Pop!: Why Bubbles are Great for the Economy by Daniel Gross

From the Publisher

Bubbles—from hot stocks in the 1920s to hot stocks in the 1990s—are much-lamented features of contemporary economic life. Time and again, American investors, seduced by the lures of quick money, new technologies, and excessive optimism, have shown a tendency to get carried away. Time and again, they have appeared foolish when the bubble burst. The history of finance is filled with tragic tales of shattered dreams, bankruptcies, and bitter recriminations.

But what if the I-told-you-so lectures about bubbles tell only half the story? What if bubbles accomplish something that can only be seen in retrospect? What if the frenzy of irrational economic enthusiasm lays the groundwork for sober-minded opportunities, growth, and innovation? Could it be that bubbles wind up being a competitive advantage for the bubble-prone U.S. economy?

In this entertaining and fast-paced book—you'll laugh as much as you cry—Daniel Gross convincingly argues that every bubble has a golden lining. From the 19th-century mania for the telegraph to the current craze in alternative energy, from railroads to real estate, Gross takes us on a whirlwind tour of reckless investors and pie-in-the-sky promoters, detailing the mania they created—but also the lasting good they left behind.

In one of the great ironies of history, Gross shows how the bubbles once generally seen as disastrous have actually helped build the commercial infrastructures that have jump-started American growth. If there is a secret to the perennial resilience and exuberance of the American economy, Gross may just have found it in our peculiar capacity to blow financial bubbles—andsuccessfully clean up the mess.

Publishers Weekly

Three cheers for "exuberant, foolish, mad overinvestment!" Slatecolumnist Gross takes a counterintuitive look at economic bubbles—those once-in-a-generation crazes that everyone knows can't last, and don't. With each one, we lament having gotten in too late, and then not having gotten out soon enough, and finally shake our heads at the inevitable bankruptcies and lost jobs and general financial wreckage. The pattern is all too familiar, which is why Gross's argument is so intriguing: that these bubbles, with their hype and madness and overenthusiasm, are not to be feared—they're actually a primary engine of "America's remarkable record of economic growth and innovation." The author surveys modern bubbles and finds the benefits far more durable than the disruptions: in each case, most investors flopped, but businesses and consumers found themselves with a "usable commercial infrastructure" that they quickly put to new uses. The telegraph "led to the creation of national and international financial markets"; extra railroad lines made national consumer brands possible and gave consumers access to distant stores; extra fiber-optic capacity gave everyone Internet access after the bust. Gross drops zingers throughout his cheery history, amusingly highlighting parallels between past and current bubbles. He concludes—with admirable practicality—by calling for a "real bubble" to jump-start alternative-energy programs. (May)

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Chapter One

Bubbles "R" Us

Oops! . . . I did it again.
—Britney Spears, MAY 2000

On October 9, 2006, with the Dow hovering near a record 12,000, the markets got a jolt. Google, the eight-year-old money machine, announced it would buy YouTube, the eighteen-month-old Web video-sharing phenomenon, for $1.65 billion in stock.

Uh-oh. Stocks at multiyear highs. A young tech company using its high-flying stock to snarf up, at a seemingly outrageous valuation, a company with little revenues but gazillions of eyeballs. (YouTube held its financials closely but loudly trumpeted the 100 million videos viewed daily at the site.) The positive reaction in the stock market. (Google's stock rose 8.5 points on the news, creating enough new value to make the transaction essentially free.) The rumors and gossip surrounding the acquisition target's also-ran peers, like Facebook. "It sounds like a tale from the late 1990's dot-com bubble," wrote astute deal observer Andrew Ross Sorkin in the New York Times. Less astute deal observer Matt Lauer seconded the notion, opening the October 11 Today show with this irresistible teaser: "Bubblicious. Could Google's billion-dollar purchase of YouTube signal another dot-com boom?"

Bollocks.

Despite the media's rush to portray the deal as a return to the glory days of 1999, before Lauer's hairline and CNBC's ratings had receded so dramatically, the Google-YouTube tie-up emphatically did not herald a return of the dot-com bubble. Rather, it was a logical and historically resonant result ofthe 1990s bubble. Google, the dork-powered cream of the Web 2.0 crop, was founded in 1998, gained critical mass amid the postbust tristesse, went public in August 2004, and instantly took flight. Superior search algorithms account for Google's astonishing performance and profitability. The stock market valued Google that day at about $128 billion—more than it did most components of the Dow Jones Industrial Average. And while the company used about 2 percent of its high-flying stock as currency, Google could have simply written a check. It had about $9.8 billion in cash and marketable securities on its balance sheet.

But all that code would have been worthless if not for the excess human and technological capacity surrounding the Internet that was created in the 1990s. Google prospered by hiring engineers and computer scientists, many of whom had been made redundant after the bust; by lashing together hundreds of thousands of cheap servers; by tapping into an installed base of 172 million U.S. Web surfers, many whom enjoyed zippy broadband connections; by selling ads to hundreds of thousands of online advertisers desperate for leads, links, and clicks; and by placing ads on blogs and social networking sites.

YouTube, which went from zero to 100 million videos per day in the time it takes an infant to learn to walk, was likewise built on infrastructure laid down in the 1990s. Without near-universal broadband (ever try streaming a video over a 56K dial-up modem?) and the spread of what Forbes publisher Rich Karlgaard calls the continuing "cheap revolution" in technology, teens would not be able to make videos on their PCs and digital cameras, upload them to the Net quickly, and post links on their MySpace pages. There's much more to the Web 2.0 phenomenon than Google and YouTube: the virtual universe Second Life; Wi-Fi networks; the burgeoning blogging industry; iTunes; the $211.4 billion e-commerce juggernaut, growing at 20 percent per year; and the $16 billion online advertising industry. Next, add the macroeconomic numbers that are more difficult to crunch. How much cash do corporations save each year due to falling data transmission and storage costs? What's the value of the time saved—and hence money earned—from instant messaging, file sharing, BlackBerrys, the online phone service Skype, ordering groceries online through Peapod, using Google to conduct research, and outsourcing insurance claims processing to Bangalore? In the years since the bubble burst in 2000, the way Americans work and communicate has changed dramatically, in large part because the technological infrastructure laid down in the 1990s has been put to such remarkable use.

The cycle seen in fiber optics and dot-coms in the 1990s and the early part of this decade—a burst of frantic building and excess capacity, outlandish hype, and cutthroat price competition, bankruptcy and consolidation, self-pity and finger-pointing, short-term losses for many and long-term gains for everybody—is nothing new. Similar manias and bubbles surrounded other promising economic and technological developments: the telegraph in the 1840s and 1850s, the railroads in the 1880s and 1890s, stocks and credit in the 1920s. These bubbles, and their contribution to America's remarkable record of economic growth and innovation, are the subject of this book.

What's an investment bubble? There's no satisfying textbook definition. But it goes something like this. In every generation, people arise to proclaim that a new technology or a new set of economic assumptions and financial tools promise untold riches. The new, new thing will both alter history and free us from its musty grasp. As a result, the old rules simply no longer apply. Promoters concoct pro forma numbers that extrapolate impressive short-term trends indefinitely into the future. Evangelists and proselytizers urge people to abandon reason and steady habits, and browbeat those who steadfastly stick to their sense of rationality. As telecom promoter George Gilder put it in a December 31, 1999, premillennial op-ed in the Wall Street Journal, "The investor who never acts until the financials affirms his choice is doomed to mediocrity by trust in spurious rationality." Yes, there are always some fuddy-duddy doubters. In 1995, surveying an unfolding investment craze in a new technology, one pessimist wrote: "A few will pay off, but when the frenzy is behind us, we will look back incredulously at the wreckage of failed venture and wonder, ‘Who funded those companies? What was going on in their minds?' " But, hey, what does Microsoft founder Bill Gates know about new technologies that George Gilder doesn't?