I once met a woman from Minnesota. I asked what she thought about Global Warming. She answered, "I'm for it". At the risk of being equally controversial I want to go on the record as saying the same about bubbles. "I'm for 'em".  

It is fashionable today to claim that if we increased government controls and regulations on the financial system we will prevent the kind of crisis we have just endured from ever happening again. Saying that monetary panics and economic crises will never happen again is like saying if we reformed our legal system crime will never happen again. We know that all the laws, rules, and regulations in the world will not prevent crime.  In states where they impose the death penalty, even though we warn the potential murderer that his life will be taken if he takes another human being's life, he still kills.

We can and should impose stringent laws against fraud and theft. We should have transparent and open markets to help prevent criminal activities. Yet, those laws will not prevent the possibility of another panic or crisis. Freedom innately results in its abuse. Freedom allows things like greed and irresponsibility to exist, and no amount of legislation will wipe that away. 

Countries that try to by imposing totalitarian laws to prevent such human flaws end up doing so at the expense of not only freedom and free markets, but at the expense of prosperity. Such nations end up with "order". But it is order without growth. Cuba and North Korea are examples of such policies. They live in a gray society devoid of innovation and creativity.  Controlled societies boast of not having to endure major recessions. It's true. You need prosperity before you can have a major recession. 

Down through history, bubbles have occurred in various industries and markets. Most are accompanied by both euphoria and warnings of an inevitable crash to follow.  Bubbles are not an economic phenomenon. They are not inevitably followed by a recession nor accompanied by a boom. They generally live a life of their own. 

This was true during the telegraph bubble of the late 1800's. Many companies competed but only a couple of major companies, Western Union and AT&T survived. But communications were enhanced for everyone forever. This was also true during the railroad bubble of the 19th century, where several railroads competed for track. Land speculation ran rampant. Only a few railroads became economically viable and as a result many speculators went broke. But at the end of the day a new transportation system was built, and there was little economic impact to the nation as a whole.

During the turn of the 20th century three hundred car companies were formed as a new transportation bubble took the nation by storm. Only a handful of car companies survived, but the nation had a new industry to show for it. 

The dot com. bubble led to a major boom and bust in the NASDAQ, but did not result in either an extraordinary rise in GDP or a major recession after the bubble popped. What was left as a result however was a new technological infrastructure. While many high tech companies did not survive,the technology that was created did. The world is better off as a result of the great innovations that occurred during that period. 

We need to understand that what's good or bad for an individual is not necessarily good or bad for an economy. Bubbles are a case in point. At the end of every bubble, a certain amount of individuals and businesses become victims. These are turned into headlines and used as indictments against capitalism. What is not mentioned and only appears in economic textbooks years later is the rise in the standard of living of most citizens as a result of the bubble.

Bubbles are usually the result of the euphoria individuals feel as new technologies are introduced.  By the time these technologies are evident and all can see that a change in the world is upon them, investors and businessmen jump onto the trend. This last stage of awareness always leads to victims. The first ones in make a fortune, the last ones in get their heads handed to them. When the correction or crash ensues,  the finger pointing begins along with the inevitable cries for government bail outs and regulation of business. Much of the population is outraged and heads begin to roll. But in the last analysis, bubbles create wealth. These are periods of great productivity.

China is a perfect example. For decades it imposed a system of Communism. The result was poverty. Then they changed and began moving towards freedom and capitalism. Today you see a dynamic and growing China.  China is in the process of an industrial revolution. Their stock market has soared. Many areas of the economy may indeed be in a bubble. Ultimately, the market will correct substantially if not crash.  But what will be left are all the factories, offices, apartment buildings, businesses, and products that were produced. The infrastructure will, with some exceptions, remain. The fact is, that bubbles are good.

There are exceptions. There are bubbles created by fads such as the tulip craze, new resource discoveries such as the gold discovery in 1849, and demographic changes such as those taking place today, but these examples are few and far between in the history of bubbles.  During the two centuries of the industrial revolution and the gold standard there were many bubbles, yet, most will not be remembered in the context of one of the greatest periods of growth known to man.

The companion of bubbles is what economists call creative destruction. When old industries, like the horseshoe or buggy whip industries were displaced by the automobile industry, dislocations took place. Unemployment occurred as these old technologies were replaced by new technologies. What was seen, was your neighbor losing his long held job. This becomes another indictment against the capitalistic system. What is rarely acknowledged is the new employment by newly created industries and the resulting rise in the standard of living of all concerned. This was true as we went from covered wagons to trains, from buggies to cars, from telegraphs to telephones, and so on and so on. Capitalism always tends to create a better product for less money. 

Many are calling for a new order where we as a nation put in place a mechanism to "pop" bubbles. For myself, I say "bring 'em on". For it is with booms and bubbles that the wealth of nations are created. For the same reason that government should not try to create them they should not try to end them. Let the market reign, and let government prosecute fraud, theft, and deceit. Then let the chips fall where they may.

One last, but a very important point. The term "bubble" is often used interchangeably with the term "boom" now a days. There is a distinction. A boom refers to an entire economy "booming" where bubbles refer to singular markets events like gold or oil or housing moving up sharply.  For example, the "roaring 20's" were the result of an excessive monetary policy by the Federal Reserve Board.  We severed ourselves from the gold standard and through the newly created Federal Reserve System created excessive amounts of paper money and credit with no concern for backing or convertibility. Artificially induced booms lead to mal-investment, over-consumption, and the misallocation of resources. (For a further discussion of the folly of artificial money and credit expansion, read any of my other articles). The artificially created roaring 20's led to the great stock market bubble which led to a decade long economic boom and corresponding bust and to what we know of today as the Great Depression. This was not the case with bubbles. Where artificial booms can cause bubbles, bubbles can not cause artificial booms. Not in the economy as a whole.

The gold standard that prevailed for over two centuries limited the amount of money and credit expansion. Yet bubbles were always apart of the economic landscape.  They are apart of human nature and occur as a result of freedom.  Eliminate freedom and free markets and you will never need to worry about bubbles again.

We are about to have a debate in this country about the practicality of "popping" bubbles.  It is argued that the housing bubble should have been popped by the Federal Reserve Board.  The question is "should a bubble be popped at the possible expense of the entire economy"?

When the dot com bubble popped the NASDAQ crashed. It wiped out hundreds of businesses and investors. But unless you were directly involved you might have never noticed.  There was a very brief recession that lasted a matter of months and it was over. The same was true with the housing bubble. The housing boom did not translate into an economic boom. Growth remained steady throughout that period. The inflation rate actually declined from 6% rates in 2000 to 2 to 3% rates in 2003, 4 & 5, the heyday of the housing boom. When the housing market fell apart in 2006, it was not until late 2008 that the economy turned down and that was due to the extension and packaging of fraudulent credit instruments that the markets could not detect. Without the credit implosion the housing boom in and of itself could have come and gone with much the same effect as the technology boom and bust. (For a more extensive discussion on what caused the present credit crisis see my article, The Elephant In The Room, under "more articles" at the top of this page).

The lesson, I believe is apparent. In a diverse market economy bubbles can come and go without causing damage to the economy as a whole. What is being suggested is that the fed should raise interest rates and tighten money in order to either prevent bubbles or pop them. When you fool around with interest rates and money supply you affect the entire economy.

Should it be a matter of policy that the government engineers a possible recession causing financial pain and distress to the population at large to prevent or stop a bubble?  Is this kind of collateral damage reasonable? I think not. Bubbles are natural occurrences. As long as interest rates and the money and credit supply remain closely related to market forces, government action will be neither necessary nor helpful. We can not prevent bubbles as long as we have freedom. The key is to learn to live with them just like recessions and snow storms. They are coming.  Plan on them.

This ongoing debate about bubbles is really a debate about freedom and capitalism. There are two camps. One believes that more regulation is needed to prevent bubbles from reoccurring. The other believes that free markets should rule and that government intervention itself is the blame for past panics and crises. I'm here to make a third argument. Bubbles will occur with or without government intervention. Bubbles are part and parcel of a free capitalistic society. While I do not believe that free market capitalism will lead to Utopia, neither am I an apologist for freedom and capitalism and its history of bubbles. I accept the fact that the system is not and never will be perfect. However it is proven to be the best system the world has ever known. It has led, and is leading today all over the world, to the highest standard of living mankind has ever known.  

The next time you hear all the scary talk about the possible bubble we're in and the inevitable crash we are about to endure, heed the warning and if you
believe it is true, protect yourself. Take the necessary precautions to make sure you will not be affected if you can, and batten down the hatches for the coming storm. But be sure not to forget to count your blessings, too. Because we all benefit from the great creativity and prosperity that comes from booms, bubbles, and creative destruction.

Paul Nathan
Paulnathan.biz