“Bubbles” are good? Sorry, Gross is moronic

Slate’s Daniel Gross claims bubbles, like the housing bubble, are invariably good for the economy.

Now, without dismantling him point-by-point, let me comment on one or two things.

First, he says:

Bubbles get started when entrepreneurs latch onto new technologies, or new economic assumptions (or both).

Nonsense. The real-estate bubble was started by, in essence, speculative lending. Nothing new there. It was enhanced by finding a way to package junk-bond money making into a new package through collateralization of subprime loans. Not much new there.

Second, he claims:

And because Americans process failure quickly, the infrastructure swiftly morphs into a cheap, pervasive, and powerful platform for other entrepreneurs—who then launch businesses and innovations that benefit the economy at large.

Well, he is assuming that they also always process failure correctly. And that’s not a given.

Third, he overlooks that we may be in a worldwide bubble right now.

Jeremy Grantham notes:

everyone, everywhere is reinforcing one another. Wherever you travel you will hear it confirmed that “they don’t make any more land,” and that “with these growth rates and low interest rates, equity markets must keep rising,” and “private equity will continue to drive the markets.” To say the least, there has never ever been anything like the uniformity of this reinforcement.

With this as the set of talking points of focus:

1. Global fundamental economic conditions are nearly perfect and have been for some time.

2. Availability of global credit is generous and cheap and has been for some time.

3. Animal spirits and optimism are therefore high and feed on themselves through reinforcing results and through being universally shared.

4. All global assets reflect this and are overpriced and show, probably for the fi rst time, a negative return to risk taking.

5. The correlation in global economic fundamentals is at a new high, refl ected in the steadily increasing correlation in asset price movements.

6. Global credit is more extended and more complicated than ever before so that no one is sure where all the increased risk has ended up.

7. Every bubble has always burst.

8. The bursting of the bubble will be across all countries and all assets, with the probable exception of high grade bonds. Risk premiums in particular will widen. Since no similar global event has occurred before, the stresses to the system are likely to be unexpected. All of this is likely to depress confidence and lower economic activity.

9. Naturally the Fed and Fed equivalents overseas will move to contain the economic damage as the Fed did last time after the 2000 break. But the heart of the last bubble, the NASDAQ and internet stocks, still declined by almost 80 percent and 90 percent, respectively. (The heart of the bubble this time is probably private equity. In 10 years, it may well be described as the private equity bubble just as 2000 is thought of as the internet bubble. You heard it here first!)

10. What is wrong with this logic? Something I hope.

11. Of course the tricky bit, as always, is timing. Most bubbles, like internet stocks and Japanese land, go through an exponential phase before breaking, usually short in time but dramatic in extent. My colleagues suggest that this global bubble has not yet had this phase and perhaps they are right. (A surge in money flowing into private equity might cause just such a hyperbolic phase.) In which case, pessimists or conservatives will take considerably more pain. Again?!

Now, he does console us with the idea that some catalysts for change may more gently deflate bubbles than savagely bursting them. Let us hope.