When the new bubbles burst

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Not all bubbles are equal. In the last 30 years, there have been three major bubbles, which are best known for the dramatic price changes that followed. That is the bubble everyone fears. They were, therefore, bubbles with far-reaching negative consequences for the economy. Yet this is not always the case. There are soap bubbles in all shapes and sizes. There are also economic bubbles that have no negative impact on the economy. It matters who financed the bubble, the financial sector, or the government. Furthermore, a bubble can arise because a commodity is scarce, but also because it eliminates scarcity. In the latter case, there is, for example, a new production method that effectively ensures that goods or services become less scarce. Such a bubble has a useful economic function. It ensures that capital concentrates on the new production method, resulting in accelerated innovation.

The three big bubbles that every investor has in mind are the Japanese double bubble, the dot-com bubble, and the financial bubble in the American housing market.

The Japanese bubble was partly caused by the Plaza Accord of 1985. The Japanese yen doubled from 240 to 130 yen versus the dollar in two years. Not good for Japanese exports. That is why interest rates had to be lowered, so low that there was enough fuel for a double bubble, both in real estate and in the stock market. The implosion of these caused two lost decades, deflation, and still high government debts. The Japanese stock market eventually lost more than 80 percent, partly due to the bankruptcy of the Japanese financial system. But the consequences were limited to Japan, although Mrs. Watanabe’s carry trades provided liquidity to blow new bubbles.

The dot-com bubble was special because it was the first global bubble. Of the 100 dot-com companies, 99 are now in the dot-com graveyard. The stock market halved for the first time this century. IT companies had been financed with equity (the free money in the stock market) but were not generating the cash flow to stay alive. Many telecom companies were over-financed with debt.

The third big bubble is the one on the American housing market in the run-up to the Great Financial Crisis. Interest rates were once again too low, especially when measured against the actual inflation on the housing market. The devastating effect of debt financing almost spelled the end of the global financial system. The stock market halved for the second time this century. All bubbles seem to end in tears. But going back further in history, the most famous bubble hardly had any negative economic effects. The tulip mania between 1634 and 1637 caused prices to soar. The rare tulip Semper Augustus sold for 10,000 guilders (€5,000) in 1637, more than a canal house. And yet there was so much art for sale. Rembrandt received only 1,600 guilders (€800) for his Night Watch. There were craftsmen who borrowed too much and then became penniless.

Tesla is now the fifth-largest company in the world. This bubble has not been financed with loan capital. If Tesla collapses tomorrow, it will hardly affect the American economy. No bank will fail. The Wall Street Journal compared the Tesla bubble to the British bicycle bubble of 1890. Bicycles were the electric cars of the time, but still very expensive. The many investments made by investors ensured that the bicycle rapidly became affordable through mass production. In the UK, there were 671 bicycle factories at one point, but half of those companies did not make it to the end of the century. The average bike share fell by more than 70 percent. Yet this is not reflected in British economic statistics. On the contrary, the cheap bicycles caused a transport revolution. Until the Second World War, the bicycle was the most important means of transport in the United Kingdom. Currently, there are several bubbles: in the bond market with more than 15 trillion in bonds with negative interest rates, in technology stocks with Tesla as a shining example, and perhaps also in Chinese stocks as they rose more in the first weeks of this year than over the whole of last year, when China was also the best performing stock market. The bond bubble is mainly a consequence of forty years of bull markets with constantly falling interest rates. The mistake made is to extrapolate these returns into the future. Bonds were safe for forty years, so they will be safe for the next forty years too. No, they are not!

The bond bubble is very similar to the Japanese bubble and will cause huge losses for investors, but spread over decades. The Tesla and China bubbles mainly look to the future: autonomous electric cars and Chinese world power. But like British bicycles, electric cars are rapidly becoming cheaper, helped by investor interest. That makes manufacturers of autonomous electric cars vulnerable, but it makes it happen faster. The bubble in China is more on the order of the tulip mania. Again, bubbles cannot be ruled out, but the average Chinese company is undervalued rather than overvalued, especially for a country at the beginning of its Golden Age.

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