May 8th, 2015
in Op Ed
by Fabius Maximus, FabiusMaximus.com
Summary: It's increasingly obvious that the US economy has become locked into a low-growth, bubble-driven, boom-bust mode. This post provides a brief description, an antidote to the news media's superficial coverage of this important dynamic. If readers are interested, future posts will provide a deeper analysis.
- Bubbles, bubbles, everywhere.
- San Francisco: America's bubble factory.
- What pops bubbles?
- Is it different this time? Yes.
- Other posts in this series.
- For More Information.
(1) Bubbles, bubbles, everywhere
The bubbles are everywhere. The best place to see them is on the pages of Zero Hedge, whose contrarian cynicism provides a good perspective for analysis of this madness; for example, see them dissect Tesla. Twitter's results need no such analysis; they are self-explanatory, with its valuation (and executives' pay) grossly disproportionate to its growth (and lack of profits). An earlier post looked inside the biotech bubble (spoiler: there's nothing there).
Bubbles are consensual hallucinations. However absurd, we want to believe. We don't look at internet advertisements, yet believe the stocks selling htem are like gold mines. We complain as the supply of internet advertising skyrockets - the "virtual economy" scrambling for money like a dying man digging for water at a desert mirage - yet we don't see that the supply of net advertisements will always expand faster than corporations' demand for them, and so ad prices will decline in price to the marginal cost of production (the virtual economy being too close to "perfect competition" for the hoped-for high profits).
Worse, the massive growth in social media traffic comes from underpricing its product. If investors forced these companies to price their products for immediate profits (as was the norm until the late 1990s), many would evaporate.
So we naively believe. But the people blowing the bubbles are not naive.
(2) San Francisco: America's bubble factory
You do look, my son, in a moved sort,
As if you were dismay'd: be cheerful, sir.
Our revels now are ended. These our actors,
As I foretold you, were all spirits and
Are melted into air, into thin air:
And, like the baseless fabric of this vision,
The cloud-capp'd towers, the gorgeous palaces,
The solemn temples, the great globe itself,
Ye all which it inherit, shall dissolve
And, like this insubstantial pageant faded,
Leave not a rack behind. We are such stuff
As dreams are made on,
- Prospero in "The Tempest"
I had a ringside seat at the first tech bubble, selling corporate services to early stage companies (start-ups to pre-IPO). In our conservative suits my partner (a grizzled veteran of Wall Street) and I would visit CFO's in their shiny HQs. They would explain their business plan. These sounded to us like the Gnomes' business plan from South Park ("Gnomes", 1998):
Content & click, magic, profits! When we asked about Step Two, the reply was that "we didn't get it." Time proved they were right: we didn't get it. Step two was sell the company's stock to foolish investors and so get rich. Most of the CFO's we spoke to profited handsomely from their ventures (less so their employees). Some got rich.
The San Francisco Bay Area has become America's newest industrial center. The model is not manufacturing centers like bankrupt Detroit, cultural hubs like Paris, government cores like Brussels and Washington, or metropolitan areas like New York and London. The model is Hollywood; the product is dreams. The world sends money and receives stock certificates.
A large industry of venture capitalists, bankers, attorneys, and investment bankers has grown to support the Bay Area's bubble machine, much like the somewhat similar machinery supporting 1930s Hollywood. Naive people survive only briefly in the New Economy.
(3) What pops bubbles?
Bubbles are not Ponzi schemes, but have similarities to them. Both rely on supply of new marks to fuel growth (belief that there is always a "greater fool" to buy my shares). They pop when the supply of new capital diminishes - from exhaustion of existing sources and lack of new ones, or a decrease of investors' risk tolerance (perhaps due to outside factors, such as recessions or geopolitical events).
They pop hard and fast when investors start to pull out capital (e.g., smart money or banks cashing out). Bubble investors are ruled by the prisoners' dilemma: early defectors end the game, but profit most.
(4) Is it different this time? Yes.
Investment bubbles are an inherent aspect of free market economic systems. They predate central banks, fiat currency and modern fractional reserve banking systems (despite conservative mythology). They leave both losers (chiefly investors and employees) and the infrastructure they built (e.g., canals, railroads, the Internet). The long-term benefits of this bubble are difficult to see. What does social media do for society?
The popping of previous investment bubbles caused recessions and depressions (e.g., the 19th century canal and railroad bubbles), because they relied on debt - much of it provided by banks. Almost every depression in modern western history (i.e., since 1800) featured a collapse of banks.
This time is different. The first tech bubble relied upon little debt, most of that being bonds (e.g., Global Crossing, Globalstar Inc). This bubble involves even less debt, so its popping will inflect only minor damage to the US economy (but severe hit to the Bay Area region economy). The real losses are opportunity costs, more damage from the financialization of the US economy: our scarce resources of capital and talent wasted on frivolous projects - while projects that could lay the foundation for a prosperous 21st century get ignored.
This would hit the credibility of the financial services industry, but its people are confident that American's amnesia will again serve them - returning its customers to be harvested again soon. I disagree - a subject for a later post.
(5) Other posts in this series about our bubbly economy
- Larry Summers gives us the bad news. Worse, the only solution is more of the same. -The necessity of bubbles for growth.
- Understanding the new world shown us by Larry Summers.
- The new tech bubble takes us to a new world. A mad world.
- Let's ignore another warning from the BIS. Do we enjoy paying for burst bubbles?
- How we've become accustomed to bubbles bursting the economy, instead of fighting them.
- We see a stock market bubble but prefer to close our eyes.
- Economics gets interesting as the economy darkens while stocks bubble.
- Don't ask if there's a biotech bubble. Ask why we have another bubble.
(6) For More Information
If you liked this post, like us on Facebook and follow us on Twitter. See all posts about our great monetary experiment, about markets, and about financial bubbles, especially this about the benefits of bubbles: Will 21st Century USA have a surprise boom, as did the 19th Century UK?
For more about bubbles see these books:
- Charles P. Kindleberger's Manias, Panics and Crashes: A History of Financial Crises (1978).
- Michael Lewis' The Big Short: Inside the Doomsday Machine (2010).
- Essential reading: Charles Mackay's Extraordinary Popular Delusions and The Madness of Crowds (1841).