Do Economic Bubbles Really Build the American Economy?

[Nice Squirrel]

The Bubbles that Built America (http://money.cnn.com/2007/05/13/news/economy/bubbles_gross/index.htm?postversion=2007051509)
The cycle of over-the-top hype, vicious competition, bankruptcies and consolidation that characterized the late-90s dot-com boom and this decade's real estate market could be the key to America's economic success.

During bubbles, the competition created by excess capacity - too many e-retailers, too many railroads competing for too few customers - inevitably leads to vicious price competition. (Score one for consumers). Post-pop, the infrastructure - housing and telegraph wire, fiber-optic cable and railroads - doesn't get plowed under. 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 as my house lost $5,000 in value this month according to zillow.com. :frown:

So do long-term economic gains really replace the short-term pains? And who are really the winners in this game? Slow and steady investors? High-flying portfolio managers? Large corporations? Innovation and creativity?

Who are the losers and what are the costs of economies of bubbles? (Is the US a macrocosm of the boom and bust economy of Alaska?)

Is Daniel Gross' theory valid or oversimplified version of reality?

[Loren Pechtel]

This as my house lost $5,000 in value this month according to zillow.com. :frown:

I never got that site to work and now it seems to be gone.

[Stinger]

The Bubbles that Built America (http://money.cnn.com/2007/05/13/news/economy/bubbles_gross/index.htm?postversion=2007051509)




This as my house lost $5,000 in value this month according to zillow.com. :frown:

So do long-term economic gains really replace the short-term pains? And who are really the winners in this game? Slow and steady investors? High-flying portfolio managers? Large corporations? Innovation and creativity?

Who are the losers and what are the costs of economies of bubbles? (Is the US a macrocosm of the boom and bust economy of Alaska?)

Is Daniel Gross' theory valid or oversimplified version of reality? You didn't lose any money unless you actually sell. The losers in economic bubbles are those that sell in the down market. The winners are those that hang tight or buy in the down market. Of course the biggest winners are those that buy low and sell high - but that is extremely difficult to do.

[Jason Harvestdancer]

I do not think that bubbles grow the economy. That is because bubbles do pop. He talks about the houses still existing after a housing bubble, but the infrastructure still existing is only true in a housing bubble. A speculative bubble, like the dot-com bubble, has invested monies vainish into what is basically thin air.

Even in housing, a house needs to be maintained to keep or increase value. Real property deteriorates over time. I have a car that had been garaged for several months while I saved to have the transmission fixed. During that time a hose dry-rotted and now I have a coolant leak. I have to constantly refil the radiator or it will over heat. Houses get infested with insects, molds, etc., and need someone to visit at least once a month to ensure that they are maintained.

Foreclosed houses still exist, but cause a loss of money both to the former owner and to the bank. That is money the bank was counting on getting repaid so it can make more economy stimulating loans.

This really is a fancy broken-window fallacy.

[Jason Harvestdancer]

It is possible to ride out the crash of the bubble. If you use constant dollars, the Florida real estate bubble crash of the 1920's finally recovered in the 1970's.

[gargoyle]

As long as the bubble is accompanied by dramatic increase in lasting infrastructure (physical - roads, electrical systems, parks etc and mental - trained professionals, skilled workers, public schools, colleges and universities etc) when the economy recovers the potential to build a bigger and more lasting bubble exists.

[Stinger]

It is possible to ride out the crash of the bubble. If you use constant dollars, the Florida real estate bubble crash of the 1920's finally recovered in the 1970's. If you had a home before 1920 and sold in 1931, then you experienced a bubble crash. But if you bought you first home in 1921, then you probably did pretty damn well. If we didn't have occasional crashes or corrections, young people would never be able to get into the market. Crashes are the best time to buy.

[mac_philo]

I don't know about its effects on the whole economy, but in terms of investing, bubbles are only a problem if you participate in the wrong way.

A rational investor should be indexing and holding their stocks "forever", and will just ride bubbles out. With proper, regular rebalancing of asset classes, this investor will frequently profit from a bubble.

An exceptional investor like Buffett can profit from bubbles by sitting on cash until the bubble pops and deflates the whole market, then he scoops up the best values. "Profit from folly, don't participate in it" is what I think he says. That's not to say Buffett can time the market or business cycle, but he only invests in certain things, he never invested in the tech bubble, and he knows when a stock is selling at a value.

The typical investor loses his shirt in a bubble because he believes in market timing, emotional investing, getting in when it's hot, getting out when it's not, etc. So of course right before the real estate bubble pops, Joe Six Pack gets an ARM to flip a house that he can't afford. And right before the tech bubble burst he was day trading and buying DogSweaters.com on margin.

That your house dips $5,000 on zillow should not concern you in the slightest.

[Stinger]

I don't know about its effects on the whole economy, but in terms of investing, bubbles are only a problem if you participate.

A rational investor should be indexing and holding their stocks "forever", and will just ride bubbles out.

An exceptional investor like Buffett can profit from bubbles by sitting on cash until the bubble pops and deflates the whole market, then he scoops up the best values. "Profit from folly, don't participate in it" is what I think he says.

The typical investor loses his shirt in a bubble because he believes in market timing, emotional investing, getting in when it's hot, getting out when it's not, etc. So of course right before the real estate bubble pops, Joe Six Pack is planning on getting an ARM to flip a house that he can't afford. And right before the tech bubble burst he was day trading and buying DogSweaters.com on margin.

That your house dips $5,000 on zillow should not concern you in the slightest. I agree with you all the way. It's an extremely rare person who is good enough (lucky enough?) to perfectly time the market. We get too greedy. It's far better to dollar cost average and aim for reasonable returns over time.

[mac_philo]

The nice thing about those reasonable returns are that they are far above what the average investor gets, due to expenses, failed timing, folly, etc.

I haven't followed it closely but it is hard to see the real estate downturn as a real nationwide bubble. Some areas saw prices drop, and there is going to be some pain regarding foreclosures on these ridiculous mortgages people were getting. But it all depends on the location, large parts of the country are outside any purported bubble. Some places are still rising. Real estate is all local.

but the infrastructure still existing is only true in a housing bubble. A speculative bubble, like the dot-com bubble, has invested monies vainish into what is basically thin air.

Are you confusing capital and infrastructure? How did infrastructure not persist after the railroad bubble? What about all the fiber cable laid during the tech bubble?

Also, depending on your perspective and age, money vanishing from the market into thin air can be most welcome. If you are young and accumulating, and invest long-term instead of trying to time the market, you should hope for this. You get to buy more equities per dollar.

[travc]

I don't know about its effects on the whole economy, but in terms of investing, bubbles are only a problem if you participate in the wrong way.

A rational investor should be indexing and holding their stocks "forever", and will just ride bubbles out. With proper, regular rebalancing of asset classes, this investor will frequently profit from a bubble.

An exceptional investor like Buffett can profit from bubbles by sitting on cash until the bubble pops and deflates the whole market, then he scoops up the best values. "Profit from folly, don't participate in it" is what I think he says. That's not to say Buffett can time the market or business cycle, but he only invests in certain things, he never invested in the tech bubble, and he knows when a stock is selling at a value.

You may want to read Soros's new book "The Age of Fallibility" for some more philosophical treatment of this idea (basically the first half is devoted to it). His investment strategy is to identify "out of equilibrium" conditions and bet against convention. While he and others have talked at length about this idea in books and such, the philosophical underpinnings are really surprising and cool (Popper's philosophy of science is a big influence.)

As for the OP. When thinking about physical infratructure, the assertion is dubious. There are cases, but probably not the norm. However, technological and methodological innovations do persist past the boom. While not a normal buisness cycle, WWII is a good example of this effect (the post war boom was largely fueled by technological innovations developed in the 'hyper-competition' environment of the war.)

For real economic progress, maybe downturns are the real driver. That is where competition and innovation really matter. Of course, the boom generates lots of diversity which then gets evaluated/weeded out in the downturn. Maybe it is just me, but this is so similar to natural selection (especially evolution in a variable environment) that I can't help by think the metaphor is relevant.