HOUSES, credit and now perhaps oil: is anything immune from the depredations of the speculators? The lives of millions have been caught up in economic bubbles that seem beyond anyone’s power to control. Boom followed by bust: can anything be done to stop this vicious cycle? Perhaps not – and perhaps we shouldn’t try.
Exactly what triggers a speculative bubble remains mysterious, as do the mechanisms that inflate and ultimately burst it. But put crudely, bubbles start when dissatisfied people try to shake things up by taking risks with their money, their careers and even their lives. Since human beings are both imitative and inventive, other people find ways to jump on the bandwagon, which starts rolling faster and faster – until it crashes.
That sounds like a bad thing. But in his 2007 book , the journalist Daniel Gross argued that in bubbles, investors’ money is used to build infrastructure that can’t possibly repay its upfront costs, but ends up being beneficial for companies and consumers in the long run – particularly after more-efficient companies have picked up the pieces on the cheap. To take a recent case, most investors in “dotcoms” lost their shirts – but their money built the software and infrastructure that runs today’s internet. There are plenty of historical precedents, too: for example, a bubble in the 1840s rendered shareholders in train companies penniless but left Britain equipped with the world’s best railway network.
Advertisement
The believes that bubbles inevitably precede each of the “techno-economic paradigm shifts” by which society advances. And Didier Sornette, a physicist who is now a risk specialist at the Swiss Federal Institute of Technology in Zurich, argues in a paper in press at Journal of Economic Interaction and Coordination that it is only during the reckless abandon of bubbles that individuals and companies take the foolhardy risks needed to develop technologies with large social impacts but low financial returns. That turns into “super-exponential” growth rates – of the kind Sornette says are now .
“A bubble is the inevitable precursor to each of the paradigm shifts by which society advances”
As well as market-fuelled bubbles, Sornette cites a number of publicly funded that involve bubble-like disregard for economics, including the Human Genome Project and the . Cynics say that the $25 billion spent on the Apollo programme brought little of enduring value other than Teflon and very expensive pens (both myths, incidentally); its defenders retort that it galvanised the US’s engineering and manufacturing base for a generation.
Sornette’s penchant for fitting dizzyingly broad arrays of phenomena into unifying mathematical frameworks has raised controversy before (żěè¶ĚĘÓƵ, 17 September 2001, p 30), but two aspects of his thesis – that bubbles enable the risk-taking behaviour necessary for building future infrastructure and are an intrinsic feature of society – ring true. So what about today’s bubbles?
The real-estate bubble has encouraged huge development of housing – which will now be available at a discount to would-be buyers. And borrowing money may be easier once the credit crunch has passed than if it had never happened, because the preceding bubble fostered the development of sophisticated risk-scoring technology. As for the oil market, the high prices resulting from the bubble might cause investors to ignore indications that supply is a long way from running out and instead pour their resources into alternative power generation, electric cars and plastic substitutes – the kind of green technologies that would be just what the planet ordered, but have met with fierce resistance from some economists.
How far should we go in allowing bubbles to run their course? Policy-makers tend to be terrified of speculative bubbles, and with good reason. Bubbles by their nature represent a failure of control, which looks bad, and threaten the social order, which is worse. People who can no longer afford their houses or cars probably aren’t much in the mood to listen to theoretical economic arguments about future benefits: a politician convicted in the court of public opinion of presiding over economic boom and bust might as well start drafting his memoirs.
On the other hand, attempts to prevent bubbles seem to be largely fruitless anyway. People have been trying to stop them since took hold in the Netherlands in the 1630s, to little discernible effect. Banking experts were still telling me that the boom-and-bust cycle had been abolished at the start of 2007 – but it seems only to have been deferred and exacerbated by their attempts to avoid it. Perhaps rather than pretending that we can do something about bubbles, we should surrender the illusion of control – and concentrate our efforts on trying to make the best of the bust that follows the boom.