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.