Tuesday 21 September 2010

Bubbles everywhere

We have seen a partial-collapse of the finance bubble based ultimately on house price inflation - however, Western governments have tried very hard to prevent house prices from dropping, so in fact the bubble is not fully deflated.

There is much talk of a bubble in higher education, based on fee inflation.

Other bubbles in the West include government employment - public sector expenditure; the legal profession, health services and science (especially medical research).

There are bubbles everywhere - indeed Western societies are essentially bubbles.


Bubbles are based on people mistaking consumption for investment:

people bought over-priced houses they did not need and could not afford because they imagined houses were an investment, when actually they were not investing but consuming the ownership of a house;

people are actually consuming college education but they imagine that it is an investment in their abilities, employability and future salaries;

people are actually consuming health care but imagining that it is improving their health;

increased spending on medical research is imagined to improve medical treatment (hence improve health) but being a medical research funder is actually consuming a status-oriented luxury good.

And so on...


So bubbles are really inflation, i.e. things are costing more and more for what you get.

But the bubble is fuelled by the delusion that cost increases are actually a good thing: that increasing house prices, years of education, amount of health care, and quantity of medical research are actually good in themselves because they invariably generate greater benefits than their costs.

In reality you are getting less per unit investment, in imagination your ever increasing-investment is misunderstood to imply that what you are getting has an ever increasing value.

This thinking is rampant in property speculation, where people have been brainwashed, or have brainwashed themselves, into believing that house inflation (paying ever more for ever less) is somehow 'a good thing' because house inflation is (supposedly) an index of prosperity.

People don't - yet - feel the same about food price inflation as such (although many people are happy to invest in consuming over-priced 'organic' and health food on spurious 'investment' grounds that doing so will improve their health - so maybe there is a bubble in food prices too?)


These bubbles amount to borrowing from the future with payments deferred and deferred by ever-increased borrowing on the basis of ever-more-exaggerated hopes; and at some point reality bites and either the future will need to be paid, or the present will default and the future will suffer a massive loss. Guess which?


dearieme said...

Is there a bubble-identification bubble?

xlbrl said...

Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds--

Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly; and one by one.

Bruce Charlton said...

@xlbrl - that's a very good quote!

xlbrl said...

Thank you, bdc. The book is available free online.

"The Mississippi scheme of John Law, which so dazzled and captivated the French people, inspired them with an idea that they could carry on the same game in England. The anticipated failure of his plans did not divert them from their intention. Wise in their own conceit, they imagined they could avoid his faults, carry on their schemes for ever, and stretch the cord of credit to its extremest tension, without causing it to snap asunder.
Mr. Walpole was almost the only statesman in the house who spoke out boldly against it...Although, in former times, the house had listened with the utmost attention to every word that fell from his lips, the benches became deserted when it was known that he would speak on the South-Sea question."

We are, of course, wise in our own conceit once again. Ever more wise, beginning in 1913.