Thursday, April 28, 2011

Good and bad bubbles

So, continuing the economics theme...

Went through a little thought experiment today. Let's imagine two alternate universes. Both have companies called Squigglerail, whose purposes is to build and run a high speed railway line from Miami to New York City.

(Why a railway? Because it's my fantasy, OK? Insert whatever you want here, but make sure it's similar.)

In Universe One, Squigglerail raises billions from investors, and plans to start by running a free passenger service while it determines the best way to monetize the system. The system is built, and the first services run for a few years, with Squigglerail gradually introducing systems based upon advertising, and premium services.

Needless to say, Squigglerail is amazing popular, but hemorrhages cash, and finally goes bankrupt three years later. With the principle proven, Slashco buys Squigglerail's assets for a song, and starts, you know, charging customers, and closing down unprofitable services. Ten years later, there's a functioning railway system that didn't exist before, it's delivering billions in value every year, and everyone's glad it exists, although there are some very upset investors.

Now, let's go to Universe Two. Squigglerail raises billions from investors, and carefully choses a business model that involves selling transit services to passengers, who buy these things called "tickets" and then are allowed to ride the train. The system is slow to start, but becomes profitable after three years, and a decade later, there's a functioning railway system that didn't exist before, it's delivering billions in value every year, and everyone's glad it exists, especially the Squigglerail investors.

Universe Two is obviously better than Universe One. But is Universe One worse than Universe Zero, where there was no Squigglerail?

Obviously, in one and two, there's something that's worth far more than was paid to make it. The only difference is that in one scenario, a bad monetization model leads one particular group of people to lose money (the investors), while delivering massive value to an even larger group of people (the riders.) In the other, the riders benefit less than they did in U1 (which is OK, because they still benefit - if they didn't, they wouldn't see the tickets as worth spending money on), and the investors don't lose anything.

I posit this rather contrived scenario because I was thinking of the two bubbles I've seen in the last decade and a half. Both caused large numbers of people to lose ridiculous amounts of money. The thing is though, that despite the problems investors had, I think - overall - the country was better off during and after the .com bubble than it would have been had the .com bubble not happened.

This isn't true of the housing bubble. That just swallowed money.

The difference? In the .com boom, as with Squigglerail, something was actually made, of enormous value, that caused growth, it's just bad monetization meant that investors had no way to share in the growth they funded.

The housing boom generally involved something that already existed, with only a superficial rise in value, and it existed largely because of supply and demand, not economic growth. So the housing bubble was actually damaging to the economy, and those who promoted it, seeing the .com collapse as no big deal, didn't bother to ask why the .com collapse didn't have a massively depressive effect on the economy, and whether inflating the price of homes had anything in common.

BTW, don't buy gold.

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