Friday, December 26, 2008

Bubbles, Tiny and Other

It's difficult to know in advance where a credit-induced bubble is going to occur.  Recently we've lived through the "dot.com" bubble and then, most-recently, the real estate bubble, both of which inevitably burst.  Each bubble involved both a certain suspension-of-common-sense mania and easy credit from the central bank.  The dot.com bubble was based on the belief in a new era of information where the old rules of investing didn't apply, a hot dot.com needn't even have a revenue stream to say nothing of profits.  The dot.com bubble burst finally and was rather quickly handled by the market.  The companies were often ephemeral and hence just vanished.  The foolish were punished and rest got on with their lives.  

The recent real estate bubble bursting and liquidation, real estate being much more "real" than a dot.com, is much more complicated.  Aggressively acting to increase rates of home ownership has been explicit government policy since the Clinton Administration.  Post-911, Greenspan pushed interest rates to 1%, funding a frenzy of real estate activity.  The government also guaranteed the risky assets created by bundling "creative" mortgages into securities; greed can get out of hand when the risk of loss is thus eliminated.  Both mortgage companies and borrowers believed that no matter how impractical a mortgage arrangement was, ever increasing house prices would save their skin--the house could just be sold to the next, greater fool.  

Left alone, the now-burst real estate bubble would liquidate and house prices would return to sane levels.  The pain would be intense, like pulling out an arrow, but soon the bleeding would be stopped and recovery could begin.  The official government policy is, however, to leave the arrow in place and hope the body can get along with it.  The body is rejecting the arrow and may continue in a sickly way for some time.  

Rather than biting the bullet, we are likely to see the attempt to create a new bubble of false prosperity, fueled by easy money provided by the infrastructure plan of the incoming Obama Administration.  Investors do not make government policy; to make profits they often must pay close attention to it.  Already the talking heads on CNBC are speculating on where the next boom will be.  Many are looking to companies likely to get a boost from the coming infrastructure building frenzy.  This frenzy may create a surge of economic activity that some may mistake for a recovery.  Don't be fooled.

The great infrastructure boom can only be sustained as long as money continues to pour in, which can't continue indefinitely.  What will follow in its wake?  A great bust, as capital will have been misallocated to industries which do not have long term viability.  Infrastructure capital is not likely to be easily convertable into other profitable arenas.  Further, ventures that could have been sustained will be starved for resources, those having been focused on the infrastructure boom.  In the end, we will have an economy with gross malinvestments that will create more economic pain as they are liquidated.

Will the infrastructure projects themselves induce a new round of prosperity?  Not likely.  Projects chosen by politicians rather than capitalists have a poor track record in this regard.  We are likely to see numerous TV news shows about the utterly useless projects left in the wake of Obama's infrastructure plan.

What do we need instead of a new infrastructure bubble?  It's just dream but, capitalism would be nice, complete with bank failures, business bankruptcies, sound money, and all of the other things that keep the potentially crazy sane and the greedy cautious.  We certainly don't need an "Obamania" induced infrastructure bubble.


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