Why The Wall Street Bubble Must Burst


. processing and maybe to balance your checkbook, than it was obsolete. The reason was that, not many months after you bought it, you found out you needed something called a modem. Then you noticed that your original software was already archaic, ineffective, and slow: six months after you bought it. A few short years later, everything you see and hear off from an overheated stock market to the problems of the E-traders is about telecommunications. Telecommunications, it turns out includes the computer you now own which is ten thousand times more powerful and about half the price of the first one you bought not so very long ago! The total complex of innovations and interconnections that has taken place in cyberspace in the last two or three years has happened so fast that you may already feel like a dinosaur.

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This can be especially true when your pre-teen comes up to you and starts whining about something called bandwidth. All of the eras of intense technological change mentioned by Schumpeter as the basis of K’s long wave were like this. The first of the Kondratieff waves, according to Schumpeter was due to industrialization itself. Schumpeter refers to the waves that followed as based on railroadization, electrification, and motorization(p.167).

To follow out Schumpeter’s logic here we would call the era that we have been living through the era of computerization.Of course, our era is not over yet. In fact, some people believe that the era of computerization has hardly begun; especially those people who are paying several hundred times earnings for those high flying Internet stocks. The question you should be asking by now is Why does there have to be a down segment of the long wave? Why can’t things just keep going up? Schumpeter’s answer to this question occupies the best part of the five hundred plus pages that make up the second volume of his major work. In a short form of words, however, Schumpeter’s position can be simply explained as follows. Industry produces two kinds of goods: consumer goods and producer goods. The production of consumer goods (in other words what the economist calls capital goods) dominates the upswing.

This inevitably leads to increases in the amounts of consumer goods being produced as the new capital goods create wealth more efficiently. This is, indeed, where the problem lies, namely, with the new producer goods that created prosperity in the first place! As Schumpeter puts it: In general, however, new products will be released as prosperity wears on, their impact being part of the mechanism that eventually turns prosperity into recession(p.502). This is where we came in! That is, with the clarion call of the Investors’ Business Daily and their concern to the effect that the period we are living through looks an awful lot like the Roaring ‘Twenties. The period of the 1920s saw both declining prices in basic commodities and a stock mania on Wall Street . According to the IBD it also saw the endless jawboning of a certain Mr. Young who was at the What seems to happen at the top of the long wave is that the effects of innovation spread out like ripples in a pool and eventually involve almost all firms in the economy.

When this takes place the profit picture for each individual firm changes.As more and more companies incorporate the new technology, profit rates are less and less exciting to each of those companies and to the people who own them. Owners of capital who are not making the kind of money that they enjoyed during the upswing decide to sit things out until better times come along. Technically, they withdraw capital from production. Consequently, the demand for raw materials normally used in production (ie, basic commodities) also declines. This demand side weakness ushers in a long period of declining prices, business failures, and, paradoxically, a stock market that becomes overheated as capital is switched from productive to speculative uses. This was, more or less, what was going on in the late 1920s.

A certain Mr. Young was Chairman of The Federal Reserve Bank of the United States at the time. Compared to Mr.

Young, who snarled about stock speculators and how he was going to hang them from the yardarm, current Fed Chairman Mr. Alan Greenspan looks like a nice guy. Like his unfortunate predecessor, however, Mr.

Greenspan is also trying to jawbone the markets out of their madness or what he calls their irrational exuberance. As far as prices are concerned, as in the 1920s, international prices in basic commodities have been down, down, down especially in agriculture. Soybeans are currently at a 27 year low and it is unlikely that silver could be produced at prices recorded for this precious metal in the futures market. The only significant commodity that has recovered its’ price level recently is petroleum and we probably have OPEC and its occasional effectiveness as a cartel to thank for this. The IBD is right.The period we are living through is very much like the late 1920s.

We have declining prices in basic commodities. We have non-stop merger activity, some of it in clear contravention of the laws on the books (has anyone here ever heard of the Sherman Anti-Trust Act?). We also have a stock market which seems to have gone wacko. This is because declining commodities prices and poor business conditions elsewhere in the world has caused foreign capital to flow into Wall Street for a speculative holiday.This is probably the real reason that stock prices have been on a rampage for the last few years.

Meanwhile, the United States has shouldered a trade deficit that is, quite simply, off the charts. It used to be that when a country imported several hundred Billion Dollars worth of goods more than it exported in the course of a year that country’s currency would suffer. Now it doesn’t seem to matter, but some people are suspicious anyway.

What will happen if old habits in the currency markets re-assert themselves and somebody mounts a speculative attack against the Dollar next Monday morning? In addition to a runaway trade deficit, Americans have the largest negative savings rate in the world. It makes us look prosperous, since many households are having a lovely time living on credit, but the reality is that the Dollar is increasingly backed by negative capital, in this case by consumer debt.Thus, if it weren’t for these massive inflows of capital from abroad, the Dollar might look pretty shaky. When Mr. Greenspan, looks at this situation he gets scared and its hard to blame him.

Like Young before him, Alan Greenspan has been attempting to deflate the Wall Street bubble, not because he doesn’t want us all to become rich, but because he is alarmed by the potential instability of the situation. Hence, the jawboning. Jawboning is a nanny-like lecturing of markets that never works, as Charles P.

Kindleberger points out in his masterful Manias, Panics, and Crashes: A History of Financial Crises.The market has been shrugging off Greenspan’s lectures for years now. Not only has no one listened to the jawboning, but also until recently ever larger quantities of cash have been flowing into mutual funds via pension plans despite the worst things that Alan Greenspan could say or imply. Thus, the little guy, too, can enjoy prosperity; on the proceeds of his life savings! Forty percent of American households now participate in the stock market through their retirement plans.

A lot of people have been making a lot of money the easy way. It is unlikely, therefore, that Greenspan will talk this market down.It is much more likely that some sort of destabilizing force will affect things from the outside. The underlying cause of depressions , as Schumpeter explains in Business Cycles, is the long term movement of prices generated by long waves of technological change. What goes up has to come back down.

There are those who believe that Greenspan would bring down this bull market gently if he could. Certainly he has tried.It is unlikely that Greenspan’s gentle jawboning will do this, however, since, as Kindleberger points out, when investors are going hog wild in an inflationary stock market they are simply not willing to listen to reason from the lips of central bankers and their like. From Schumpeter’s point of view, the underlying cause of the next market crash, would simply be that the long wave of prosperity that began in 1938 is now over.

According to Kindleberger’s careful history mentioned above the speculative bubble in many past economic crises has often burst as the result of some purely exogenous event. If an army somewhere loses a battle, for example, markets crash as investors run for the exits. The IBD closes its’ provocative article mentioned above by suggesting that the infamous Y2K bug might just play the role of the required exogenous force here. Let’s hope that they are wrong for once!.