Greenspan: Bubbles Are a Necessary Part of Innovation

It’s no secret that former Federal Reserve Chairman Greenspan would never sacrifice the whole economy for the sake of popping a bubble. It does not matter how obvious or difficult to determine that bubble might be. Nor is he concerned whether the bubble is small or actually engulfs the whole economy. Remember the stock market wealth-affect of the 90s and the recent housing wealth-affect in the first half of this decade.

Never one to retreat from defending his record, Greenspan has regrouped and is preparing to finally defeat those attacking him. Greenspan will not be deterred by the current Federal Reserve Chairman Bernanke’s bubble study group. Greenspan has finally realized that no one is buying the 'bubbles cannot be recognized' mantra, and is setting the stage for Act 2.

In Financial Times "Greenspan urges policymakers to focus on banks' capitalisation", Greenspan argues that bubbles are a necessary part of innovation. Bubbles fund the rapid growth seeded by innovation, and are also a result (or byproduct) of the enthusiasm for innovation. Is he announcing the innovation-asset price inflation spiral? Sounds like Greenspan doesn’t know his chickens from his eggs.

Greenspan claims the internet would not have grown as rapidly without the dot com bubble to feed it, and “advances in home financing” would not have evolved as fast without our recent housing boom. It’s a tough argument to buy. The internet evolved technically far more in the last few years than during the 90s and the financial alchemy of the recent past does not appear to have benefited many. However, I do concede that the telecom bubble was an integral part in the growth of fiber optics, and alternative energy innovations gained momentum with the commodities bubble.

Greenspan’s conclusion is that banks should be adequately capitalized to handle the fallout when bubbles collapse. At this point his rant completely collapses onto itself. During a bubble both commercial and investment banks become substantially overleveraged. Greenspan would want them to keep pumping air into the innovation bubble, promoting rapid growth. How can they possibly de-lever fast enough to support the economy in a downturn? We all have seen they can’t.

Comments

[zenalgorithm:]

Manipulation of the CPI data with Greenspan's help has caused the last 2 bubbles.

2008 May 29 08:00 AM

[moonbat1775:]

Sure, fiat money will spur some innovation but the analogy of drug abuse applies here, particularly stimulants. And here is a question, were the roaring 20's worth the Great Depression and World War II and all the anti-business, anti-freedom legislation of the New Deal?

2008 May 29 08:04 AM

[vaduz:]

now greenspan has engulfed total nonsense

2008 May 29 08:22 AM

[David Lentz:]

I, for one, can see the merits of the argument that today's robust internet was spawned from the dot-com bubble investment.

Incidentally, I see the dot-com boom as being primarily driven by corporate Y2K spending, which pulled an enormous amount of orders for new systems forward, it being deemed cheaper in many cases to replace older mainframe systems with newer web-oriented server-based systems. Of course, when Y2K came and went, all that spending ceased, and there was a vacuum in the order space that popped the boom, turning it into the dot-com bust.

But in the ashes of the dot-com collapse, we found ourselves with a lot of shiny new hardware and software oriented toward integrating corporate operations with the web. THAT's what Greenspan is talking about, and that part I'll buy into.

Looking forward, the idiots who object to the coming green revolution should be seeing it as a similar opportunity to replace the old with the new, a veritable investment bonanza, replacing centralized power generation and transmission with a distributed grid of green power. And the nice part is that this boom won't go completely away when the calendar rolls over past a specific date.

The trick with all bubbles, is to recognize what is going on, and let the air out of them from time to time -- something Greenspan never did. That's the job of the Fed, with interest rate hikes triggered in part by indications (e.g., excessive velocity in the flow of funds) that things are becoming overheated.

It is NOT the job of the Fed to prevent bubbles from forming, as they are part of the formative process of change, and without change we would be left behind rather quickly.

But neither should bubbles become so large as to damage the economy as a whole when they pop. Housing is an excellent example of this -- a bit of research on the Fed's part into why housing was growing a bubble would have uncovered the rotten lending practices, and shown a clear path to the corrective actions that were needed. But Greenspan adopted the hear/see/say-no-evil approach, and that bubble eventually exploded with economy-shaking consequences.

2008 May 29 09:35 AM

[doylegroup:]

Greenspan is no longer the Fed chaiman, please have someone tell him to go lay by his bowl! He's already done enough damage.

2008 May 29 10:23 AM

[matthutch:]

Bubbles certainly come with innovation. Whenever a new innovation comes out, the marketplace will struggle to price it. Sometimes "the market" is wrong. Whether or not bubbles are "necessary", I don't know. I do know, though, that I wouldn't sacrifice our capitalistic method of discovering innovation for a world without bubbles.

2008 May 29 12:33 PM

[flow5:]

I prefer the article Greenspan wrote about "Can the U.
S. Return to a Gold Standard?" on 9/1/81. He's done a complete turn around.

Bubbles aren't necessary. And it's impossible to miss an economic forecast using bank debits. All drafts cleared thru DDs.

2008 May 29 01:15 PM

[Joyful Alte...:]

David Lentz is right, about the effect of Y2K spending and about the green revolution. I never quite grasped those two points and their connection before.

2008 May 29 01:48 PM

[moonbat1775:]

Joyful,

I am sure Mr Lentz has many wonderful insights and ideas but the crucial thing is how decisions are made in a society. Should they be made by a micromanaging government with a central bank or should they be made by a truly free market (which excludes the government backed banking cartel we presently have)?

A simple rule: Most good ideas do not have to be forced on others and bad ones should NOT be forced on others.

2008 May 29 02:52 PM

[Canbyte:]

Greenspan must be a Sheakespeare fan, poetSam seems to like Milton and makes a good point to boot. As Germany is finding, whats left after the green bubble will be a lot of public debt /unstable currencies / struggling taxpayers trying to pay off inefficient solar collectors (& rich FLSR shares) as opposed to the dot com's legacy of miles of bandwidth and singed investors. Quite different.

2008 May 29 06:53 PM

[icandoitdon:]

someone go tell this senile old fool that he had his chance and he blew it. he's the richard nixon of economics...disgraced.

2008 May 29 10:44 PM

[CLH:]

I think Greenspan is right. Bubbles are always found where ever there are markets. You can do away with them with socialism. However, that leads to worse misery.

2008 May 29 10:56 PM

[moonbat1775:]

CLH,

I would hazard that bubbles are only possible if interest rates are artificially kept low or via some other government intervention in the marketplace. Otherwise an equilibrium would be reached between the returns one could get from loaning out his capital vs what one could get by speculating with it.

People lament that Americans save so little but why should they when the Fed depresses the rates they can get for their savings and drives inflation at the same time. Why should Americans accept negative real interest rates? It is the Fed's fault that Americans save so little.

2008 May 29 11:20 PM

[icandoitdon:]

CLH....

bubbles that bring the financial system to the verge of collapse are not a normal part of capitalism. this was not like the tech bubble that ignorant investors brought upon themselves. it was a credit bubble brought on by the federal reserve mispricing risk and it has permeated the entire financial system. we're all paying for it. that's socialism too....

2008 May 30 12:18 AM

[pearl2k:]

David Lentz,

"Incidentally, I see the dot-com boom as being primarily driven by corporate Y2K spending.."

Pets.com et al was Y2K corporate spending? I see.

2008 May 30 02:02 AM

[cariqunyil:]

CLH: "You can do away with [bubbles] with socialism. However, that leads to worse misery."

What is your idea of capitalism? Privatizing profits and socializing risk?

2008 Jun 02 04:55 AM

[Diegojames:]

GREENSPAN,RUBIN,SUMMER AND REMOVAL OF GOVERNANCE OF WALLSTREET IN 1999(?) BY CONGRESS(GLASS-SPIEGEL... AND AIR BLOWING CONGRESSIONAL COMMITTEES NEARLY SANK THE US ECONOMY.
WHEN DOES THE FBI ARREST CONGRESS? GREENSPAN? FOR FRAUD?
GOOD LUCK TO US ALL; WALLSTREET COULD HAVE INVESTED IN ENERGY- DRILLING ,REFINING, WINDMIMLLS, NAT.GAS/MOTOR HYBRIDS NUCLEAR POWER GENERATORS, SOLAR ON ALL ROOFS AND OUR CURRENCY VALUE WOULD INCREASE LIKE RUSSIA VIA PUTIN...BUT NO...WE HAD GREENSPAN...JAWBONING LIKE HE KNEW SOMETHING.. CONGREASS SUPPORTING RICH CORN FARMERS..SO CONVERT YOUR SUV TO PROPANE OR JUNK IT AND BUY A MINI COOPER AND HOPE YOU HAVE A CAREER AND A COLLATERIZED HOME TO GO TO

2008 Jun 03 12:03 PM