.

Or, consider a more recent example, the bubble in the housing market, which occurred not just in America but around much of the industrial world. As home prices more than tripled between the first quarter of 1987 and the first quarter of 2006--demand increased. Home sales rose from 3.8 million in 1987 to 6.5 million in 2006.

While part of the increase was due to a 25 percent increase in population and rising household income, we also convinced ourselves that prices could only go up, that the smart...