This piece was written before the extent of the market depravity of the securitization trend of the first decade of this century had played out. Because of this, the thesis was overtaken by the Great Financial Crisis and never really had a chance to play out. Sure, we had the Solyndras and Fiskers and A123 batteries but the overinvestment that characterizes bubbles never really had a chance to get going.
Now we get that chance.
From Harper's February 2008:
Priming the markets for tomorrow’s next big crash
A financial bubble[1] is a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression. 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 would prevent subsequent occurrences. After the dust settled from the 1720 crash of the South Sea Bubble, for instance, British Parliament passed the Bubble Act to forbid “raising or pretending to raise a transferable stock.” For a century this law did much to prevent the formation of new speculative swellings.
Nowadays we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitiztion, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.
[1] I will use the familiar term “bubble” as a shorthand,
That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle.
but note that it confuses cause with effect. A better, if
ungainly, descriptor would be “asset-price hyperinflation”—
the huge spike in asset prices that results from a perverse
self-reinforcing belief system, a fog that clouds the judgment
of all but the most aware participants in the market. Asset
hyperinflation starts at a certain stage of market development
under just the right conditions. The bubble is the result of
that financial madness, seen only when the fog rolls away.
( 2 of 7 )Such transformations do not take place overnight. 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. 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. Following a brief recession in 1921, federal policy accommodated progress by keeping interest rates below the rate of inflation. 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. For the next sixty years, that chastened generation managed to keep the fog of false hopes and bad credit at bay. Economist John Maynard Keynes emerged as the pied piper of a new school of economics that promised continuous economic growth without end. Keynes’s doctrine: When a business cycle peaks and starts its downward slide, one must increase federal spending, cut taxes, and lower short-term interest rates to increase the money supply and expand credit. The demand stimulated by deficit spending and cheap money will thereby prevent a recession. In 1932 this set of economic gambits was dubbed “reflation.”The first Keynesian reflation was botched. 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.[2] Banks failed, credit contracted, and GDP shrank. The economy was running in reverse and refused to respond to Keynesian inducements. In 1933, President Franklin D. Roosevelt called in gold and repriced it, hoping to test Keynes’s theory that monetary inflation stimulates demand. The economy began to expand. 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. The war did what a flawed application of Keynes’s theories could 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. It wasn’t much of a negotiation. Western economies were in ruins, and the international monetary system had been in disarray since the start of the Great Depression. The United States, now the dominant economic and military power, successfully pushed to peg the currencies of member nations to the dollar and to make dollars redeemable in American gold.Americans could now spend as wisely or foolishly as our government policy decreed and, regardless of the needs of other nations holding dollars as reserves, print as many dollars as desired. But by the second quarter of 1971, the U.S. balance of merchandise trade had run up a deficit of $3.8 billion (adjusted for inflation)—an admittedly tiny sum compared with the deficit of $204 billion in the second quarter of 2007, but until that time the United States had run only surpluses. 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. Opposed to the exercise of such “exorbitant privilege,” de Gaulle demanded payment in gold. With the balance of payments so greatly out of balance, newly elected President Richard Nixon faced a run on the U.S. gold supply, and his solution was novel: unilaterally end the U.S. legal obligation to redeem dollars with gold; in other words, default.
More than a decade of economic and financial-market chaos followed, as the dollar remained the international currency but traded without an absolute measure of value. Inflation rose not just in the United States but around the world, grinding down the worth of many securities and brokerage firms. 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. After 1975, the United States would never again post an annual merchandise trade surplus. Such high-value, finished-goods-producing industries as steel and automobiles were no longer dominant. The new economy belonged to finance, insurance, and real estate—FIRE.
[2] Historians argue whether the Federal Reserve and Congress did enough soon
enough to slow the rate of debt liquidation at the time. Most agree that once
the inflation rate turned negative, monetary stimulus via short-term interest-
rate management was ineffective, since the Fed could not lower short-term rates
below zero percent. The Bank of Japan found itself in a similar predicament
sixty years later.( 3 of 7 )FIRE is a credit-financed, asset-price-inflation machine organized around one tenet: that the value of one’s assets, which used to fluctuate in response to the business cycle and the financial markets, now goes in only one direction, up, with no more than occasional short-term reversals. 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. This was “exorbitant privilege” on steroids. 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. financial assets.[3] The process of financing our deficit with private and public foreign funds became self-reinforcing, for if any of the largest holders of our debt reduced their holdings, the trade value of the dollar would fall—and with that, the value of their remaining holdings would be decreased. Worse, if not enough U.S. financial assets were purchased, the United States would be less able to finance its imports. It’s the old rule about bank debt, applied to international deficit finance: if you owe the banks $3 billion, the bank owns you. 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. 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. 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. 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. The high-water mark of such truckling might be the publication of the Cato Institute report “America’s Record Trade Deficit: A Symbol of Strength.” Freedom had become slavery; persistent deficits had become economic power.
The bubble machine often starts with a new invention or discovery. The Mosaic graphical Web browser, released in 1993, began to transform the Internet into a set of linked pages. Suddenly websites were easy to create and even easier to consume. Industry lobbyists stepped in, pushing for deregulation and special tax incentives. 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. Such legislation does not cause a bubble, but no bubble has ever occurred in its absence.
I had a front-row seat to the Internet-stock mania of the late 1990s as managing director of Osborn Capital, a “seed stage” venture-capital firm founded by Jeffrey Osborn,[4] with positions on the boards of more than half a dozen technology companies. 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. Logic and historical precedent were pushed aside. 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. 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. 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....
....MUCH MORE
Time for an electric vehicle SPAC? We're only getting started, wait 'til we securitize batteries.
As always, The Onion knows what's what. From July 14, 2008:
Recession-Plagued Nation Demands New Bubble To Invest In
And February 18, 2021:
Ford CEO Launches Electric Vehicle Push By Having Buddy Stand Watch While He Steals Battery From Parked Prius
