TCS Daily

Bubble, Bubble, Toil... No Trouble

By The Editors - September 26, 2007 12:00 AM

Editor's note: TCS contributor Andrew Och recently sat down with Daniel Gross to discuss the American economy for a forthcoming primetime documentary edition of the PBS series Think Tank with Ben Wattenberg. Gross is the author of "Pop: Why Bubbles Are Great for the Economy."

TCS: Dan, large parts of the country are in the middle of a bursting real estate bubble. Tell us again why this isn't a bad thing?

GROSS: Well, the conventional wisdom holds that bubbles are bad. Economists don't like them because they represent irrational behavior. A lot of people get hurt. They invest at the top, they lose their money. It's a misallocation of resources. My argument is that the pop of the bubble is only half the story.

TCS: So what is the other - and hopefully happier - side of the story?

GROSS: Well, the way that new infrastructures get built in this country is frequently through investor enthusiasm. The government may help roll out new technologies, but we don't have the government putting up telegraph lines or stringing fiber optic cable that connects people's homes to the internet.

These activities don't proceed in a rational, easy-going way. They move in fits and starts. It's the bubbles that lead to this very rapid roll out of a new commercial infrastructure, one that businesses can plug into and use, like the telegraph or the railroad or the internet.

So bubbles create platforms for growth and innovation that help propel the economy forward.

TCS: And what happens after the bubble bursts?

GROSS: You get excess capacity, which leads to competition that brings prices down for normal users, which creates the climate in which somebody can come along with a new business idea that instantly plugs into a large user base.

Google is the best example of that. You had a lot of failures in the '90s with companies that spent way too much money putting in way too much fiber optic cable. They spent a lot of money on marketing, getting people to try stuff online, to get high-speed modems. And a lot of those companies went bankrupt.

Then Google comes along. In 2001 and 2002, it can plug into this huge base of installed users, all these fast internet lines. All of a sudden, in a matter of years, it's this global company with huge scale and huge profits. And all these other businesses - blogs, online advertising, online video, things that didn't quite work in the '90s because the infrastructure wasn't there - have since become significant businesses.

All built on cheap infrastructure that was laid down during the bubble.

TCS: Is there something particularly American about economic bubbles, or do they happen everywhere?

GROSS: We've seen bubbles in every economy. But one of the unique aspects of America is the way we recover from them. We have the ability to process failure more quickly and with less fear than a lot of other economies in the world.

You know, Japan had a legendary real estate and stock bubble in the 1980s. The story is legion about how a square foot of Tokyo real estate was going for tens of millions of dollars. The Nikkei Index was really high. Japan was going to overtake the US.

Well, that bubble popped in the late '80s. In Japan, the business culture and the culture at large was one in which people have to save face. They let companies stumble along without paying their loans. They didn't recognize the losses. They didn't process the failure, and they didn't move on. That economy had more than a decade of stagnation.

Look back at the US. We had the internet bubble pop in 2000 and 2001. We had a brief recession. We shed some tears about it. A lot of companies went bankrupt, but others picked themselves up, got going on a smaller basis, and have grown.

We very quickly moved on to the next thing. Instead of dot com stocks, people started investing in housing.

TCS: Which leads us to the bubble de jour. Where's the silver lining?

GROSS: We're at the stage right now where clearly the housing credit bubble has popped. We are seeing bankruptcies and foreclosures, Congressional investigations, casting of blame, all of which you typically see after a bubble bursts. And right when the bubble pops, when it's darkest, that's precisely when it is hardest to see the upside.

Clearly, with housing, a lot of the speculation was financial. That doesn't leave behind a whole lot you can use.

You could hypothesize and say, "Well, some of the services that were built during the bubble that people use to check housing values - like Zillow and Domainia - have become powerful tools for consumers. They'll stick around."

A lot of the housing that was built, even if it gets foreclosed on, will not be torn down. People will move in at lower prices.

And I think this whole culture of re-financing survives the bubble. A lot of the press today is about people who got in trouble by refinancing, by getting these weird mortgages that re-set at higher rates. But for every person that got caught up in that, there is another person or perhaps more who did very well by simply exchanging a fixed rate mortgage for one at a lower rate and doing it again and again and saving themselves upwards of thousands of dollars.

The mechanisms to do that, the mentality to do that, the idea that individuals watch interest rates and if they fall 50 basis points, 100 basis points, re-finance, that's new. The mechanisms are now there to do that quickly, which did not exist in the '80s or even the early 1990s.

Going forward, that has to be a big economic positive.

TCS: We feel better already. Is there a way to predict economic bubbles?

GROSS: When you look back at history, you can see these early stages to a bubble. People say there's a new technology and a new set of economic assumptions behind it. You tend to get government subsidies behind a new sector. You tend to get investor enthusiasm.

TCS: And where do you see those things happening now?

GROSS: We are seeing all those elements right now in alternative energy. People are saying that there are a new set of economic assumptions surrounding energy use. Oil prices are very high. There's all the concern about global warming. Therefore, they say, we need to invest more in this area.

There's been fantastic growth in wind, solar, ethanol. We have government subsidies for all of these things, which encourages people to invest in them even at high levels. And you can see it crossing over into the popular culture. It's not just business publications. It's everywhere you look - TV, radio, newspapers, company's websites. Everybody is talking about producing alternative energy, using alternative energy.

So, I think the stars are aligning for a bubble in alternative energy.



Time to dust off your Bastiat
I respectfully refer Mr Gross the timeless Bastiat, in particular the fallacy of the broken window .

That old broken window
The fixing of broken windows-- and anything else in need of maintenance or repair-- provides a fair percentage of the cash volume of our economy. Funds are spent on converting items of non-utility (something broken) into items of utility (something working). Thus the efforts are expended toward the same ends as the manufacture of new items for use-- and as well for disposal of the old, useless items. Next you (or Bastiat) will be telling us waste disposal serves no economic function.

Plus which, this is an important sector for employment, allowing millions to sustain their families. The funds earned in maintenance and repair are duly plowed back into the economy at large, to purchase yet other items and services from other employed people. Finally taxes are paid, enabling our government to continue its existence, fund its wars of economic expansion, etc.

Thus, the world goes around.

The point of Bastiat
as I remember, is that intentionally throwing a rock through a window doesn't make a positive contribution to the economy. But things do break and need fixing. It's Murphy's Law or thermodynamics, take your pick. Besides, in the case of the dot com bubble, new stuff was made, not old stuff broken.

Risks of being first
Most third world countries now have better, more advanced cell phone service than most of the USA.

They were able to install the latest and greatest while the USA is still having to deal with several generations of technology.

Intentially breakig the window could be a could thing if your are replacing it with triple pane thermal glass that will pay for itself in a year or two.

Wrong and Right...
For the most part, I disagree with Gross and think that bubbles are bad for the usual reasons that economist give for why they are bad. However, as all know well, people are irrational and suckers are born every minute. So, I think Gross is right that there will be another bubble and that it will be in alternative energy/green tech.

Unlike the previous two bubbles, IT and housing, I think this bubble may actually be good in that it may develop some technologies that have been languishing for some time such as solar, wind, and other alternative technologies. One of my favorites is synthetic biology for the generation of hydrocarbon fuel for transportation. My other favorite energy technology is one or more of the alternative fusion technologies being developed, such as Tri-alpha's reverse field configuration and Bussard's polywell. Either of these could lead to Boron-Hydrogen fusion.

For me personally, unlike the last two bubbles, I am in a position to play this one if I want.

"people are irrational and suckers are born every minute"
Which is why we want them to live forever?

Or just the ones that are rational? But who will judge?

People who play bubbles are the kind always looking for a quick buck. Sometimes they get lucky.

I would suggest the more bubbles we have, the frequency between them will gradually decrease as people finally 'get it'.

The Fairy Dust Bubble
While "alternative energy" is a very vague term, let's agree that it really covers those energy sources that are not yet commercially viable without government subsidy.

Will all or some of them ever stand along without subsidy and deliver net positive energy to customers?

As an energy professional, I remain deeply skeptical of those most beloved by the environmentalists and liberal politicians - namely wind and solar.

The bubble will pop for these sources once other sources like petroleum, natural gas, and nuclear are no longer able to meet people's demands due to governement disincentives and/or neglect. Then we'll see that wind and solar were but pipedreams at best and con jobs at worst.

roy, please learn a little basic economics
1) The myth of the broken window refers to the claim that it is good when things break, because fixing them causes economic activity. Thus you should measure economic gain from unbroken window to repaired window. Not from broken window to repaired window.

2) As usual you ignore what would have been done with the resources used to repair the window, had they not been devoted to repairing the window.

If there is any potential in these technologies, they will be developed, regardless of any bubble.

The reason the technologies have languished is because people who are having to bet their own money have studied these technologies and determined that they are losers.

The reason there is going to be a bubble is that people, playing with other people's money (politicians) are willing to invest in anything that gets them political attention, regardless of how bad an investment it might actually be.

I just heard that Biodiesel is worse for the climate than normal diesel.

What a joke. With the exceptions of nuclear and nuclear generated hydrogen the other alternative sources are political sophistry. If you live in a real windy area then wind might make sense from a local scale but the pundits and politicians (and leemings) of the world ignore the magnitude of our energy requirements.

Planned obsolesence
That's sort of the way I remember Bastiat, too. But there is one sense in which breaking a few windows can benefit the economy overall, or at least portions of it. And that's by making cheap, shoddy products that aren't designed to last. Nylon stockings, for instance.

Originally developed as parachute material, early nylon could lift an elephant. Before they could use it for stockings, they had to re-engineer the stuff to be flimsy, so the things would run every second time a woman put them on. Otherwise they'd just sell one pair to each woman on earth... and then go out of business.

The Baby Ben alarm clock was another great invention. The Big Ben cost six-fifty, but you could get a Baby Ben for only four. (In case you're a youngster, these were ancient, wind-up alarm clocks.) The works inside both models were identical, except that in the Big Ben all the gears were brass. The Baby Ben had one nylon gear, and it gave the clock precisely half the working life span.

Both products sold in the millions.

Then there's World War Two. One great big broken window. Playing devil's advocate, it did get us out of a depression and into our first great period of postwar prosperity. True, it did so by pushing us into an unprecedented bout of deficit spending. And we could have done that without having to break a single window.

Disclaimer: I spent a long, mostly pleasant career in the field of maintenance and repairs. So I'm a big believer in broken windows, as a stimulus to my personal economic well-being. However, in homage to Bastiat, I never broke one. Honest. :)

Serving our needs
My point-- which you missed-- was an important one. Your premise (and Bastiat's) defines an economy as running perfectly when all "demand" is satisfied.

Such a definition does not count people with no money-- who by this definition "demand" nothing. So if we solve the economic puzzle for the benefit of all people, and not just the efficient allocation of all dollars, we need to provide full employment. This way the economy can not merely be efficient, but it can also serve the needs of human society.

We would have a utopian, totally efficient economy if we could somehow provide only new products for people to buy-- and to make them all last forever. But the problem there is that in time, people would come to possess everything they needed but food and energy. And without jobs, they would have no way to earn the money to buy those things.

So we live in an imperfect universe, where things frequently break down. Often, in fact, they do so by design. And we employ millions of people who would otherwise be jobless in the repair, the maintenance and ultimately the disposal of those things.

I do "get" what Bastiat was getting at. But the man, however brilliant he may have been as an economist, was in the real world a dunce.

Levelling the playing field
I agree entirely. Everyt energy source should have to compete head to head with every other.

That would mean, of course, an end to depletion allowances, which are just a big con job designed to gain relief from taxation. And the nuclear energy industry would also have to give up its own monster subsidies.

Every energy source out there-- coal, you name it-- receives huge gifts of largesse from Uncle Sam. I would like to see ALL subsidies removed, just so we could see what the various sources actually cost us. As it is, the true costs remain hidden.

Who knows which one would be the winner?

Why the housing bubble is particularly bad.
Compared to the internet bubble (IB) or the proposed alternative energy bubble (AEB), the housing bubble (HB) developed no new technology. It just resulted in more expensive housing and a rapid shift in property prices. The people in marginal mortgages who are now suffering foreclosure are (I guess) mostly in the lower third, economically, and will be hurt disproportionately. The IB and AEB hurt mostly investors and techies, more resilient groups. The HB resulted in much construction that is likely to be abandoned or neglected, and if our efforts to restrict immigration are successful, the overhang could last several more years.
Had the HB not existed, some other foolishness would probably have developed, but not something with such a low (or negative) net gain. The gains from the IB are with us today in the form of instant access to educational and entertainment materials; a "successful" AEB could leave us with a solution to nasty pollution and political problems that will benefit us for decades to come.

ALL welfare payments too?
What a great day that would be for mankind!

And now for the rest of your posts.

You act as if you don’t know the difference between a “naturally” broken window and windows forcibly broken by the GOVAGs. Of course you remember what GOVAG means, don’t you?

As regards the nylon stockings and other such intentionally poorly designed products, it is their Right, as long as the design does not endanger the customers. If you can, go ahead and offer a product (for example, tooth brushes) that does not wear out during the life time of the purchaser.

You claim the WWII took us out of the Depression. It was the GOVAGs actions (first Hoover Administration’s Tariffs and then FDR’s alphabet Organizations and all the rets) that needlessly prolonged the crisis in the first place.

And finally, you claim you haven’t broken any windows. I am sure that is true literally. But, by condoning and encouraging the intrusion of GOVAGs into civil life (by batting for welfare payments, for example) you have broken many metaphorical windows; the intergenerational dependence of family members, for example.

I missed your point because I couldn't believe that even you are that ignorant
as I said before, try learning a little economics, for once.

The idea that any economic theory rests on an economy that has met "all demand" is so absurd that only someone who doesn't know what the heck he is talking about could possibly make it.

The entire basis of economics is that it is impossible to meet "all demand". That's why the call economics the science of scarcity. It's about how to distribute goods when there are never enough goods to go around.

As to Bastiat being a dunce, since you quite obviously have no clue regarding economics, you need to be applying that name to yourself.

The sad thing is that roy actually believes the garbage he spouts
Ah yes, all the nylon makers got together in a conspiracy to create a shoddy product. Not a single one got a notion that by making a good quality product, they could corner the market.

For crying out loud, is there any subject under the sun, that roy is not mind numbingly ignorant in?

Roy, in your world, is it not possible that the fact that nylons for legs are thousands of times thinner than nylon for parachutes plays some small role in nylons for legs being less hardy?

No, of course not, corporations are evil, so it must be a conspiracy.

What a moron.

in roy's world, any tax level less than 100%, is a subsidy.
with the exception of his tax load of course.

Bubbles are Good
One point that Mr. Gross didn't make about the real estate bubble was how the refinancing craze has led to dramatically lower transactions costs. I owned my home and wanted to refinance it. Instead of taking a mortgage out I took a 'second' on it at the same rate with almost no transactions costs. The reduction in financing transaactions costs through automation and competition is a huge efficiency gain that will sustain after the bubble is done.

An odd response
Certainly you must understand the identical nature of a window intentionally broken and a product intentionally designed to break before its time. Or do you? Let me know if I have to spell this concept out in greater detail.

In neither instance does such a move "add value" to the economy. All it does is provide added employment, and increase in some slight degree the circulation of money from one hand to the next. The remark that it does not add value is something of a red herring-- these acts are not designed to do such a thing, but rather to add to one's bottom line.

In like fashion, witch doctors of old in the Amazon Basin would occasionally come up against a dry spell, in which no one in the neighborhood was geting sick, or being hexed by some neighbor.

In those instances they occasionally resorted to putting strange powders into someone's food or water, making that person ill. Then they'd show up ready to make them well again. Same principle.

But I have a question for you. You say there are govags in your life, who run around breaking windows? Please give us an example or two.

Be sure to note in your answer that welfare as we once knew it ended back in 1994. And follow up with an explanation of how welfare relief is the equivalent of breaking a window.

"I would suggest the more bubbles we have, the frequency between them will gradually decrease as people finally 'get it'."


The test of this is just how far the green tech/alternative energy bubble goes before it pops. People do seem to be catching on to the fact that certain options, like the so-called "hydrogen" economy, are not feasible technically or economically.

There is history, you know. The previous oil bubble (late 70's and early 80's) cleaned out a lot of people (and banks, this is what took out Seattle First Bank in 1984) when it began popping in 1983.

Be not the first
by which the new is tried,
Nor the last to set the old aside.

~ Alexander Pope, 'Essay on Man'

'Nuff said already.

It's not quite right that bubbles are "good",
it is, however, reality that bubbles WILL happen, and WHEN the INEVITABLE bubbles happen (because despite all efforts by the wise to educate them, most investors remain sheeple who jump at every fear-signal or greed-signal irrationally), those who are more intelligent and/or savvy and have the resources rise to the occasion and when the bubble bursts they are ready to make us silk purses out of sow's ears.

So what is "good" about bubbles is not the bubbles, it's the responsive actions by the people who know what to do when those bubbles inevitably rise and then burst.

"People do seem to be catching on to the fact that certain options, like the so-called 'hydrogen' economy, are not feasible technically or economically."

Um...what? Oh, I see--you must be that guy from the Heinlein novel, 'Stranger in a Strange Land'. Yeah.

This type of economy is certainly not feasible in 2007. But by, say, 2020, why the hell not?

not entirely correct
Biodiesel contains some things that are more corrosive (acidic??) than most low-sulphur petrol-diesel. But they tend to make up for that in other areas, such as lower level CO emmisions. Also, bio-diesel is showing the best promise in cost comparison (the ability to compete without subsidy), though it isn't there yet. Bio-diesel also has a better energy-in/energy-out ratio than petrol diesel.

So bio-diesel does have some environmental advantages and they tend to out weigh the dis-advantages. And it still seems to be the best potential alternative fuel, with present technology, all around. The down-side is that, at best, it can't take up more than 50% of the present diesel market.

The best present alternative is for blends, probably 80-20 or, 50-50. The blends have the added advantage of reducing, significantly, the concentration of corrosive qualities in straight bio-diesel and decreasing the outputs of several negative emmissions from petrol-diesel.

Bubbles do throw off cash...and cash is good...
When a particular part of the market is moving up too quickly to be sustained by the larger economy then there are, indeed, opportunities to make some "fast money" and to get back out before the correction comes.

That easy money might then constitute the working capital necessary to launch businesses with greater long-term upside. This must be the point.

However, the idea that excess capacity built up during the boom will necessarily find useful employment in the economy after the correction is specious. Might happen...but with technology moving as quickly as it does...lots of that stuff is lost forever and scrapped out.

Recessions caused by broad based stupidity in the financial markets are far more harmful and dangerous than useful. Someone must benefit through salvage and picking up the shattered pieces...but the losses are always greater than the value of the scrap.

As for the deflation and economic depression in Japan after 1985...Daniel Gross is simply wrong.

He trivialize the nature of that correction by saying "In Japan, the business culture and the culture at large was one in which people have to save face. They let companies stumble along without paying their loans. They didn't recognize the losses. They didn't process the failure, and they didn't move on."

He completely ignores the impact of the Plaza Accord.

He completely misunderstands the structural operation of deflation combined with a strengthing currency. The mechanisms of financial capitalism within the Japanese economy essentially shut down. They were lucky to tread water. Writing down Balance Sheet assets more quickly than they did would have taken the Japanese economy to the bottom of the sea.

Daniel Gross is an Ivy League historian turned journalist...not a trained economist and he has never worked in finance or accounting. He is just making this stuff up. Or repeating dumb ideas that he read someplace. But he is dangerously wrong about the harmlessness (or the benefits) of market bubbles.

serving the people
YOu use language like, 'we solve for all people', and 'we need to provide', 'serve the needs of human society', etc. This is the talk of all dictators thru history, they don't want people to do that stuff themselves, so they presume to do it for them, and look at the results of left wing countries. And Bastiat wasn't a dunce, he just wasn't a leftist like you, he belived in freedom instead, wheras you believe in coercion.

response re the subsidies
You said you don't like the subsidies for any energies. Give us a list of the other subsidies you would end, or is that the only ones? Also, there are some other countries where they don't subsidise any energy, and it turns out that they use gas, lately LNG, and oil, because it's the cheapest. Singapore is an example of that, no windmills nothing that's wasted like that. And they don't have a drop of oil, but make billions a year from handling it like refineries , added value products etc. Same for switzerland. Dislcalimer: I own shares in swiss and singapore refineries.

Who decides when it is “before its time”?
Why, of course, the GOVAGs. What Right do they have to decide that? Right? What right? We have the Might (the Guns).

Many of my Indian and Chinese colleagues go for Toyota or Honda cars. Most of my American colleagues want Ford or GM cars. Some go for the Korean cars (mainly the Hyundai, for its 100,000 mile / 10 year warranty).

You mean nobody sells any product on as is where is basis?

If doctors make people sick (in order to get money by treating them) then it is a crime. It has nothing to do with offering a product of a certain quality in the market place.

You want examples of “windows” broken by GOVAGs? What better example than that last year the average American was forced to work till May 2nd (I think) for others, before he is released to work for himself?

You mean no (federal, state or local) GOVAGs are doling out money to (welfare) recipients since 1994? Then what are those Food Stamps I see once in a while at the Super Market chain I shop (for my groceries)? I haven’t heard of any Private Charity printing out Food Stamps. I have checked the website of the Super Market awhile ago and I could not find any mention of any Private Charity’s food stamps as acceptable currency.

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