The Benefits of a Bubble, Even When Burst

Daniel Gross is a very good and quite prolific writer on the economy, from his “Moneybox” columns in Slate to his “Economic View” columns in the New York Times; soon, he will be taking his skills to Newsweek. His new book, Pop! Why Bubbles are Great for the Economy, tells the story of various American investment bubbles, from frenzied railroad overbuilding in the 1880s to the dot-com delirium of the 1990s. His conclusion: notwithstanding the damage to individual companies, and perhaps millions of stockholders, bubbles play a determinedly healthy role in the continuing success of U.S. industry. The following excerpt sums up his argument quite well:

[I]f you take the long view … it’s possible to detect a pattern that emerges in bubbles and their aftermaths. Especially bubbles that leave behind a new commercial and consumer infrastructure. With apologies to Oliver Stone, these bubbles, for lack of a better word, are good. These bubbles are right; these bubbles work. Thanks to the American penchant for creative destruction and the U.S. bankruptcy system, investors — and the economy at large — tend to get over bubbles quickly. … The stuff built during infrastructure bubbles — housing and telegraph wire, fiber-optic cable and railroads — doesn’t get plowed under when its owners go bankrupt. It gets reused — and quickly — by entrepreneurs with new business plans, lower cost bases, and better capital structures. And when new services and businesses are rolled out over the new infrastructure, entrepreneurs can tap into the legions of users who were coaxed into the market during the bubble. This dynamic is precisely what has made Google the “it” company of this decade …

Looking back, many similarly iconic companies and industries that have stimulated economic growth, and that helped define America’s commercial culture, were either formed in those hothouse bubble environments or can trace their origins to their aftermaths. Consumer packaged goods and mass retailing, data services and mass media, the vast financial services sector, tourism, telecom, and what venture capitalists still call “the Internet space.” Sears, the Associated Press, Western Union, Fidelity Investments, Google — they may all have developed anyway. But they certainly would not have developed as they did without the Pop! dynamic.


kentavos

That's a great perspective and I'd have to agree.

Taking this idea and applying it to the housing market, what will be the long term benefit of a housing bubble?

Willy

I would add that there is also a natural selection effect, where you have a situation similar to that of an asteroid hitting the Earth. There is a lot of devastation, but evolution jumps forward at an amazing clip. A bursting bubble leaves only the few strong survivors, and that's where the Googles come from.

shanek

This sounds a bit to me like the Shadows from Babylon 5. They believed that wars let the stronger survive, and resulted in better societies with more technology, so they'd go around starting wars to help drive progress through evolution. Is the destruction caused in the process really worth it?

Also, it seems to me there's a bit of a Broken Window Fallacy going on here: if it weren't for the bubble, the money spent in investing in whatever market is having a bubble at the time would be spent some other way. Who's to say what industries have suffered because of these bubbles that we don't see? And therefore, who's to say we're better off with the bubbles, given that there's no way we can calculate that loss?

gradys_kitchen

kentavos,
See Gross' take on the housing bubble here: http://www.slate.com/id/2121684/

egretman

what will be the long term benefit of a housing bubble?

Lots of cheap large houses for the coming dominant Hispanic demographic who have and keep large extended families.

I for one am tickled pink by the prospect that a hard working part of our population will someday be well rewarded by the ruling classes of today.

It almost as if god planned it.

Bill Basso

You can see this in popular trends, too. For example there are far more people surfing (in the ocean) than there were during the heyday of the Beach Boys. And the surfing economy is stronger than ever even though it is no longer a fad.

But I guess bubbles and fads are pretty much interchangeable words.

steelndirt

Well, there is a reason why the Garter hype curve provides a relevant model to how society accepts technological change. It takes a while before the ability to do something sparks a business plan that can capitalize on that ability. So, once the original luster of the technology fades, the value crashes until someone knows what to do with them.

frankenduf

not sure if this applies to Marx's analysis of the boom/bust cycle- his conjecture was that the mother-of-all bubbles would be destructive enough for people to regulate the system- hence the fallout from the great depression- all Gross' point says to me is that bubble burstings are better absorbed by wealthy people (Mexico's 90's burst was devastating)

Chris Dillon

The aftermath of a bubble is a great time to be an investor. If you're careful, you can pickup bargains and simultaneously support the recovery.

ryan79

This all sounds great from a theoretical stand point but in on the ground reality terms this is terrible. Using the current housing coniditions as an example; you are creating all this liquidity by cheapening credit in order to create a ponzi scheme.

Who in the end gains from this? Not you or I. This bubble scheme hurts many in the process and there is no real tacit gain to most Americans when it is said and done. Housing tanks, people are foreclosed upon, hedge funds dealing in CDOs go belly up, pension fund and other savings instrument lose value or crash, companies such as Bestbuy and Homedepot take big hits, builders get hurt....I could go on and on. Who gains from this?

In the aftermath banks restrict credit and jack rates up to match a huge risk thereby making home purchasing even less cost effective. I just don't see how hurting investors and average americans by in large is good thing even if you create a new market or structure.

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kujo76

This should be looked at as a shocking thesis. It's literally the theory on which much of US economic/fiscal/monetary policy has been based for the last 100 years. So not only does he have a pretty unoriginal concept on his hands, it looks like he also hasn't taken an especially broad view of the effect US economic bubbles have in other parts of the world.

Since the US dollar is the world's reserve currency, the US can recover from bubbles by creating another bubble somewhere else. (The bursting of the dot com bubble led to the Fed firing up the money presses, which led to American consumers sending money overseas for cheap goods, which led to other countries reinvesting those dollars into US assets, which lead to the housing bubble.) Other country's aren't so lucky. Japan's bursting bubble in the early 90s has left its economy with a terrible liquidity trap and stagnant growth ever since. It is only now being lifted out of the economic doldrums by the global bubble that is being fueled by the US Current Account Deficit. The same is true for the rest of the Asian economies, most of which are in the process of overheating right now.

Also, do not forget that before the US was at the controls of a manipulatable world currency, the Fed presided over an economic bubble in the 1920s. I have a hard time accepting that the Great Depression was good for the country. Since then, the US has been able to export much of the downside of their bubbles overseas, but there is a limit to how long this trend can continue. Once the world has had enough of the dollar, we'll see how beneficial our bursting bubbles are. The euro is already challenging US hegemony. Couldn't it be that we just haven't really seen a true bubble correction because of the unique position the US found itself in after WWII?

I'm going to read this book, but I feel rather certain that I'll find it to be a terribly short-sighted view.

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kujo76

That last entry was supposed to start "This should NOT be looked at as a shocking thesis." Whoops.

Laura

I sent you this previously, but forgot to print it out for the book. It should be added.

Altelltixples

Once you know these values, is becomes fairly simple to make adjustments.

Balamutikweb

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kentavos

That's a great perspective and I'd have to agree.

Taking this idea and applying it to the housing market, what will be the long term benefit of a housing bubble?

Willy

I would add that there is also a natural selection effect, where you have a situation similar to that of an asteroid hitting the Earth. There is a lot of devastation, but evolution jumps forward at an amazing clip. A bursting bubble leaves only the few strong survivors, and that's where the Googles come from.

shanek

This sounds a bit to me like the Shadows from Babylon 5. They believed that wars let the stronger survive, and resulted in better societies with more technology, so they'd go around starting wars to help drive progress through evolution. Is the destruction caused in the process really worth it?

Also, it seems to me there's a bit of a Broken Window Fallacy going on here: if it weren't for the bubble, the money spent in investing in whatever market is having a bubble at the time would be spent some other way. Who's to say what industries have suffered because of these bubbles that we don't see? And therefore, who's to say we're better off with the bubbles, given that there's no way we can calculate that loss?

gradys_kitchen

kentavos,
See Gross' take on the housing bubble here: http://www.slate.com/id/2121684/

egretman

what will be the long term benefit of a housing bubble?

Lots of cheap large houses for the coming dominant Hispanic demographic who have and keep large extended families.

I for one am tickled pink by the prospect that a hard working part of our population will someday be well rewarded by the ruling classes of today.

It almost as if god planned it.