UNCORKING A DISCUSSION ON POP
Investment bubbles have received something of a bad rap. Journalists, who tend not to like it when stupid ideas prosper, find bubbles to be endlessly frustrating. So do economists, since bubble-era behavior tends to undermine their (generally) bedrock view that markets are efficient and people behave rationally. Historians enjoy looking back at bubbles, if only because they provide a rich vein of folly.
But I, for one, think that history provides some other lessons about bubbles—ones that can be applied to contemporary analysis of public policy, economics and markets. The book we’re discussing, Pop! Why Bubbles Are Great for the Economy, is unabashedly present-minded history. That’s a no-no in the academy, but it can be useful for those interested in the stories unfolding in front of us. (I should pause here and acknowledge the great contributions of perhaps the greatest business historian of all time, Alfred DuPont Chandler, Jr.,who died last week.)
When you look back on bubbles in the U.S., a clear pattern has emerged—time and again. Bubbles get started when entrepreneurs latch onto new technologies, or new economic assumptions (or both). As promoters enter the scene, the phenomenon crosses over into public culture. The result is familiar: excess capacity, competition, and the sort of promotion and hype that draws in new users. That combination generally proves lethal for the infrastructure builders. Many of the investors who backed investments in the first telegraphs, railroads, and the Internet lost everything.
Pop! focuses on the process that comes after the bust. The infrastructure isn’t torn down. And because Americans process failure quickly, the infrastructure swiftly morphs into a cheap, pervasive, and powerful platform for other entrepreneurs—who then launch businesses and innovations that benefit the economy at large. The telegraph bubble laid the groundwork for a national market in information—think newspapers and stock exchanges. The orgy of railroad construction in the 1880s led to a national market in goods. And remember what people were saying about the Internet as a business in 2001 and 2002: it was a scam, a joke, a colossal debacle. Yet the busted dotcom sector proved to be a great basis for new businesses.
Physical infrastructure isn’t the only thing left behind after bubbles. During bubbles, a great deal of cash is spent building what I call “mental infrastructure”—convincing people to try new ways of doing business. Most of the pioneering Internet bubble-era companies failed as businesses. But they succeeded in making millions of people believe that it was safe, efficient, and desirable to complete transactions online. Post-bust innovators were thus able to tap into both a commercial physical infrastructure (near-universal broadband) and a huge installed base of customers. As a result, the best time to start an internet business wasn’t in 1998 and 1999, when venture capital money was plentiful and the NASDAQ offered a sure route to IPO riches. It was in 2002 or 2003, when investors were irrationally pessimistic about the internet, when the building blocks of internet businesses were dirt cheap, and when there was a massive, installed base of users to tap. So the questions I’d throw out for discussion are:
1. Given how the U.S. economy works, do we need this sort of process? Do we need the disasters of Global Crossing and Worldcom in order to get the brilliant, beneficial, profitable business of Google? Would a more orderly rollout of new technologies, which causes fewer dislocation, mints fewer fortunes and lays fewer people low, still lead to the kind of innovation we’ve seen in recent years? To quote Barbra Streisand: “If we had the chance to do it all again, tell me: would we, could we?”
2. How does real estate fit (or not fit) into this thesis? We’ve clearly had a bubble in real estate assets in certain markets (the coasts), and a national bubble in real estate credit. What’s the physical and mental infrastructure that gets left behind? To a degree, the upsides of bubbles are what Donald Rumsfeld would have referred to as “unknown unknowns.” And it may be too soon to make anything but educated guesses. I’d throw out a few: the culture of re-financing; services like Zillow. But what else? Will excess capacity in real estate brokers lead to lower commissions?
3. We tend to think of bubbles as episodes when the private sector runs amok. But one of the themes of this book is that government policy has always played a huge role in kicking off and sustaining bubbles. Congress commissioned the first telegraph and financed railroad construction. The real estate boom of recent years was fueled by, among others, Federal Reserve Chairman Alan Greenspan, the home mortgage deduction, and Fannie Mae, a government-sponsored enterprise. The alternative energy bubblet now underway has been similarly inspired by state and federal government policy. By blaming (or crediting) government for bubbles, am I letting Americans off the hook? And given the possible benefits that could accrue to the United States—to our economy and our environment—should the government be doing more to encourage investment in alternative energy?
I’ll be eager to hear what you have to say.
one word.
tulips.
May 14, 2007 9:04 AM | Reply | Permalink
I certainly buy the way things unfolded, but here's the real problem. If we buy the argument, would-be entrepreneurs of Worldcom and Global Crossing would have just held back, wait for the fallout, and then enter in with abandon. Well, if EVERYONE thinks this way, then there would be no bubbles, no fallout and no one reaping the benefits.
We need the potential for an initial investment NOT to be a bubble for innovation to take place. I think we can find that in pharmaceutical companies and aerospace industries (say), but I'm no expert in these areas.
May 14, 2007 9:05 AM | Reply | Permalink
I think that questions 1 and 2 that you pose hint at a possible avenue of investigation: do we have any "control" examples of technological development to compare bubbles to? Or does major technological innovation necessarily require a bubble? I definitely see the argument that there are significant positive benefits to a bubble bursting, but is the outcome better than the alternative? Or is there even an alternative?
May 14, 2007 9:42 AM | Reply | Permalink
This idea is not new but it may be "revolutionary."
Your observation may have first been made by none other than Karl Marx in Das Kapital.
"The far greater cost of operating an establishment based on a new invention as compared to later establishments arising ex suis ossibus. This is so very true that the trail-blazers generally go bankrupt, and only those who later buy the buildings, machinery, etc., at a cheaper price, make money out of it."
May 14, 2007 9:46 AM | Reply | Permalink
Only a middle class doofus with health insurance who's never felt the sting of an economy gone flat could come up with an argument like this.
May 14, 2007 10:12 AM | Reply | Permalink
Depends.
A real estate bubble is great for land owners and speculators. It may be fine for homeowners but it is not so hot for renters and young people trying to buy a first home. The bust can be devastating.
On the other hand a boom in technology may indeed be beneficial despite the aftermath that wrecks havoc with investors.
Interesting - ahh, umm - speculation either way.
Best, Terry
May 14, 2007 10:34 AM | Reply | Permalink
Yet the busted dotcom sector proved to be a great basis for new businesses.
No, it didn't. It was a scam, a joke, a colossal debacle. A waste.
May 14, 2007 10:35 AM | Reply | Permalink
The dot.com bubble certain caused economic pain and took with it a number of companies that had no business operating. However, dot.coms are still in exitence and still very profitable.
An interesting questions is Microsoft. They have already adapted through two permutations of transistion to high-tech. However, they tend not to be creators so much as adopters of other technology and then market their "advances" to the public.
Daniel A. Greenbaum
May 14, 2007 10:56 AM | Reply | Permalink
I need to learn more about your argument, but I've been going around emphasizing the costs of bubbles, something I think economists are only starting to wrap our heads around.
I think burst bubbles lead to a sharp contraction in optimism, expectations, investment, and hiring, and a big surge in caution--the flip side of the abandon that caused the bubble in the first place.
Exhibit 1: the longest jobless recovery on record. That was ugly and we're still suffering its consequences.
In other words, burting bubbles take a really long time to absorb, and that hurts lots of people's economic prospects.
May 14, 2007 11:12 AM | Reply | Permalink
Imagine that! Dow Industrials at all-time new highs and here's a book telling us that record highs in global financial liquidity (formerly known as inflation and credit exceess) are actually good for us!
I would have been more impressed if Gross had written this book in 2002 (or 1992, or 1982 ...) ...
May 14, 2007 11:25 AM | Reply | Permalink
I'd say these type of discussions represent another type of "bubble" - that of nominally conservative and liberal commentators apologizing for the massive failures of neo-liberal economic policies. I think these apologists recognize that the jig is up. The rampant cannibalization and looting of the productive sectors (and labor force) of the US and Europe over the last generation due to deregulation, asset-stripping, investment steered clear of productive industry and into dot.com and real estate bubbles, the wholly unregulated derivatives and Hedge Fund fiascos - these factors amongst others have taken investment away from crucially needed basic infrastructure and will insure the collapse of the world monetary system (despite the growth in China and Asia generally).
You can create bubbles till the cows come home - and we have been, one after another since the market crash of '89 - but that will never solve our underlying problems. It just makes those problems bigger and more dangerous when the inevitable unraveling unfolds. Unless and until we return to a FDR-type Dirigist policy of directed investment in production of real wealth, as opposed to neo-liberal production of scads of monetary aggregate (funny money is the technical term), and concurrent de-emphasis of speculation, we are doomed to reap the harvest of previous John Law scams of the financial royalists - the oligarchy - world depression and world war. Both parties in the US and similarly all the parties in Europe are in the thrall of the neo-liberal dogma of globalization and free trade. They are not equipped to prevent the coming collapse intellectually or morally. Once it happens, one wonders if where a new FDR will come from. The moral and intellectual degeneracy of the Atlantic Alliance elite seems complete.
UA
May 14, 2007 11:38 AM | Reply | Permalink
Dow 36,000!
May 14, 2007 11:41 AM | Reply | Permalink
But what else? Will excess capacity in real estate brokers lead to lower commissions
You, sir, are a regular laugh riot. The problem with bubbles is the human wreckage they leave behind, and the suffering that goes with it. I'm not sure if the bursting of the first telegraph bubble caused a great amount of deprivation or displacement (did people have their telegraph keys re-possessed?) but I'm pretty sure the bursting of the real estate bubble will.
If capitalism (which can hardly exist without a stable society) can be destroyed so easily be a few government interventions to ameliorate the human suffering which accompanies these financial disruptions, why it's not much of a system.
Or have you developed a Panglossian econmics?
May 14, 2007 11:58 AM | Reply | Permalink
The dotcom bubble is a particularly bad one for the "bubbles leave free infrastructure behind" argument (best exemplified by the post-WW2 electronics and manufacturing boom) because of Moore's Law. Sure, people bought lots of stuff that then went on the surplus market, but except for some of the buildings, a little bit of the network backbone and maybe the aeron chairs, the bulk of the stuff that got overbuilt during the bubble became worthless almost overnight. Who needs a few million 14.4-kilobit modems or 100-MHz pentium boxes with 2-gigabyte disks?
The overbuilding was also quite plausibly at the expense of current or future infrastructure investment that might well have been far more useful. I'd expect the same to be true of the houses, roads and infrastracture built during the housing bubble. It's not, for instance, as if people can actually afford to live in the average starter castle (think heating and air-conditioning costs). And houses deteriorate drastically in usability when abandoned for even short periods.
May 14, 2007 12:09 PM | Reply | Permalink
Mr. Gross asks:
I'm the wrong person to ask. You might ask those whose pensions were invested in Worldcom or Global Crossing.
aMike
May 14, 2007 12:19 PM | Reply | Permalink
Terry:
I don't know that your point undercuts his thesis. It could be a matter of timing. As a property-owner, I'm not in favor of busts, but I have to admit that a housing bust could be good for a first-time buyer- if they haven't bought yet. As far as renters go, the aftermath of a bust would be good thing because rents would be lower, and renters would have the best opportunity to benefit since they have the most mobility.
-Dave Adams-
May 14, 2007 12:33 PM | Reply | Permalink
Will excess capacity in real estate brokers lead to lower commissions?
bubbles or no bubbles, the number of real estate salespeople (and by extension, the number of brokers who 'employ' them) waxes and wanes on volume. of course when median and average sale prices rise rapidly (again, bubble or no bubble), volume generally rises just as rapidly. it is very easy and cheap to get into real estate sales. but it is very difficult to actually be successful. even more so when volume is low. but it is still relatively easy and cheap to keep your license and stay in the business (even if you aren't doing any business). while this tends to draw out the waning in the numbers of salespeople and brokers in a market that follows a downturn in volume, the numbers of salespeople and brokers in a market does eventually settle out. any 'overcrowding' that follows a downturn in volume is only temporary.
when it comes to brokerage fees ('commissions'), so-called 'discount' brokerages have been around forever in just about every market. and in just about every market, they represent a very small percentage of the sales volume. in the very competitive business of real estate brokerage, you get what you pay for. and when what you pay (the brokerage fees) is mostly based on a percentage of sales price (as opposed to a fixed dollar charge), when prices go down so do 'commissions'. so in that sense, lower commissions are in fact a result of bursting bubbles in real estate markets.
May 14, 2007 3:11 PM | Reply | Permalink
I think had there been some rationality about profits - the mantra was profits were irrelevant all that matters is market share - the Internet would be at least as prominent and influential as the Internet is today. Just because the Internet failed to crash back to Earth that is no proof that a different Internet trajectory might not have reached escape velocity with less fuel expended.
May 14, 2007 4:21 PM | Reply | Permalink
It appears to me that a pattern of one bubble on top of another is being established as the Fed attempts to control inflation in spite of enormous debt and deficits that have necessitated an over 40% decline of the dollar verses the Euro since its inception by flooding the markets with liquidity and then tightening to dampen the fires. There were the Dot coms, then real estate, now the Dow.
This rapid cycle of boom and bust is reminiscent of the 20s - and will lead inevitably to the same result.
It is true that a burning forest fire brings new growth and is even necessary for the health of the forest. Many good things came from the great depression; the SEC, beginnings of a social safety net - people with money got a lot of really good stuff cheap.
Most would agree however, that moderating the boom of the 20s with all it's excesses could have prevented that enormous bust - and most would agree that would have been a very positive thing.
The question actually raised (in my mind) by the writer is not A) Can these boom/bust cycles be prevented? (My answer is no - not at this time. We have the tools but not the historical wisdom to avoid "quick, painless and easy" politicos like Nixon, Reagan and Bush.) or B) Are they a healthy and necessary stimulus to new growth and innovation? (An interesting question and I would like to see serious study of the benefits of steady growth versis "new growth from the ashes" examined by the author. Does one or the other stifle or enhance innovative change? Which does it better? We know which path causes more pain.)
The question in my mind is how far does this forest fire analogy go? Is all that destruction necessary in the financial markets? Would more stability inevitably equal stagnation?
My personal answer to that question is no - but I think it is a worthwhile question to ask and wouldn't mind at all having more examples to consider.
May 14, 2007 8:04 PM | Reply | Permalink
Funny you should mention that. I'm a renter and have considered the possibility of getting a good deal as the bust accelerates. Frankly, from what I know about the crackerbox homes built here in Texas lately (where you can no longer sue the homebuilder if a new house falls down around your ears), I think I'll continue to rent.
May 14, 2007 8:13 PM | Reply | Permalink