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A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. A year after the bubble collapsed, of course, the market was flooded with such hard assets.Deregulation had built the church, and seed money was needed to grow the flock. Actual market value from “Federal Reserve Flow of Funds Accounts of the United States.” Historical trend from Robert J. After 1975, the United States will never again post an annual merchandise trade surplus. After several years of recession, the affected industry will eventually grow back, but slowly—the NASDAQ, for example, at 5,048 in March 2000, had recovered only half of its peak value going into 2007. After World War I, Wall Street wrote checks to finance new companies that were trying to turn wartime inventions, such as refrigeration and radio, into consumer products. All that was needed for hypergrowth was a supply of new capital. As FIRE rose in power, so did a new generation of politicians, bankers, economists, and journalists willing to invent creative justifications for the system, as well as for the projects— ranging from the housing bubble to the Iraq war— that it financed. As more and more loans with a high risk of default were made from the late 1990s to the summer of 2007, the shared level of credit risk increased throughout the global financial system.Think of that enormous risk as ecomonic poison. As the Yale economist Robert Shiller has pointed out, since 1890, discounting the housing boom after World War II, that rate has been about 3.3 percent. At first, Internet startups were merely one part of a spectrum of enterprise-software and other technology industries into which venture capitalists put their money. At the bubble’s peak, $12 trillion in fictitious value had been created, a sum greater even than the national debt.Total market value: Real estate. At the state and local levels, related bills have been passed or are under consideration.Supporting this alternative-energy bubble will be a boom in infrastructure—transportation and communications systems, water, and power. Banks failed, credit contracted, and GDP shrank. Because all asset hyperinflations revert to the mean, we can expect housing
prices to decline roughly 38 percent from their peak as they return to something closer to the historical rate of monetary inflation. Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that will prevent subsequent occurrences. But by the second quarter of 1971, the U.S. But if you owe the banks $10 trillion, you own the banks.The FIRE sector’s power grew unchecked as the old manufacturing economy declined. But it was World War II that brought real recovery, as a highly effective, demand-generating, deficit-and-debt-financed public-works project for the United States. By 1995, the Internet had been thrown open to the profiteers; four years later a sales-tax moratorium was issued, opening the floodgates for e-commerce. Changes in the reserve requirements of U.S. Demand skyrocketed, though home builders will need years to gear up their production.With more credit available than there was housing stock,
prices predictably, and rapidly, rose. Economist John Maynard Keynes emerged as the pied piper of a new school of economics that promised continuous economic growth without end. Estimated fictitious value of next bubble compared with previous bubbles The candidates for the 2008 presidential election, notably Obama, Clinton, Romney, and McCain, now invoke “energy security” in their stump speeches and on their websites. Even after the faith that supported a bubble recedes, false beliefs continue to obscure cause and effect as the crisis unfolds.Consider the chemical industry of forty years ago, back when such pollutants as PCBs were dumped into the air and water with little or no regulation. Even more of this pollution will become manifest as home
prices continue to fall.The metaphor is not lost on those touched by debt pollution. Finally, the industry must be popular, its name on the lips of government policymakers and journalists. FIRE, meanwhile, will already be engineering its next opportunity. Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation. For the Internet, the seed money came from venture capital. For the next sixty years, that chastened generation managed to keep the fog of false hopes and bad credit at bay. For those investing in that sector, legislation guaranteeing favorable tax treatment, along with other protections and advantages for investors, should already be in place or under review. For years, the mantra of the industry was “the solution to pollution is dilution.” Mixing toxins with vast quantities of air and water was supposed to neutralize them. Government stood back—after all, there was little incentive for lawmakers to intervene. Historically, the
price of American homes has risen at a rate similar to the annual rate of inflation. How you consider, who will win elections in Unated States of America?Joe Vittale: bobcat tractorBen: The United Arab Emirates are building a massive state of the art eco
city from scratch, they’ll be using...What do you enjoy the most in Bulgaria? I observed otherwise rational men and women fall under the influence of a fast-flowing and, it was widely believed, risk-free flood of money. I remember a managing partner of one firm telling me with certainty that if the company in which we’d invested failed, at least it had “hard assets,” meaning the notoriously depreciation-prone computer equipment the company had received in exchange for stock. If the rate of decline stabilizes at between 6 and 7 percent each year, the correction has about six years to go before things stabilize, leaving the FIRE economy in need of $12 trillion. In 1932 this set of economic gambits was dubbed “reflation.”The first Keynesian reflation was botched. In 1999, the Glass-Steagall Act of 1933, which regulated banks and markets, was repealed, while a servile federal interest-rate policy helped move things along. In a hyperinflation, infrastructure upgrades will accelerate, with plenty of opportunity for big government contractors fleeing the declining market in Iraq. In December 2007, Chip Mason of Legg Mason, one of the world’s largest money managers, said that the U.S. In reality, credit pollutants pose the same kind of threat to our economy as chemical toxins do to our environment. In the United States, Merrill Lynch took a $7.9 billion hit from its mortgage investments and experienced its first quarterly loss since 2001; Morgan Stanley, Bear Stearns, Citigroup, along with many other U.S. In theory, risks that used to concentrate on a bank’s balance sheet had been safely spread far and wide across the financial markets among well-financed and experienced institutional investors.The U.S. In theory, those risk pollutants have been diluted in the oceanic vastness of the world’s debt markets; thanks to the magic of securitization, they are made nontoxic and so pose no systemic risk. Indeed, the next bubble is already being branded. Industry lobbyists stepped in, pushing for deregulation and special tax incentives. Inflation rose not just in the United States but around the world, grinding down the worth of many securities and brokerage firms. It should be familiar to those who watch television news or read newspapers.There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. It’s the old rule about bank debt, applied to international deficit finance: if you owe the banks $3 billion, the bank owns you. Keynes’s doctrine: When a business cycle peaks and starts its downward slide, one must increase federal spending, cuttaxes, and lower short-term interest rates to increase the money supply and expand credit. Like housing in the late 1990s, this sector of the economy must already be formed and growing even as the previous bubble deflates. Logic and historical precedent were pushed aside. Luckily, Al Gore will be making principled venture capital investments on our behalf.The next bubble must be large enough to recover the losses from the housing bubble collapse. Many decades later, with our plagues of hermaphrodite frogs, poisoned ground water, and mysterious cancers, the mistake in that logic is plain. Massive external debts built up as trade partners to the United States, especially the oil-producing nations and Japan, balanced their trade surpluses with the purchase of U.S. Members of Congress, who influence the agencies that oversee market-regulation functions, have never been unfriendly to windfall tax revenues, and the FIRE sector has very deep pockets. Members of the Bretton Woods system, most famously French President General Charles de Gaulle, worried that the United States intended to repay the money borrowed to cover its trade gap with depreciated dollars. Modern bankers, however, have carried this mistake into the world of finance. Now the Funds Rate is only 4.5 percent, the dollar is at multi-decade lows, the federal budget is in deficit, and tax cuts are still in effect. One of our companies was investigating the timing of an IPO; the management team was hoping for April 2000. Opposed to the exercise of such “exorbitant privilege,” de Gaulle demanded payment in gold. Pundits hailed a “new era” of prosperity until Black Tuesday, October 29, 1929.The crash, the Great Depression, and World War II were a brutal education for government, academia, corporate America, Wall Street, and the press. Risks are embedded in
price and lurk as defaults. Roosevelt called in gold and re
priced it, hoping to test Keynes’s theory that monetary inflation stimulates demand. Shortly thereafter, millions of investors with unrealized gains in mutual funds sold stock to raise enough cash to pay taxes on their capital gains. Skeptics were occasionally interviewed by journalists, but in general the public was exposed to constant reiterations of the one true faith. Such high-value, finished-goods-producing industries as steel and automobiles were no longer dominant. Such legislation does not cause a bubble, but no bubble has ever occurred in its absence.Total market value: NASDAQ. Such liquidity events came faster and faster. Suddenly websites were easy to create and even easier to consume. The bubble cycle has replaced the business cycle.* * *Such transformations do not take place overnight. The consumers of the rising middle class were ready to buy but lacked funds, so the banking system accommodated them with new forms of credit, notably the installment plan. The demand stimulated by deficit spending and cheap money will thereby prevent a recession. The economy was running in reverse and refused to respond to Keynesian inducements. The Energy Policy Act of 2005, a massive bill known to morning commuters for extending daylight savings time, contained provisions guaranteeing loans for alternative-energy businesses, including nuclear-power technology. The Federal Reserve pushed interest rates into double digits, setting off two global recessions, and new international standards and methods for measuring inflation and floating exchange rates were established to replace the gold standard. The future of transportation may be neither solar- nor ethanol-powered but instead rely on numerous small nuclear power plants generating electri
city and, for local transportation, hydrogen. The main event was the hyperinflation of home
prices. The mass selling set off a panic, and the bubble popped.In a bubble, fictitious value goes away when market participants lose faith in the religion—when their false beliefs are destroyed as quickly as they had been formed. The mechanics of financing vary with each bubble, but what matters is that the system be able to support astronomical flows of funds and generate trillions of dollars’ worth of new securities. The media barely questioned the fine points of the new theology. The Mosaic graphical Web browser, released in 1993, began to transform the Internet into a set of linked pages. The new boom was in McMansions on the ground—wood and nails, granite countertops. The
price-inflation process was traditional as well: there was way too much mortgage money chasing not enough housing. The representatives of one of the investment banks we talked to gave us a surprisingly specific recommendation that ran counter to advice offered by banks during the IPO-driven cycle of the preceding five years: they warned the company not to go public in April. The root of the 1920s bubble, it was believed, had been the conflicts of interest among banks and securities firms, but in the 1990s, under the leadership of Alan Greenspan at the Federal Reserve, banking and securities markets were deregulated. The Royal Bank ofScotland Group was forced to write down $3 billion on credit-related securities and leveraged loans, and Japan’s Norinchukin Bank suffered $357 million in subprime-related losses in the six months prior to September 2007. The war did what a flawed application of Keynes’s theories can not.A few weeks after D-Day, the allies met at the Mount Washington Hotel in Bretton Woods, New Hampshire, to determine the future of the international monetary system. Then a few startups like Netscape went public, netting massive returns. Then, from 2001 to 2002, in the wake of the dot-com crash, the Federal Reserve Funds Rate was reduced from 6 percent to 1.24 percent, leading to similar cuts in the London Interbank Offered Rate that banks use to set some adjustable-rate mortgage (ARM) rates. There will and must be many more such booms, for without them the economy of the United States can no longer function. These drastically lowered ARM rates meant that in the United States the monthly cost of a mortgage on a $500,000 home fell to roughly the monthly cost of a mortgage on a $250,000 home purchased two years earlier. This left in its wake a crucial dilemma: how to counter the loss of that $7 trillion in fictitious value built up during the bubble.* * *The Internet boom had been a matter of abstract electrons and monetized eyeballs—castles in the sky translated into rising share
prices. This was “exorbitant privilege” on steroids. This was the formative stage of the bubble. To be fair, it was perhaps impractical under the gold standard, for by the time the Federal Reserve made its attempt to ameliorate matters, debt was already out of control. We took the advice in the context of other indicators as a clear sign of a top, and over the next few months we liquidated stocks in public companies that we held as a result of earlier IPOs. Western economies were in ruins, and the international monetary system had been in disarray since the start of the Great Depression. Where will that money be found?* * *Bubbles are to the industries that host them what clear-cutting is to forest management. Why, then, did housing
prices suddenly begin to hyperinflate? With FIRE leading the way, the United States, free of the international gold standard’s limitations, now had great flexibility to finance its deficits with its own currency. With the balance of payments so greatly out of balance, newly elected President Richard Nixon faced a run on the U.S. Without “energy security” and repairs to our “crumbling infrastructure,” our very competitiveness is at stake. Without the efficient transit of gasoline-powered trucks laden with goods across our highways there will be no Wal-Mart, no other big-box stores, no morning FedEx deliveries.
