THINKING THINGS OVER
What's a 'Bubble' Anyway?
Don't use terminology in lieu of analysis.
BY ROBERT L. BARTLEY
Monday, August 5, 2002 12:01 a.m. EDT
"At the time of writing, the theoretical literature has yet to converge on an agreed definition of bubbles, and on whether they are possible."
So instructs the entry on "bubbles" in the elaborate economic encyclopedia, "The New Palgrave." The entry was signed by Charles P. Kindleberger, the profession's high priest of bubbles, or at least of "Manias, Panics and Crashes," the title of one of his books now selling well in the boom-and-bust stock market.
While a grand old gentleman who'd never neglect an opposing view, Mr. Kindleberger of course believes in bubbles. From time to time and place to place, he and friends argue, markets are seized by an irrationality that pushes prices to levels that must end in spectacular collapse and often systemic financial distress. In particular, the villain is speculation, or buying for no good purpose but in the hope of selling to a bigger fool.
The opposing school of economists preaches "efficient markets." Its members argue that capital markets are huge information-processing machines, and prices rationally reflect more information than any one human mind can comprehend. If markets are irrational, how come no one systematically beats them?
I've always been leery about words such as bubble, panic and crash. For one thing, I admit, I've been a partisan of efficient markets. Of course it's hard to claim that the 30 Dow Jones stocks change in fundamental value by 25% in seven months or as much as 6.7% in a day, to take recent changes in market cap. Even so, over the years I've found rational markets a useful first assumption, especially so in the instructive question, "What is the market telling us?"
More importantly, capitalist economies have been a spectacular success. With their decentralized decision-making, they have an uncanny knack of directing capital into businesses of the future. Momentary overinvestment in optical cable or telecom is a small price to pay. Markets could scarcely achieve what they clearly have if they were directed by nothing more than passing fads or the delusions of crowds.
The Kindleberger manias book has an instructive paragraph "There can be no doubt that rationality in markets in the long run is a useful hypothesis. It is a 'pregnant' hypothesis, to use the terminology of Karl Popper, one that illuminates understanding. The world more or less acts as if men were rational in the long run, and we should analyze economic affairs as if the hypothesis holds."
My second reason for leeriness about words such as "bubble" or "crash" is that they're so often used in lieu of analysis. They're typically invoked to explain sharp market movements we don't yet understand. In particular, no serious economist any longer believes that the "speculation" of the 1920s caused the depression of the 1930s. Yes, perhaps in 1929 the market was due for a correction and the real economy for a standard recession, but the Great Depression was caused by policy errors: Mishandling of monetary policy both domestic and international, tariffs cutting off trade and tax increases in the midst of a downturn.
Our recent experience is almost uniformly called a "bubble," now burst. It is entirely conceivable that further analysis will again find real macroeconomic causes. To some, indeed, the word "bubble" is almost synonymous with mistakes in monetary policy. This needs further debate and analysis on another day.
If what we've experienced, though, was a spontaneous episode of speculation and societal euphoria, the script would run something like this: Investors large and small were bedazzled by the promise of new technology. All of the things they imagined will happen, but the future did not dawn as soon as they expected. A sharp correction became inevitable, accentuated by internal imperfections such as slack accounting standards, abuse of stock options and so on.
Notably, too, the euphoria took place in a moral climate of what you can get away with. The climate of the "Clinton bubble" was well established before anyone heard the name Monica Lewinsky. Unlike the beleaguered folks at Harken Energy or Halliburton, the Clintons' Arkansas business partners went to jail. Why shouldn't Jeff Skilling or Andy Fastow seize their main chance when they saw it? After all, Mrs. Clinton parlayed her $100,000 cattle-futures killing into a seat in the U.S. Senate.
When "bubble" turned to "crash," predictably, real skullduggery was discovered. Some of the alleged culprits are just now being charged, after months of denigration of businessmen as a class by both Democrats in Congress and Republicans in the administration.
The current stock market downturn, indeed, bears a remarkable resemblance to the market dive of 1962. Just when stocks were already sliding, the Kennedy administration set out to control inflation by browbeating the steel companies to rescind a price increase. After a U.S. Steel press conference, the FBI even called newspaper reporters in the middle of the night; ours told them to read it in the paper. Then President Kennedy was quoted as saying, "My father always told me that all businessmen were sons of bitches."
As this climate spread, label pins read "SOB Club" and bumper stickers said, "I miss Ike--Hell, I even miss Harry." The market fell 28% over seven months, despite an economy that was growing, albeit at a disappointing rate.
The administration responded with a "take a businessman to lunch" campaign. By December, President Kennedy was addressing the Economic Club of New York, talking about reversing "burdens to private initiative," in particular a tax system that works to "reduce the financial incentives for personal investment, effort and risk-taking."
The 1962 market recovered without a recession, and the germ was laid for the Kennedy supply-side tax cut passed two years later. The 2002 market looks for similar reassurance. But JFK listened to what the market was telling him; he didn't dismiss it with the words "panic" or "bubble."
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Mr. Bartley is editor of The Wall Street Journal. His column appears Mondays in the Journal and on OpinionJournal.com
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