HOME / the chat room: Real-time discussions with Slate writers.

Pop TalkDaniel Gross chats with readers on why economic bubbles are good.

Posted Thursday, May 10, 2007, at 5:56 PM ET

Daniel Gross was online at Washingtonpost.com on Thursday, May 10, to discuss his Slate article "Pop! Why Bubbles Are Great for the Economy," also the title of his new book. An unedited transcript of the chat follows. (View the Bubble Hall of Fame, take a Bubble Quiz, and buy Pop! Why Bubbles Are Great for the Economy.)

Daniel Gross: Hi Everybody — Thanks for joining me. Why do I think bubbles are good? It has as much to do with what happens *after* the bubble bursts as it does to do with what happens during the bubble. In the U.S., we've had this great history of innovation that comes after the Pop!

RSS

Basically, the excess capacity that gets built up during bubbles (telegraph, railroad, Internet) winds up serving as a really powerful, cheap, and pervasive platform on which new businesses are constructed. So the people who strung up the telegraph wires in the 1840s and 1850s all lost their shirts, but the telegraph proved really important to the business models of the Associated Press and stock exchanges. Investors who backed railroads in the 1880s lost all their money in many cases, but companies that relied on freight to conduct business (Montgomery Ward, Sears, Coca-Cola, Procter & Gamble) were able to gain scale quickly.

More recently, companies like Global Crossing and WorldCom, which built the Internet infrastructure in the 1990s, failed quite loudly. But in the years since, all sorts of businesses have been built on the wreckage -- Google being the most obvious example.

The argument, then, is that the excess capacity built during bubbles, which winds up hurting the comparatively small number of people who invest in the bubble companies, winds up being a net positive for the mass of consumers and for the economy at large.

_______________________

North Salem, N.Y.: I remember the solar craze of the mid-'70s. Why is it that a country like ours cannot find a long-lasting alternative to fossil fuels, etc.?

Daniel Gross: Hi — Actually, I think we are in the process of finding a solution. As you note, there was a solar boom after the oil shock of the 1970s. In my book, the final chapter deals with alternative energy. Are we in an alternative energy bubble? Not quite, but we're almost there.

You can really see how alternative energy has grown rapidly in recent years, and has become something of a popular culture phenomenon, whether it's "An Inconvenient Truth," or Wal-Mart selling compact fluorescent bulbs, or Rupert Murdoch talking about global warming and carbon neutrality.

That's being matched by significant investments. And, importantly, the government is playing a role. In virtually all the infrastructure bubbles to date, the U.S. government has played a bigger role than most people think. And in alternative energy, state and federal governments are big players. Through subsidies, tariffs, and a range of initiatives, they are stimulating huge investments in alternative energy.

Many of these companies will ultimately fail. But if this cycle works out like the previous ones, we'll be left with important usable infrastructure that will set the stage for new innovations. It's a safe bet that in the next several years, even if solar companies fail, the price of solar installations will fall.

_______________________

Anonymous: Bubbles? Or simple rotations from one asset class to another?

Daniel Gross: There's definitely been a rotation from asset class to asset class--real estate got hot right when the NASDAQ melted down, and alternative energy got hot right when housing peaked.

But I think in this decade we've had back to back to back bubbles in technology, real estate, and alternative energy. Bubbles are hard to define, but there are a series of stages I outline in my book that help you know when you're in one: you get a few good years of solid fundamentals, then you get promoters arguing that something fundamental has changed (about technology, or the economy, or our world) that justifies investments at any level, then it crosses over into the popular culture and ropes in millions of new enthusiastic users.

_______________________

Alexandria, Va.: I've got all my money invested in black tulips. Want to buy one?

Daniel Gross: I'll trade you one share of Webvan for a black tulip!

_______________________

Harrisburg, Pa.: When I studied economics in college, including econometrics, I was taught that economic statisticians can have some accuracy on predicting ongoing trends. What was very difficult and almost impossible to predict was when trends would reverse, i.e. when economic bubbles would burst. Has there been progress in recent years in better determining when economic bubbles suddenly will downturn?

Daniel Gross: That's a great question. And unfortunately the answer is no. I've written a couple of articles in recent years about the challenge of economic forecasting. If you look back when we had the last recession back in 2001, the quarter before the recession started, all the forecasters were predicting smooth sailing. And the quarter when the recession ended, all the economic forecasters were predicting that the economy would continue to contract.

The state of the art of economic analysis has improved vastly in recent years, but economists tend to do very poorly at noting turns. One group -- The Economic Cycle Research Institute -- has done quite a good job in seeing turns. And they like to say that their fellow economists engage in too much of forecasting by analogy -- i.e. they simply extend existing trends into the future. It sounds reasonable. But it means that when there's an interruption, or a shock, or simply some unexpected occurrences, the forecasting goes haywire. Frequently, peaks in markets, or in sectors, are only seen in retrospect. And, as investors know, it is exceedingly difficult to time markets.

_______________________

Rochester, N.Y.: I'm not convinced. Sure, some bubbles promote things we find useful (Internet, rail), but in some case the upside is limited: I'm sorry, but Zillow.com is good for voyeurs but not terribly helpful. And there's a bubble downside, too: how on Earth can young people afford to live on the coasts (other than to use a zero-down, negative-amortization option adjustable-rate mortgages)? How did the tulip bubble help anyone?

washingtonpost.com: Tulip mania

Daniel Gross: Hi Rochester — thanks for your question. I'm with you on the Tulips. Nobody benefited from that (except for economic historians who received a subject they could discuss for years.) I'd urge you to read the book for a fuller explanation. But in a nutshell, I'd say this.

Not all bubbles are great for the economy. It's only those that result in the creation of a new commercial or mental infrastructure that can then serve as a platform for other businesspeople.

In the U.S., unlike in Europe, the government doesn't build new commercial infrastructures. The state didn't roll out the telegraph, or the railroad, or the Internet, or an ethanol industry. Instead, the private sector did it. And frequently, when the private sector seizes on a hot new idea, a bubble follows. Bubbles can be good for a couple of reasons. First, they result in the rapid roll-out of new technologies. The U.S. got wired for telegraph, and railroad, and Internet as a result of bubbles. Without the lure of quick riches, investors wouldn't have piled in the way they did, and created competing companies that bashed each others brains in and cut prices furiously to lure in new users.

bubbles also result in what I call "mental infrastructure." By that I mean that during bubbles lots of money is spent on hype and promotion. Think back to the 1990s, when dot-coms spent so much money and ran businesses on negative margins to get people to buy stocks or books or airline tickets on line. A lot of the pioneers lost money and went bust. But they left behind a wired population that was accustomed to buying stuff online. What that meant was that someone who came along in 2002 with a new idea for doing business online (blogs, selling advertisements, a video site, whatever) they could tap into this cheap physical infrastructure and a huge installed base of potential customers.

Regarding housing: it's always nearly impossible to see the upside of a bubble after it pops. Back in 2001 or 2002, nobody could have foreseen that Google would be a $150 billion company by May 2007. The fact is that we just don't know what upsides may come about.

Finally, re: all the people priced out of the coasts. one of the things we have seen in recent years, as a result of the bubble and challenge of affordability on the coasts, is more people moving inland--leaving California for cheaper housing in Utah or Missouri, or leaving New York for Philadelphia. For areas that have been losing population (like upstate New York), really expensive housing on the coasts may prove to be a lure for young people to move there.