The bubbles we deserve – Investors’ Chronicle


  • High asset prices were once associated with optimism. Today, they are a sign of pessimism.
  • Indeed, investors have become aware of the economic stagnation and the real sources of sustainable profits.

Asset price bubbles are not what they used to be, which tells us something about the economy.

Historically, bubbles have been associated with optimism and even utopia. In his classic The great crash of 1929 JK Galbraith described how the 1920s bubble was fueled by “boundless hope and optimism”. 1928, he writes, “was the last year that Americans were vibrant, uninhibited, and totally happy.” Likewise, bubbles in internet stocks in the late 1990s or rail stocks in the 1840s were accompanied by the idea that new technologies would transform society and the economy and that investors were buying them in part because that they thought they had a better future.

High asset prices today, on the other hand, are not based on optimism but on pessimism. The high valuations of America’s big tech companies owe a lot to the belief that their monopoly power is ingrained and persistent. This indicates pessimism about the strength of competition and creative destruction, which are the forces that have traditionally fostered economic growth. And the now faltering cryptocurrency boom is based in part on expectations that people will lose faith in “fiat money” – something that is only likely (if it does happen at all) in a horrific political crisis and economic.

Even high house prices are partly a sign of pessimism. On the one hand, they were pushed largely (if do not entirely) by low interest rates which are themselves a symptom of economic stagnation. My chart shows that as real interest rates have fallen since the 1980s, the ratio of house prices to earnings has increased. And the fact that people are using cheap money to buy homes rather than productive assets is in itself a sign of a lack of investment opportunities.

Also, as Willem Buiter, a former MPC member said, housing is do not net wealth. Rising house prices only transfer wealth to owners and to the detriment of potential buyers and tenants. In this sense, rising house prices are different from rising stock prices, which (if held up) denotes an increase in real wealth.

What we have seen, then, is an important but overlooked change. While bubbles were once associated with hope, they are now associated with pessimism.

This does not mean that there is no technique breakthroughs now. The are. Our escape from the pandemic is due to developments in messenger RNA, and green energy offers a lot of hope. One of the reasons investors should consider private equity funds is that they give us early exposure to companies using these technologies.

Similarly, therefore, many technologies have not (yet?) Enriched investors with equity. 3D printing, the Internet of Things, neural networks and graphene have been discussed for years, but few of us have seen the benefits in our portfolios.

In a sense, pessimistic bubbles are a sign that investors have taken notice. The mistake they made in the dot-com bubble was Aswath Damodaran of New York University. called the “great illusion of the market”. They correctly saw that internet shopping would be an important thing, but drew the wrong conclusion – that many businesses would benefit. In fact, the competition for the market, the ease of access and the difficulty of expansion meant that many never made a profit and went bankrupt. Like Nobel Laureate William Nordhaus wrote, “Most of the benefits of technological change are passed on to consumers rather than captured by producers.”

Investors have now largely corrected this error. They now know that what matters most to a business is not the size of its potential market, but rather its market power – its ability to convert such growth into profits. Hence the high valuations of firms with monopoly power – whether they are as different as Microsoft (US: MSFT), Diageo (DGE) or Games workshop (GAW). Investors have lost their illusions about capitalism: they now realize that what matters is the result, not the romance stories on “the rapid improvement of all instruments of production”.

This recognition of the importance of the monopoly is, however, the counterpart of stagnation. As Thomas Philippon of New York University has documented, declining competition and the rise of monopolies is one of the causes of the slowdown in long-term growth in the United States – hence the disappearance of bubbles based on optimism.

Which is a particular example of what Northwestern University’s Joel Mokyr has called Cardwell’s Law (named after economic historian Donald Cardwell): “Every society, when left on its own, will only be technologically creative for short periods of time.” Ultimately, he wrote, “the forces of conservatism” slow creativity down as they preserve their own power and privilege – in this case by strengthening monopoly power. In a world where the forces of conservatism have prevailed, we are less likely to see optimistic growth-based speculation.

Maybe every society gets the bubbles it deserves – and ours has dystopian ones.


About Nina Snider

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