Moon of Alabama Brecht quote
February 21, 2008

The Next Bubble - Where?

Where will the next economic bubble evolve?

I have long argued that basic materials and commodities, including agricultural products and energy will lead to a financial bubble. With record pricies in these areas we can already see it forming but are not yet in zones of parabolic price rises and a speculative build up of overcapacities.

In a Harper's piece Eric Janszen, a longtime venture capitalist, is trying to answer the question too and finds a different though related market where a bubble might evolve.

Janszen starts off with a good overview of U.S. monetary history and concludes that a big change happend when the Bretton Woods system ended with Nixon taking the dollar off 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.

The FIRE system became an end in itself that creates bubble after bubble to keep going.

Janszen then explains how the Internet stock bubble evolved, exploded, and the tech stocks markets deflated back to their longterm historic trendlines.

The need for a new bubble arose and, as the conditions were already in place, it evolved around housing. Janszen applies the same parameters to the housing bubble he observed during the Internet bubble bust. According to his calculations a reverse to the historic trendline in housing requires prices to drop 38% from their peak, will take about 6 years and will reflect a loss of $12 trillion in nominal value.

Now a new bubble is urgently needed. It will appear in a certain market only when several preconditions are in place:

We have learned that the industry in any given bubble must support hundreds or thousands of separate firms financed by not billions but trillions of dollars in new securities that Wall Street will create and sell. Like housing in the late 1990s, this sector of the economy must already be formed and growing even as the previous bubble deflates. For those investing in that sector, legislation guaranteeing favorable tax treatment, along with other protections and advantages for investors, should already be in place or under review. Finally, the industry must be popular, its name on the lips of government policymakers and journalists. It should be familiar to those who watch television news or read newspapers.

Janszen believes that especially one theme currently fullfills these preconditions - alternative energy (he includes advanced nuclear energy).

The criterias for a boom of alternative energy which can easily evolve into a bubble are mostly fullfilled:

  • it is a huge potential market that can absorb lots of real (and speculative) money
  • it has been growing for a while
  • there is already legislation favoring alternative energy with more underway
  • it is a very popular theme (Al Gore ...)

Janszen calculates that the basic industry and the infrastructure needed for a full alternative energy boom will have a gross market value of about $2 trillion. Using numbers from the past two bubbles he calcualtes that bubble premiums and financial dervatives formed around the alternative energy theme will reach a fictitious value of $12 trillion. The infrastructure development industry coming with the alternative energy wave will create another $8 trillion bubble for a total of $20 trillion in speculative wealth.

Eventually the bubble will pop and the $20 trillion will vanish.

I find Janszen's argument plausible. There is a huge worldwide demand for alternative energy. A new solar industry based on chip technology is developing in Silicon Valley and a lot of research into the alternative energy theme has already created several new nascent product lines: wind-, solar-, seawave-, bio- and geothermal power generation.

A boom in alternative energy is certainly coming and it might well evolve beyond that.

This does not exclude the bubble I expect in commodities, it rather enforces it. Alternative energy will be decentralized and requires a different electricity network than is available today. Windenergy generators need a lot of copper and use steel for their towers. To build a significant amount of alternative energy installation a lot of raw materials will be needed.

But there is a big question so far left out of the discussion:

If the current credit bubble busts leads to real systemic problems in the financial system, will it recreate itself in the same form, or will it evolve totally different and less bubble prone?

If the bust becomes too severe, will legislators step in with new regulation preventing some bubble-behaviour? Will the bust change global market relations? A China financed bubble in U.S. markets, like the currently busting housing bubble, would then be more unlikely. Where then would the money come from?

The current assumption is that the U.S. is diving into a recession and will eventually inflate itself out of it. That would support the above scenarios of new bubbles in alternative energy and commodities.

But a recession is not the worst possible case and if a depression evolves much deeper system changes may be needed and eventually be found. Those could preclude all bubbles for a while.

Posted by b on February 21, 2008 at 11:36 AM | Permalink


Can't see it. An alternative energy bubble of necessity means an general energy bubble. That's not like tech stocks or McMansions, an energy bubble would detonate pretty quickly, I'd guess.

Posted by: Tim H. | Feb 21, 2008 2:15:41 PM | 1

b-, would you do occasional posts to keep us up to speed on what's happening in Germany? Spiegel has art. up now claiming state owned banks on verge of collapse. German State-Owned Banks on Verge of Collapse - WORST FINANCIAL CRISIS SINCE 1931? Author writes from right-wing perspective claiming that's what happens when you don't have competition...guess he's never heard of Ameican banks.

Posted by: jj | Feb 21, 2008 2:26:20 PM | 2

[spam deleted - b.]

Posted by: Ron Holland | Feb 21, 2008 2:32:40 PM | 3

Can't see it. An alternative energy bubble of necessity means an general energy bubble.

Not quite right Tim: An alternative energy bubble of necessity means an general energy bubble.

There is a difference between a boom and a bubble.

A boom is real investment at a high price level, a bubble is financial speculation on a "never-ending" boom.

A boom in alt-energy does indeed require a boom in energy-prices. Oil at $100+ - a year ago it was at $65 - is a boom. It is an incentive to build alternative energy causing a boom in alt-en industries. It's only starting now. Three years from now $200/barrel may look cheep, really cheep.

But a bubble in alt-energy doesn't require a bubble in energy. It only requires a boom in energy prices to start. We are getting that now.

It will be hard to say when the alt-en boom turns into a bubble but a significant sign will be the creation of financial derivative products (high leverages) based on the alt-en boom.

An overheating bubble in alt-energy can be launched by a disconnect from a boom in real value, i.e. real energy prices. Exactly what happened with internet stocks and housing.

Put into concrete: In a boom people will invest into additional, too expensive, energy mills even after demand has become less than existing sources. A lot of "internet"-fiber was digged into the ground a while ago and capacity use is still below 20%.

The bubble may happen through public hype, appropriate tax laws and weird allocation of a surpluss of money (thanks to the fed for that).

Other questions to your positin:
Why would an energy bubble detonate pretty quick? What measures do we have to prevent/counter a scarcety strategy (OPEC countries tightening supplies)?

Posted by: b | Feb 21, 2008 3:05:25 PM | 4

@jj - 2 - I personally know the writer of that piece - a know-nothing libertarian amateur - sorry, can't be more favorable about Wolfgang. He argues against $x00k CEO payments for stae owned banks while justifying $x0,000k CEO payments for private banks - doesn't make sense to me.

That said - the banking authority to oversight these state backed banks clearly failed, because politics didn't give it the needed backing. Taxpayers will bleed for it.

But I still believe Germans will bleed less than UK and US taxpayers. (Northern Rock has $100 billions of liabilities and wait until Citibank reveals it real problems and the U.S. administration will have to take over.)

So don't panic - this is a systemic prices that will hit around the globe. Some "sweet spots" will be in resource countries ...

Posted by: b | Feb 21, 2008 3:23:49 PM | 5

Great subject.

Its my belief a large alt energy bubble would take a long time to form. There is a bubble in oil now. I've talked to many commodities traders that believe oil should be 50-70 dollars a barrel. I have a friend in the Michigan Public Service Commission and he said the oil giants are taking advantage of Bush being in office and stealing while they can. Oil sands can be produced for $11 per barrel, Bakersfield stripper well oil for $17 a barrel. $100 barrel oil is pure speculation.

The speculation in alt energy will come from selling carbon credits. There is a market in that now, but with more alt energy you see more speculation. Currently companies that run coal plants buy credits from say wood fired plants. Because wood is considered renewable you can offset your carbon footprint. Speculators will find a way to package these credits and make money pushing up the cost and at the same time pushing up the cost of alt energy.

Housing will have to come back. The millennial generation are 70 million strong and they'll need housing. The oldest are about 25 and the youngest about eight. And, more land isn't being created.

I also find it interesting Bush is in Africa where oil well drilling is being done on a massive scale.

Posted by: jdp | Feb 21, 2008 6:44:54 PM | 6

Has oil gone up all that much, or has the dollar gone down? After all, priced in Euros oil's rise is substantial but much less dramatic. Priced in gold, platinum, silver or even copper, oil has hardly gone up at all. An ounce of gold would have bought you 10 barrels of oil in 2001. Today it would still get you about 9.

Granted, a weakening dollar causes speculation n commodities as well as a real relative increase in their dollar price.

Posted by: Lysander | Feb 21, 2008 9:38:56 PM | 7

For an alt energy bubble to form there is still one element missing. Some sort of credible linkage from Wall St to the alt energy companies/resources. At the moment alot of the basic financial, legal and government policy infrastructure is surely missing in the US because of Republican anti-global warming ideology. All that stuff exists in Europe but how can Wall St develop all the crazy financial schemes to make a buck out it in a European regulatory environment? They need their own paid politicians making the rules for it to work. No doubt Obama will begin copying Europe soon but it will still take years for it to be something substantial. It will be very interesting to see if Wall St tries to hurry him and Democrats up so they can get a piece of an alt energy bubble.

Posted by: swio | Feb 21, 2008 11:50:41 PM | 8

"Green energy" will be the next bubble. "Green energy" and "carbon credits". To make it a bubble, they pimp up the price of oil, which all economic analysis says should be at $55 - $65 a barrel right now. The $102 is pure speculation, just as the bubble in gold behind the supposed USD devaluation, and supposed "imminent banking crash".

So the suckers will buy methanol stocks, green power stocks and a kaboodle of gold, then imminent US recession and post 2008 China Olympics loss of face and derivative meltdown in EU will flatten energy demand. Investors will hit a classic air pocket.
Big methanol projects will be announced, but never come online. Farmers will plow under field corn and soy. Windmills will falter and stop, unmaintained. Solar panels will point aimlessly, dust-covered and windblown shattered. Carbon credits will be shown to be vastly overvalued, and vastly derivatized, leveraging the big meltdown.

Then 150,000,000 sucker investors on Wall Street will wail, why me, oh Lord, why me?!
But 25,000,000 Americans won't know it happened. That's our current homeless!
Life goes on. Help others. Kill your TV. The Internet is Big Brother. Time to try!

Posted by: Wai Lapeng | Feb 22, 2008 12:17:10 AM | 9

Lysander makes a good point, except that in the climate of a falling dollar, the value of a prime commodity, real estate, is also falling, instead of rising. I'm not sure what that means. Do I sell my house to protect my equity, or if I do will the money preserved itself become worthless? Maybe I should sell my house and buy another one. Or is that stagflation? In which case its on to the (not running but towable) Winnebago.

Posted by: anna missed | Feb 22, 2008 3:16:10 AM | 10

Renewable energy has different definitions in different places.

Wind. Waves. Rivers, dams. -Hydraulic. Wood. Ethanol or more generally bio-fuels made from biomass, that is most often cultivated, irrigated, mechanically harvested grains, plants. Animal detritus is not in the numbers.

Solar, in various forms.

All hyped, adopted, but they also have very bad press. E.g. ethanol from corn; wind farms which require massive investments; solar (of one type or another) which may furnish a very poor EROEI (energy returned on energy invested), or have long return times, not known at present.

Certainly many initiatives, improvements on what is known, etc. are worthwhile and should be explored, set up, tested, measured.

The punch of oil cannot be compared to all these dodgy sidelines which are energetically speaking hopeless, or frills that rich countries can afford at loss to get brownie points, kudos, positions at the UN, tourist revenue, etc.

Renewables are supported by the PTB because they seem reassuring alternatives, a way out. A way of distributing income (subsidies to some voters.) Taking over parts of the ME after WW1, to the 2003 the invasion and control of Iraq, is a long story, All of it based on the need, the absolute and desperate need, to control oil at any cost.

Investors, I think, won’t be suckered into this scene. It has already sprouted, gargled, failed.

Maybe we will see the end of these ‘bubbles’.

Posted by: Tangerine | Feb 22, 2008 3:15:58 PM | 11

It's not just the listed value of an index of stocks going up or down, it's trade
volume going up and down, it's alpha chasing alpha around the world at 1670 km/hr,
and all of that momentum-played, and pension-fund parsed, and covered and hedged.
The faster than inflation (growth of money supply) grows, or accelerates, the more
markets will churn, and bubble, and occasionally blow soot and ash to 20,000 feet.
Nobody makes money when the markets are flat, except the brokers and the bankers.
Those flats, "dwell points", will grow increasingly brief, and the rate of decline
or ascent increasingly steep, and the "blink time" increasingly short. Think of a
giant pachinko game, ball rattling down through the pins, and each pin hit sets off
a roulette wheel, and as each roulette ball orbits around waiting to drop, a million
bettors are crowded around a virtual table, screaming Red Five! Red Five! Red Five!
Need visual? It's gonna be alright Nicky.

Posted by: Delbert Keys | Feb 23, 2008 2:08:27 AM | 12

The comments to this entry are closed.