Will There Be Another Bubble?

Whether or not there will be another bubble is a key issue, in part because we needn't take actions to avoid it if it isn't likely to happen. One school of thought is that there will not be. It won't happen again—at least there will be no bubble of this magnitude, doing the damage it did, in the foreseeable future.

The argument proceeds as follows: The dot-com and telecom bubbles required the confluence of a speculative mania with a technological discontinuity. The potential for mania resides in the human psyche and will be there always, but a technological discontinuity of the magnitude of the Internet is very unlikely. What was crucial about the Internet was that it promised to transform all of the economy. Every company's board was required to think through the possible impact of the Net on its business—whether consumer goods or capital goods, or services—and government and nonprofits as well. It was absolutely pervasive. So it was a technological discontinuity of enormous proportions, and gave rise to a speculative mania otherwise unlikely.

The argument continues that no such pervasive discontinuity is likely in the years immediately ahead. For example, biotechnology, including cloning, is a very exciting new technology which provides a major discontinuity, but one impacting primarily the health services. There could be a speculative mania there, and has been to some degree already, but it won't be of the size of the dot-com/telecom bubble because it is limited to a single sector.

The argument concludes that without a technological discontinuity on the scale of the Internet, there is not likely to be another bubble of the size of the one just past, so there is no reason for doing anything to try to avoid it.

But this view isn't convincing, so that the possibility of another bubble of the magnitude of the recent one is not ruled out. In fact, ironically, the notion that the Internet was a discontinuity of such great magnitude is itself merely an illusion fostered by the hype which accompanied the bubble. To see this, we should recall the Y2K scare. In the 18 months prior to January 1, 2000, the notion developed that computers would be disabled by the shift from the 1900s to the 2000s. A few people argued against this, but others insisted on it to the point that, concerned about possible disruptions of commerce and society generally, almost all firms, the government, and nonprofits, allocated time and money to trying to prepare for a Y2K crisis. It was believed likely to affect almost all organizations and functions in the world. Airline travel was supposed to be disrupted, communications impaired, computers of all sizes caused to malfunction. Corporations built backups, bunkers, hardened rooms. The federal government at one time suggested that it had spent over $100 billion preparing for Y2K.

The Fed inflated the money supply in the fall of 1999 to cushion an expected negative impact of Y2K on the nation's economy.^[118]

And what happened? Nothing.

In retrospect it was all hysteria, in which many of the most sober officials of our society participated.

Something of a similar nature happened with respect to the Internet. That it is an important technology no one can deny. That its impact is so pervasive and substantial as the proponents of the view above assert is unlikely. But that people believed it was, and still do, and that this contributed to the bubbles, is undoubtedly true.

So what is needed to drive a bubble is not a technology of generally pervasive discontinuity, but rather one that can be made to seem of that significance. And there are likely to be many candidates for this role in the years ahead, some undoubtedly sons and daughters of the Internet. The media is continually advancing candidates for the next technological discontinuity, and as the memory of the dot-com/telecom bubble recedes, the likelihood of excitement about a new technology grows.

All the financial market players in the Internet bubble remain in place, most having prospered in the bubble just burst, even though entrepreneurs and retail investors did not. The players have the means and the incentives to repeat the bubble whenever another opportunity offers itself.

The supply and demand model of the bubble says that so much money poured into venture funds in the late 1990s that too much money chased too few good deals, causing valuations to rise enormously. Further, that when investment bankers were able to generate a public market for what had been companies at too early a stage, the venture funds hurried to supply the market with companies. One can almost hear the venture capitalists asking themselves, “If I can actually sell this thing, and I can get the capital to keep putting into other companies like this, then should I be doing it and not refusing to invest because the company looks like junk?” There seemed to be an endless supply of capital, and as long as the wheel kept spinning, everyone would be happy.

And none of this has changed. While the inflow of capital to venture funds has slackened a bit since the bubble burst, it still remains high by historical standards, and is high by the standards of what innovation now requires. So the money machine continues to spin, and the capital for another bubble is available.

The Hype Machine also remains active. The only question is, when will it again be listened to and drive share prices upward?

Here's an example. “Sometime in the next few years we will find ourselves surrounded by a pervasive, always-on network… The world is moving toward hyperconnectivity. Mobility and physical space will be the new drivers of innovation. And location awareness is the ingredient that will bind the physical world to the virtual.”^[119] It would follow that companies built to provide hyperconnectivity and location awareness would be prime candidates for investment, perhaps causing excitement, even mania, among investors about their prospects. This is how a bubble builds.

Finally, what is also needed is plenty of credit, and the Fed is supplying it. Presently, America's money supply is growing at what by key measures is the highest rate in more than 20 years, providing ample fuel for another bubble.

It follows that another bubble is a certainty. It's how financial markets today go after big opportunities. Every great move ahead is at the cost of too much money being thrown into an arena, a bubble being formed and bursting.

This is an enduring dynamic in capitalism. The scale of the recent bubble was bigger, but the dynamic is the same.

The thought has been that bubbles don't repeat. But the Internet bubble was in a real sense the second bubble for the personal computer. First there was speculation in the shares of companies that produced the machine; then there was a bubble in the technology of the Internet which connected the machines. And the second bubble was so much bigger than the first because it was really four bubbles in sequence building into one gigantic burst, as described in Chapter 2.