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Bubbles are like hurricanes, tearing through the economy

“Those are said to be the most expensive words in the English language, by the way: it’s different this time. You can’t have a bubble without good explanations for why it’s different this time. If everyone knew that this time wasn’t different, the market would stop going up. But the future is always uncertain—and amid uncertainty, all sorts of faith-based theories can flourish, even on Wall Street.
In the 1920s, the “differences” were said to be the miraculous new technologies (phones, cars, planes) that would speed the economy… In the tech bubble of the 1990s, the differences were low interest rates, low inflation, a government budget surplus, the Internet revolution…In the housing bubble, they were low interest rates, population growth, new mortgage products, a new ownership society, and, of course, the fact that “they aren’t making any more land.”
In hindsight, it’s obvious that all these differences were bogus…

Henry Blodget, The Atlantic (December 2008)

An interesting chap, Henry Blodget. You may recall the name for all the wrong reasons. Blodget was a famous analyst at Merrill Lynch in the 1990s, and one of the chief cheerleaders for the ‘dot-com’ stockmarket boom. He bet on the right side of the market throughout the boom, backing new companies like Yahoo! and Amazon, and gaining great fame in the process. Until it all ended in tears, when the internet bubble burst and Blodget’s clients lost their shirts. He was even accused of conflicts of interest, of currying favour with companies whose stocks he promoted.

But Blodget picked himself up, and these days is a respected analyst again, running his own widely followed blog. He was invited by The Atlantic to write about the housing bubble, for what man has more personal experience of bubbles and how they inflate and burst? His article made for very interesting reading.

Blodget tells us something stark: that we may learn nothing from this bubble, just as we learned nothing from the previous ones. And so more bubbles will inflate in the future, and they will certainly burst all over us. This is a sobering claim: how can it be that so many intelligent people run a system that is so prone to boom-and-bust cycles?

For one thing, as highlighted in the excerpt, we will always convince ourselves that “It’s different this time”. Our need to believe in miracles and feel-good stories and positive thinking is infectious: once a boom picks up pace, we are all prone to delusion. We know this to be true in Kenya: we have always had very pronounced boom-and-bust economic cycles in this country, but every time a boom starts, we think: “This is the big one”; that we are on the way to unending rapid growth. Certainly, we were gripped by economic hubris from 2003 all the way to 2008, until the fault-lines in our society re-emerged to graphic effect.

Secondly, bubbles are caused by naked self-interest. We are all participants in bubbles, because we all hope to join in the gains. So we cannot just lay the housing-and-credit bust at the feet of realtors and banks – ordinary people were rushing in to buy things they could never afford, simply because they didn’t want to be left out of the party. NSE during the past few years, anyone? The same thing was happening there: ordinary people deluding themselves that stocks can only go up.

Blodget advises that we do not worry unduly: “Bubbles are to free-market capitalism as hurricanes are to weather: regular, natural, and unavoidable.” And they do have a cleansing effect: once the frenzy is over and pain is felt, some degree of reason does reappear. The best thing we can all do is learn the painful lessons that bubbles are there to teach us.

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