One of my all-time favorite headlines from The Onion was this gem from all the way back in 2008:
Bubbles do seem to be in our DNA for some reason.
We’ve had a handful of manias this century.
The dot-com bubble popped in early 2000, which laid waste to the stock market (especially tech stocks). That led to the housing bubble of the mid-aughts1, which combined with a global credit orgy, led to the Great Financial Crisis.
I’m comfortable calling the pandemic/meme stock boom of the early 2020s a mini-bubble situation. It didn’t lead to the stock market getting cut in half again but the 2022 bear market was rough and cleared out a lot of speculative excesses.
The inevitable bust after the boom is always painful but bubbles can be a net positive in certain cases. The pandemic-induced mania caused a bunch of people to invest in the stock market for the first time. Other bubbles have led to massive infrastructure investment.
Here’s what I wrote on the subject a few years ago:
Too much competition for investment, overcapacity, and lofty expectations during a bubble can lead to enormous losses for those left holding the bag when the bubble eventually pops.
But if some of that investment is used for productive purposes, it can lead to net gains for society when it’s put to productive use. Before the dot-com bubble popped, telecom companies raised almost $2 trillion in equity and $600 billion in debt from investors eager to bet on the future.
Those companies laid down more than 80 million miles of fiber optic cables, which represented more than three-quarters of all digital wiring installed in the U.S. up to that point in all of history. There was so much overcapacity from this buildout, 85% of these fiber optic cables were still unused as of late-2005. Within four years of the end of the dot-com bubble, the cost of bandwidth had fallen by 90%.
So despite more people coming online by the day during this period, costs fell and there was so much capacity available that those who were left standing were able to build out the Internet as we know it today.
The dot-com bubble laid the tracks for the Internet as we know it today.
Bubbles produce FOMO which eventually leads to financial losses but also the potential for productive overinvestment.
In their new book Boom: Bubbles and the End of Stagnation, Bryne Hobart and Tobias Huber make the case that we need more productive bubbles:
Ultimately, this book argues that bubbles, properly understood, have been the driving force in escaping economic stagnation, and will drive further advancements to come.
By generating positive feedback cycles of excessive enthusiasm and investment, certain financial bubbles mobilize the capital necessary to fund disruptive technologies at the frontier of innovation and accelerate breakthroughs in science, technology, and engineering. Crucially, such bubbles decouple investment from purely rational, backward-looking expectations of economic return, which correspondingly reduces risk aversion. Therein lies our escape from the Great Stagnation.
They show how bubbles can be innovation accelerators.
I loved the distinction Hobart and Huber make between progress and innovation:
It’s telling that right after the Moon landing the use of the word “progress” started to decline and use of the term “innovation” took off, reflecting a linguistic narrowing that refers almost exclusively to developments in software and information technologies.
After the Manhattan Project and the Apollo program, whose major technological innovations–atomic bombs, nuclear energy, rockets, semiconductors–were largely physical, progress became increasingly confined to the virtual.
In other words, instead of building the future, we are becoming better at developing increasingly realistic simulations of it.
On the one hand, it seems silly to argue we’re not making progress.
On the other hand, it does seem like much of today’s innovation is occurring outside of the physical world. The authors use the Manhattan Project and Apollo space program as examples of bubbles where we actually made real things and benefitted for years to come from the positive externalities.
Today we’re getting better at becoming more efficient digitally but building in the real world is harder than ever.
I didn’t agree with all the takeaways or ideas in the book. There’s some gold standard stuff that doesn’t make much sense to me. But this was one of the more intriguing ideas I’ve read in a finance book in some time.
This book is worth a read if you’re into this stuff like me.
Michael and I talked booms and bubbles on this week’s Animal Spirits video:
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Further Reading:
Why Bubbles Are Good For Innovation
1I really wish there was a better nickname for the first decade of this century but I’ve yet to find one.