Tuesday, March 11, 2008

A Functionalist Theory of Bubbles

I’ve been reading Eric Janszen’s interesting piece in last month’s Harper’s, “The next Bubble: Priming the Markets for Tomorrow's Big Crash.” He compares the dot.com and housing bubbles as part of a general theory of why the US economy is so bubble-prone. Reading it is like sitting next to a caustically witty financial analyst at a bar; he’s had one too many and is shredding his life’s work, and for you it’s prime entertainment.

So what’s his theory? In a nutshell, he says that the US is now in the hands of its FIRE brigade — finance, insurance and real estate. They own the politicians and control economic policy. Bubbles are their stock in trade. These guys get rich and leave the rest of us with the tab. To save our economy from certain ruin in the wake of one bubble, we have to pump up the next one. This is how the housing bubble inflated after tech bubble popped. And where do we turn after housing goes bust? Janszen predicts alternative energy (including nuclear) as the new new new thing.

I like anyone who builds a worldview around bubblesome finance. Nevertheless, putting on my skeptical academic hat, I think he has slipped into the dangerous waters of functionalism, believing that social or economic events happen because they are needed to happen. There is a longstanding critique of such reasoning, but I’ll spare you. The point is that functionalist explanations don’t really explain. For instance, Janszen’s article doesn’t explain why some economies are more bubble-prone than others, nor does it offer a reason why efforts of insiders to inflate a new sector will necessarily succeed.

As my loyal legions know, I think there is a structural factor behind US asset price inflations during the last 15 years or so, capital account recycling. I’m hoping to get a few hours in the coming weeks to put this into its proper algebraic form. This is how we become convincing in my business. As Groucho almost said, “Who are you going to believe, my model or your own eyes?”

Speaking of quotes, I like this one by Janszen: “Since the early 1980s, the free-market orthodoxy of the Chicago School has driven policy on the upward slope of an economic boom, but we’re all Keynesians on the way down: rate cuts by the Federal Reserve, tax cuts by Congress, deficit spending, and dollar depreciation are deployed in heroic proportions.” Amen brother.


kevin quinn said...

"...or your lying eyes," n'est-ce pas? (-;

rosserjb@jmu.edu said...


It is far from obvious to me that the US is all that much more bubble-prone than other countries. The Economist has been charting housing bubbles all over the map, with a lot of other countries looking further out on limbs than the US recently. What is curious right now is the large crash going on in the US, which does not seem to have hit these others so hard, although some of the most extreme ones have slowed down. I think what is special about the US now is our greater vulnerability to crashes, and that I think relates to the problem of massive and chronic current account deficits, which gets into your capital account recycling story, a fragile reed indeed.


sootytern said...

I listened to Eric Janszen on NPR this morning and one remark caught my attention immediately. He blamed Social Security for the lack of savings in the United States. That really turned my head. Here all this time I thought Social Security was a savings program particularly for those who were unable to save during their working lives, apparently not.
Unfortunately, he did not elaborate on this idea, although he did say that China had a much higher rate of savings than the US because they could not trust their government to take care of them. In that, I am beginning to agree with him, especially with the current government hinting that the bonds in the SS Trust Fund are worthless paper.

Myrtle Blackwood said...

I'm waiting for Australia's bubble to explode.

Really high interest rates. High volatility in the Au dollar (whose value is consistently quite low), the commodities boom, housing in many cities now unaffordable, consumer confidence down. Millions of people expected to foreclose on their mortgages here. Rudd's combinations of tax cuts and interest rate hikes that benefit the lower paid workers and the rich, squeezing the middle classes.
Government suppression of embarrassing health news related to the environment, Au banks and insurers going down. High levels of private equity debt. stockmarket plummeting. Very high levels of personal debt. Clientelism, politics of privilege, State-owned corporations busy giving our natural assets away to multinational corporations. Escalating fuel and food costs.

Why spend money travelling when the world is homogenous?

rosserjb@jmu.edu said...


This story that SS is responsible for the low savings rate in the US is one of the biggest pieces of bilge that gets regularly handed around in US political-economic discourse. The main source of this baloney is Martin Feldstein, who some think deserves a Nobel, but whom I think should be taken out and put in the stocks for public humiliation and ridicule.

A quick reply? Well, there are lots of western European countries that have much more generous social security systems than the US, but also have higher savings rates, with Germany a prime example, and especially good as they have had social security in place longer than any other country in the world, beating the US by a good half a century.

Why does China have such a high savings rate? Because it is growing very rapidly. It is well known that consumption tends to adjust upwards gradually when incomes rise, so that when a country starts growing rapidly and its income levels soar, consumption lags, leading to a rising savings rate. We saw the same thing in Japan, whose savings rate is now much lower since its growth rate tailed off.


Eleanor said...

I am still wondering why savings matter. It's prudent for individuals to save, but is it necessary for the economy, especially an economy dependent on consumer spending?

The redistribution of wealth up should give the rich more money to invest, since you can buy only so many diamonds and Bentleys or whatever the rich buy now; but they seem to be investing in weird financial instruments and a speculative bubble, which doesn't seem of long-term benefit to the economy.

Corporations are investing their savings in factories in China. How does that help us here?

I would prefer an economy where people were not in debt, because personal debt strikes me as dangerous; and where investments were made in infrastructure, education, public health and so on.But it seems to me the problem is not savings, but where whatever money the nation has is spent.

Money does not naturally go to the most socially useful place; and savings aren't much help if they aren't used wisely.

Peter Dorman said...

A brief reply to Barkley:

Yes, there are housing bubbles in some parts of Europe, and bubbles of others sorts make their appearance here and there. I'm not claiming that all bubbles are the result of outsized capital inflows, but that outsized capital inflows make an economy more bubble-prone.

Agreed, the claim that SS is bad for savings is deeply misguided, factually and theoretically. I had a post about this a while ago, the one about savings mania. My view is that the US savings-less rate is principally a product, not a cause, of its current account deficit. (It also has much to do with income distribution, cultural factors, etc.)

Of course, a Keynesian would ague that dwelling on savings rather than investment is putting the cart before the horse.

juan said...

It strike me that Janszen is making a type of post-Fordist, regime of accumulation, statement: Nice, clean green regime will be substituted for the well failed Fordist, all to be financed by return seeking rentiers who, as if by script, will generate one more economy saving bubble and save the planet to boot.

No doubt capital might find the idea of commodifying and profiting from its past destructiveness appealing; no doubt Wall Street sees opportunities, but bubbles require self-fullfilling, self-generating, fuel and its just this which is process of being destroyed in what is much more than any so-called subprime crisis.

Shag from Brookline said...

This is a reminder of the good old days of vaudeville's stirring song:

"I'm forever blowing bubbles ...."

(No need to mention the follow up of the routine on a family blog.)

rosserjb@jmu.edu said...

No! Not another thread getting taken over by Eliot Spitzer jokes!