The Case Against Bubbles

It seems the wise thing to do is to resist enthusiasm for any new innovation. That's not to say that technological bubbles will not emerge. But why encourage a very dangerous process?
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Tim Duy at Tim Duy's Fed Watch liked Felix Salmon's piece in The New York Times Monday about shrinking public equity markets. Duy takes off from Salmon to mull over the old chestnut of whether the tech bubble was "good" or "bad." In the end, he gives the tech bubble a qualified thumbs-up, admitting that there were spectacular failures, but also arguing that "the bubble-driven intensity of activity in information technology almost certainly accelerated its development and adaptation." In this regard Duy is joining an argument that then-BusinessWeek economist Michael Mandel made in Rational Exuberance in 2004 and that then-Newsweek columnist Daniel Gross offered in Pop! Why Bubbles are Great for the Economy in 2007. Their case for bubbles promptly got washed under when the larger subprime crisis burst.

Does this pro-bubblestance make sense? The real problem with the all-bubbles-are-bad (or good) is that it's unrealistically broad and one-dimensional. Like most things in life, bubbles are a mix of good and bad. True, the dot-com bust did accelerate the Internet and digital technologies, but it also destroyed large amounts of invested capital, jobs, in some cases careers, not to say stock portfolios; and it left behind a very unpleasant recession. And, if you want to get historically cosmic about it, the reaction to this bust -- in Fed low-interest rates and on the deregulatory front -- nicely set up the next, much more serious bubble. Indeed, even the subprime bubble had some good, albeit less with each passing day: Some people ended up with homes they still own.

The problems with arguing that some bubbles are worthwhile while others are disastrous are manifold. First, how do we know going in, whether a bubble will a) generate anything of value or b) destroy us all? After all, a key component of bubble psychology is a failure to consider consequences, a deliberate reduction of skepticism in the embrace of enthusiasm; everything will be great so shut your yap. This establishes policymakers in the same role they might have if they were in charge of picking technologies to develop. How can they know that software will advance in transformative leaps but not, say, materials or nanotechnology? (One alternative, of course, has taken its knocks: The market tells us so. But while this takes bureaucrats out of the picking game, it creates a classic chase-your-tail market syndrome, which is also endemic of bubbles; it must be great because the stock is rising.) Managing all this involves a kind of strategic loss of discipline, an attempt to allow bubbly means to produce, after a final calculation that none of us can execute ahead of time, tangible ends. That simply can't be done.

Moreover, Duy minimizes the psychological damage that a bubble wreaks. Bubbles, after all, produce a speculative fever that involves the snapping of ties between price and underlying value. Beyond the losses, what effect does that have after reality has reasserted itself? Like hyperinflation, it leaves in its wake a kind of vertigo, a deep relativism about value. How much of Salmon's drift from public stock markets by companies and the growth of speculation is attributable to an increasingly bubbly market? And there is very real damage. For all the acceleration that the dot-com bubble produced for digital technologies, how much damage was inflicted on the chain of financing vehicles meant to fund startups, nurture their development and then, from the public markets or from strategic buyers, allow them to expand and flourish? What we do know after the dot-com bust is that venture capital was severely wounded and that its ability to fund startups diminished over a number of years; indeed, the initial public offering market for tech companies may only now be reviving. How do we balance "acceleration" with a broken startup mechanism?

Again, there's no way to judge these things going forward. That said, it seems to me the wise thing to do is to retain skepticism and discipline and resist the hype and enthusiasm of any new innovation, no matter how bountiful the ends appear. That's not to say that technological bubbles will not emerge. But why encourage a very dangerous process?

Robert Teitelman is editor in chief of The Deal.

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