Telling good bubbles from bad
This book is a wonderful counterweight to the mostly finger-wagging historical literature about bubbles. The idea that irrational exuberance can build industries and spark economic growth in a way that fully rational investing would not is one that deserves a lot more attention from economists and historians.
But it seems pretty clear to me that not all bubbles are created equal. Of the six bubble episodes described in detail in the book, four support the bubbles-are-grrreat theory pretty strongly (giving you a stupendous .667 batting average!): the telegraph, railroads, the Internet, and alternative energy. In each of these cases, overly optimistic and sometimes downright nutty investors financed the building of valuable infrastructure that others were later able to put to productive use.
It's the other two bubbles you cite that worry me.The positives you cite for the now-deflating residential real estate bubble are pretty lukewarm, as Jesse has already pointed out. Then there's what happened in the late 1920s, which you characterize as mostly a bubble in financial innovation. You argue that after this new financial infrastructure collapsed, the New Dealers built a new and more durable government backbone for the banking and securities businesses. I'm willing to buy that last part, I guess. But should the 1920s bubble really get credit for it? I mean, a different president than FDR might have reacted to the meltdown of the early 1930s by simply shutting down securities markets for good.
Some bubbles do good, and some probably don't. So how do we tell them apart? My theory: Bubbles are far more likely to look good in retrospect when they grow out of enthusiasm over a real innovation like the Internet or the telegraph. They're less likely to look so great when the driving force is financial innovation.
Think about it: Everybody makes fun of the tulip mania that gripped the Netherlands in the 17th century, yet it laid the groundwork for a big Dutch tulip industry that survives and thrives today. Contrast that with John Law's Mississippi bubble in France a century later. That mania was built upon the purely financial innovation of paper money, and while it certainly provided lots of useful lessons to subsequent central bankers, it didn't leave the French economy with much of anything but a lasting suspicion of financiers from English-speaking countries.
I like the your theory,especially the part about the ultimate percieved value of technological vs. financial innovations, but then I'm a propeller-head, not a bean-counter.
-Dave Adams-
May 14, 2007 12:08 PM | Reply | Permalink
Then there's the South Sea Bubble (1711)--which if I'm not wrong, was the first crash to be actually called a bubble. One of the nice things about having memory lapses is having to go look things up--which led me to Stock Market Crash!.Net one of the approximately 10 jillion websites I had never heard of before. Fun place, in a macabre way--especially if you don't have any money in the market. It advertises itself as
I'm not recommending it for advice--but the history looks pretty good.
aMike
May 14, 2007 12:08 PM | Reply | Permalink
Hey Justin? How come I was IP blocked from all of Time.com's blogs?
I can't get an explanation from anyone.
paul
awol AT glcq.com
May 14, 2007 12:40 PM | Reply | Permalink
I think the diffrerence is this: the railroad bubble, the interstate highway bubble and the internet bubble were all the result of people getting too enthusiastic about projects that really did have lasting effects on society. They were infrastructure projects. They were projects that needed investments now but that didn't pay off for a long while later.
Some bubbles, like the recent real estate and commodities bubbles are not infrastructure changing and were basically funded by free money from the federal reserve.
If you are in a position to invest for your heirs, joining an infrastucture bubble can really pay off. If you need money now, you'll probably get wasted when the bubble bursts. Just look at the Internet... crashed in 2000 and ruined a lot of lives. But it's still here and I'm not only posting on it now, but consider it a "fact of life."
thosethingswesay.blogspot.com
May 14, 2007 1:02 PM | Reply | Permalink
"If you are in a position to invest for your heirs, joining an infrastucture bubble can really pay off. If you need money now, you'll probably get wasted when the bubble bursts." Actually, the reverse, I suspect. Buy and hold might work if there's no real reason for the competitive burst that fuels the bubble and the competitive shakeup that fuels its collapse. This indeed, according to the slightly warped celebration of Schumpter and free market, is the value of bubbles. I got killed on the last real estate bubble, Reagan's, and I'm (for now) ok, and perhaps I'll be ok again after this, or maybe not. But Enron's not coming back.
John
http://www.haberarts.com/
May 14, 2007 3:05 PM | Reply | Permalink
Justin, I think you might be on to something, if I read you right.
You're saying that when technology drives investment, it works; when investment drives technology, it doesn't work.
Hmmm... Interesting idea... 8^)
Could it be that at least some technologists innovate effectively because they get a clue about what might be useful in the long term, as least compared to investors (and economists), who seem limited to what might make a profit in the short term?
Could it be that such technologists are, then, by definition, motivated by something other than profit, and their motivation, whatever it is, is a more effective and trustworthy motivation than is profit?
And not only do these technologists provide a public service without being motivated by profit, but some of them (though certainly not all) do end up hitting it big financially?
Could it be? Hmmm....
May 14, 2007 5:46 PM | Reply | Permalink
By the way, since I like how you think, allow me to offer this.
The tech sector bust of 2000, and specifically the "dot com" bust during that time, was not a remnant innovator of infrastructure; it was user of existing infrastructure. Nothing went away, nor was anything at risk of going away, for lack of hare-brained "dot com" companies going belly up.
And for that matter, there's a heck of a lot more in infrastructure and other terms to the Internet, besides the World Wide Web, and there's a lot more to the World Wide Web than the .com top-level domain.
The creation of that infrastructure owes as much to US federal funding (particularly from DARPA, the Defense Advanced Research Projects Agency) as it does to any private entrepreneurs. As far as I'm concerned, the "hostile takeover" of the Internet by profit-motivated concerns did a lot more harm than good.
Email, for example, actually used to be useful. But now..., well, ... can you say "SPAM"?
May 14, 2007 5:56 PM | Reply | Permalink
From anyone? Really?
Are you trying to use "awol AT glcq.com", e.g., for validation? Try creating and using an email address at bluehost.com instead.
Time is owned by AOL. AOL, as an ISP, likes to blacklist residential domain names. Yours, glcq.com, is residential; it's not a 2-way DNS mapping:
glcq.com. 14400 IN A 69.89.27.227
227.27.89.69.in-addr.arpa. 86400 IN PTR box227.bluehost.com.
I.e., you're mapping glcq.com to what is reverse-mapped as box227.bluehost.com; dead giveaway for a residential domain name. I'd guess you can't email to AOL-owned email addresses either.
I'm speculating, since I haven't tried posting to any Time blogs... YMMV...
May 14, 2007 6:21 PM | Reply | Permalink
Yours is the second mention of Schumpeter I've seen in this book club...
"... slightly warped celebration of Schumpter(sic) and free market ..."" Boy, you got that right.
Does anyone else find it interesting that Schumpeter concluded (as Mr. Fox has) that technology was already a bigger driver of innovation than is investment, and also concluded, despite his own purported personal disdain for socialism, that technology was killing capitalism, and that socialism would have to save the day? And this, from the same guy who apparently originated the idea of the entrepreneurial investor?
Talk about picking and choosing... If this were only that simple...
And Schumpeter, by the way, wrote before the middle of the 20th century, before the more recent exponential growth in information technology in the latter half of the 20th century. But if one knows the history of technology in the 20th century, one could surmise that enough had happened to shape his ideas, even by 1950.
Not a single automated factory existed in 1950, by modern standards. Not a single useful industrial robot. Not a single personal computer. But there was Bell Labs and similar private research institutions of the sort, and I'm sure he knew about them.
I'm really starting to think that economists are terribly eisegetic readers, not just interpreting observations to fit their preconceptions, but even making up many of those observations, out of whole cloth.
The dot com bubble built the Internet, and left it behind as useful infrastructure? Please, people, check your claims before you consider them facts.
May 14, 2007 6:40 PM | Reply | Permalink
Oh, and also by the way...
Wanna know what commercial sector most drives Internet technology? Fasten your selt belt...
Pornography.
Not left-leaning political blogs, or anything else with a true public service leaning, frankly. Not Google, not Wikipedia, not anything else of that sort.
Bandwidth increases have been driven as much by pornography as anything else, possibly more than everything else combined. And no, the Internet pornography bubble hasn't ever burst, as far as I can tell.
So tell me, who among legit economists want to confess that pornography is the true driver of the Internet of today, and that that's a good thing?
Profit and public interest, as motivations, lead in different directions. Let's stop playing games with that. If one cares how technology turns out, one darned well better fund it publicly. Otherwise, all bets are off. That's what the history of technology in the past 50 years should be telling economists, if they care to listen.
May 14, 2007 7:03 PM | Reply | Permalink
Ack! It's a bubble in johnOneOne comments! But, as so often happens, a useful infrastructure is left behind...
Anyway, I'd recommend reading Dan's book. It talks a lot about the interplay between government subsidies (like DARPA) and the profit motive.
May 14, 2007 7:36 PM | Reply | Permalink