The Price of Everything - Eduardo Porter [111]
Still, it’s hard to know what to do about bubbles, even when we know they are going to pop up time and again. The cycle of investment surge and bust can bankrupt many investors but can also do good along the way. Investment booms built upon technological breakthroughs like electricity, railways, or the Internet ultimately revolutionized the world economy—fueling surges of productivity that could—at least temporarily—justify the exuberance.
The long-standing American approach, shared by the chairman of the Federal Reserve, Ben Bernanke, as well as his predecessor, Alan Greenspan, has been that bubbles should be dealt with only after the fact. The Fed should be ready to pick up the pieces after they burst—flooding the economy with cheap money to encourage lending and help debtors avoid bankruptcy as the value of their assets deflates. But the government should do nothing to the bubbles themselves. Their point is that we can’t tell when a bubble is a bubble.
This, to critics, sounds as crazy as a bout of euphoric investment in single-family homes. Why not lean against a bubble by gradually raising interest rates and cutting the flow of money into the new investment before things get out of hand? Allowing it to grow will ensure that the fallout from its implosion will be that much more painful. Yet while this seems clear-cut after the collapse of the housing bubble has sent us careening to the edge of another Great Depression, it’s not quite as easy to figure out beforehand what to prick and when to prick it.
Economists still debate whether Greenspan was wrong to have kept interest rates low to boost employment as the United States emerged from recession from 2001 to 2003. Raising interest rates would have taken the air out of the incipient housing bubble, but it would have also slowed the economy, lengthening the recession and boosting unemployment. Had housing growth stalled, lots of construction-sector jobs—which provided a livelihood for many workers—wouldn’t have existed. “Whenever in the future the US finds itself in a situation like 2003, should it try to keep the economy near full employment even at some risk of a developing bubble?” wondered the economic historian J. Bradford Delong. “I am genuinely unsure as to which side I come down on in this debate.”
Beyond the immediate impact on aggregate employment, what would happen with innovation if every time investors swooped upon a new technology the emergent bubbles were preemptively pricked? Big jumps in asset prices can lead to misallocated investments that squander productive resources. Bubbles generate enormous economic volatility as they inflate and burst. The damage is always most acute among the most vulnerable, who lose their jobs, lose their houses, and lose control over their lives. But speculation can also increase investment in risky ventures, which often yields benefits to society. The Internet is no bad thing to have.
In 1922 James Edward Meeker, the economist of the New York Stock Exchange, wrote: “Of all the peoples in history the American people can least afford to condemn speculation in those broad sweeping strokes so beloved of the professional reformer. The discovery of America was made possible by a loan based on the collateral of Queen Isabella’s crown jewels, and at interest, beside which even the call rates of 1919-1920 look coy and bashful. Financing an unknown foreigner to sail the unknown deep in three cockleshell boats in the hope of discovering a mythical Zipangu cannot, by the wildest exercise of language be called a ‘conservative investment.’” What’s more, whatever we do to prevent financial turmoil, we must acknowledge an important limitation: we are unlikely to stamp out bubbles and crashes entirely.
Financial crises spawned by investment surges, credit booms, and asset bubbles appear to be a standard feature of the landscape of capitalism. Economists Carmen Reinhart and Kenneth Rogoff found that of the