By Daniel
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An article from The Gardian entitled:
Like all bubbles, this will burst
Wall Street investors know they are riding a tiger, but are too afraid of losing out in the short term to jump off. Simon Caulkin looks at the nature of the beast
Sunday April 18, 1999
In 1990, the world's economic centre of gravity was Tokyo. Share and property prices were in the stratosphere, Japanese banking, electronics, automotive and steel companies were all-victorious, and the Japanese economy seemed armour-plated.
Yet the true miracle was not Japan's economy but the delusion on which it was based - a gigantic asset-price bubble whose explosion has reverberated ever since.
After almost 10 years the Japanese economy still obstinately refuses to recover from recession, and there is no flush more busted than a Japanese bank or steel firm. Economist Professor Paul Ormerod qualifies Japan's lost decade of the Nineties as 'the second most serious recession in capitalist history' after the Wall Street crash of 1929 and the Great Depression.
Ten years after Tokyo, it is the US's turn to bask in financial euphoria. It's not hard to see why. While it took the benchmark Dow Jones index 88 years from its launch in 1896 to crawl permanently past 1,000, it has needed only another 15 to sprint from 1,000 to 10,000.
In the Nineties alone, the longest bull run in history, the market has more than trebled - and, brushing off warnings from Alan Greenspan, chairman of the Federal Reserve, not to mention Bill Gates and Rupert Murdoch, investors have continued to pile into the market, furiously chasing a small group of technology and Internet stocks beyond the known limits of stock market gravity.
Now, in a secondary boost, investors flush with confidence are channelling paper wealth into a consumer boom - bigger houses, flashier cars, more computers and gizmos - currently swelling at 15 per cent a year.
Is the US in the grip of a bubble? 'Oh yes, share prices are absolutely crazy,' declares Professor Tim Congdon, managing director of investment adviser Lombard Street Research, speaking for many economists.
With a price-earnings ratio of more than 35 and an income yield of just 1 per cent, he says, Wall Street 'is not just expensive: It has never been remotely like this before'.
It's a classic bubble, agrees Prof John Kenneth Galbraith, doyen of US economists and author of A Short History of Financial Euphoria. Says Galbraith: 'You should always have your suspicions aroused when you hear someone saying we have entered a new era which justifies the price increases and ignores the speculative element.'
This, of course, is exactly the claim of the optimists, a group of influential Wall Street analysts led by Goldman Sachs' chief US strategist Abby Joseph Cohen, Prudential Securities' Ralph Acampora and a few Internet specialists such as Henry Blodget at Merrill Lynch.
They believe that a re-engineered US economy, powered by information technology and the Internet, has reached a new level of effectiveness characterised by low inflation, fewer recessions and strong productivity growth - a scenario that could support further share price rises, they argue. In a book self-explanatorily named Dow 40,000 one expert stakes his reputation to a steadily rising trend for the next 20 years.
Maybe. If the optimists are correct, however, it will signal a new era of economic history. Bubbles, panics and crashes are a permanent feature of the economic cycle. In modern times they have often involved shares (as today) and property (as in the Eighties) - but by no means exclusively. In his classic Manias, Panics, and Crashes, financial historian Charles Kindleberger lists canals and turnpikes, railways, tulips, gold and silver mines, currencies, commodities, derivatives, building sites, ships and even Boeing 747s among assets to catch the speculators' fancy. Nor are bubbles becoming easier to stop - in fact, they may be getting more frequent.
One account situates the first property bubble in Athens in 333 BC. The earliest fully documented example is tulip-mania in the Netherlands in the seventeenth century, but as national economies became more interlinked and communications improved, opportunities for speculation spread internationally. By the nineteenth century, the world economy was creating and popping bubbles with the speed of a giant jacuzzi.
Increasing wealth, or virtual wealth (ie imaginative new forms of credit), has played a part here: one US firm geared initial capital of $500 into a world-beating $1 billion in the Twenties, and when the Kuwait stock exchange imploded in the Eighties under the weight of $91bn of backdated cheques, no less than $10bn of them were traced back to one enterprising ex-immigration clerk.
Why do bubbles happen? Economists quarrel ferociously over the issue. Monetarists such as Congdon believe that the causes must lie outside the market itself.
In this case, says Congdon, the 'madness' that leads to investors supporting 'irrational' share prices - profits of many top companies are down this year and the private sector is running an unprecedented deficit - is the result of over-rapid growth of the money supply.
Excess liquidity is channelled by individuals into shares, and the 'wealth effect' then feeds into a consumer boom, which in this case is stoking, unusually, not inflation but a burgeoning trade deficit.
Eventually, says Congdon, interest rates will have to rise to prevent further overheating and confidence will be punctured. 'US growth has got to slow down,' he says.
Other observers locate the bubble's causes squarely inside the system. 'New' economists like Ormerod believe that volatility is built into any complex system such as a market or economy where many different agents interact. Bubbles are inherent in the way the system works.
Galbraith also sees bubbles as intrinsic, but the causes as psychological - the 'speculative orgy' that precedes the crash rather than the external events blamed afterwards. Galbraith declines to predict the final outcome of the current bull market, which he had expected to end last year. But a feature of all bubbles, he emphasises, is the lethal combination of two flawed beliefs: first, that there is something new in the world, and second, that success is the result of this insight. Hubris is everywhere - in the South Sea Bubble, in railway mania; and especially in the Internet.
'What must be borne in mind is that we have far more people acting and advising on the market, including mutual funds, than we have intelligence to run them,' Galbraith explains.
As he warned in A Short History: 'Only after the speculative collapse does the truth emerge. What was thought to be unusual acuity turns out to be only a fortuitous and unfortunate association with the assets... The rule will often be here reiterated: financial genius is before the fall.'
The other sobering common denominator of crashes is that they bring rack and ruin to rash individuals and the real economy alike. After the Great Crash, for instance, US credit froze, manufacturing ground to a halt, and a near-decade of global depression was only ended by economic preparations for the Second World War.
No one believes that a millennial crash would have the same global effects as 1929, partly because investors in the rest of the world are less incurable commercial romantics than Americans; partly because the monetary authorities are better equipped (touch wood) to deal with the after-effects.
Nevertheless, Japan and last year's Asian bubble crisis are important precedents. If or when Wall Street subsides, expect the UK and European mini-bubbles to deflate in sympathy, and in the real world, US import orders to suddenly halt.
'No bubble breaks gently,' says one prominent City fund manager. Whether they act on it or not, he adds, many institutional investors share his views. 'Most people know there's something wrong with Wall Street at these levels,' he says. 'They know they're riding a tiger, but they're too concerned about the short-term performance to get off. They're just praying they can do so when the tide turns.'
