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Peter Thiel on the Great Bubble
One would not have thought it possible for the internet bubble of the late 1990s, the greatest boom in the history of the world, to be replaced within five years by a real estate bubble of even greater magnitude and worse stupidity. Under more normal circumstances, one would not have thought that the same mistake could happen twice in the lifetimes of the people involved...
The most straightforward explanation begins with the view that all of these bubbles are not truly separate, but instead represent different facets of a single Great Boom of unprecedented size and duration. As with the earlier bubbles of the modern age, the Great Boom has been based on a similar story of globalization, told and retold in different ways — and so we have seen a rotating series of local booms and bubbles as investors price a globally unified world through the prism of different markets.
Nevertheless, this Great Boom is also very different from all previous bubbles. This time around, globalization either will succeed and humanity will achieve a degree of freedom and prosperity that can scarcely be imagined, or globalization will fail and capitalism or even humanity itself may come to an end. The real alternative to good globalization is world war. And because of the nature of today ’s technology, such a war would be apocalyptic in the twenty-first century. Because there is not much time left, the Great Boom, taken as a whole, either is not a bubble at all, or it is the final and greatest bubble in history.
This also means that catastrophic risk has never been higher and the peso problem -- changing small probabilities of total collapse -- is screwing around with asset prices to an unprecedented degree. Here is the full essay, which also has much of value on China, among other topics. If nothing else, remember this:
...there is no good scenario for the world in which China fails.
And this:
...a long “China” position is not a forecast that financial globalization will succeed, but rather a bet that its internal contradictions will persist.
The hat tip is from wunderkind Ben Casnocha.
Posted by Tyler Cowen on April 28, 2008 at 04:13 PM in Economics | Permalink
Comments
Maybe I didn't read this quite right.
"This time around, globalization either will succeed and humanity will achieve a degree of freedom and prosperity that can scarcely be imagined, or globalization will fail and capitalism or even humanity itself may come to an end."
Definite confusion here. The most likely reason why humanity would come to an end right now is through the continuing environmental degradation brought about by continuing economic growth - fuelled by globalisation.
If you are unconvinced: try reading Mark Lynas' 'Six Degrees' on the impact of different levels of climate change.
Posted by: Andrew Curry at Apr 28, 2008 5:03:44 PM
Doubtful. If people actually start keeling over from CO2 asphyxiation, not long after, we'll stop making the stuff, or at least ratchet back a bit.
The most likely method of globeacide is some genius manufactures some technology for some government that is very efficient at killing people, then the government lets it into the hands of maniacs (or, the maniacs are the government) and the maniacs team up with the downtrodden victims of capitalism to get even.
Posted by: Andrew at Apr 28, 2008 5:29:25 PM
It's apocalyptic nonsense. Thiel believes we will soon either reach blissful Singularity or destroy ourselves. But the world is now, and always has been, an uncertain place, and overall volatility and risk premiums are well within their historical ranges. We had a short nice spell of lower than average risk in the 1980s and 1990s, due to some uncommonly good political events, but we are nowhere near the uncertainty that befell the globe in the first half of the 20th century.
Posted by: nick at Apr 28, 2008 5:50:41 PM
Wouldn't the number of stories predicting a catastrophic future correlate more with a bust than a boom?
Posted by: kebko at Apr 28, 2008 5:52:00 PM
I am with nick. There is nothing much special about the present but that we are living in it.
Posted by: lemmy caution at Apr 28, 2008 6:09:11 PM
Is it fair to decouple the Internet bust and the real estate bust as separate events, unrelated events? It seems quite probably that they have common origins, and thus do not represent discrete periods of stupidity, but instead linked stupidity. No?
Posted by: Ben at Apr 28, 2008 6:15:27 PM
If I had a message of such import for the world, I wouldn't post it on a website with such a miserable little font.
Posted by: dearieme at Apr 28, 2008 6:51:50 PM
Theil could rewrite the start of his article, wondering about how, only years after an internet bubble and a housing bubble, we walked to an even larger and even stupider commodities bubble. Just sayin'.
Posted by: cure at Apr 28, 2008 7:09:31 PM
Is it fair to decouple the Internet bust and the real estate bust as separate events, unrelated events?
They both have in common millenarian nonsense, which judging from Thiel's essay seems to have mutated into yet another form. The Internet was supposed to Change Everything. The Internet was to magically increase disintermediation and profit margins at the same time, and every Internet startup had a high probability of being the first mover that would win the entire market. All brick-and-mortar retail would be out of business by 2008, even though no such risk was reflected in their stock or bond prices.
Real estate represented another blissful Singularity, an asset that could only go up because they're not making more of it. Just the kind of safe sure bet that someone swooning from the Internet bust was looking for. Everybody should own a house and get in on this windfall, regardless of their income or credit history. Since we can have Markets in Everything, we can certainly buy and sell risk in a perfectly efficient market as if risk were potatoes. Only crotchety cynics would so distrust their fellow human beings as to believe in moral hazard and suggest that there's something wrong with a setup where the people who make the loans have little incentive to collect them. And even if that cynical bastard who believes in moral hazard turns out to be right, we can just foreclose on the deadbeats and resell the foreclosed property at a profit, because Real Estate Always Goes Up. And even if it sometimes goes down, risks are by the mathemetical definitions of probability evenly distributed, so if we just distribute them around enough we can rate all the resulting mortgage security portfolios AAA. What could go wrong?
Now we are at the Last Great Bubble of History, folks. It's time to put all your money into Good AI or die in the attempt. High Priest Thiel will lead the way.
That said, market bubbles that promise to Change Everything are not nearly as harmful as political bubbles that promise same.
Posted by: nick at Apr 28, 2008 7:42:22 PM
"This time around, globalization either will succeed and humanity will achieve a degree of freedom and prosperity that can scarcely be imagined..."
Relative to prior periods in history, I think one could already argue that humanity has a achieved "a degree of freedom and prosperity that can scarcely be imagined".
Posted by: steve at Apr 28, 2008 9:02:24 PM
Bubbles are not hermetically sealed events. Even as the tech bubble was inflating, there were signs that the same thing was slowly developing in real estate. Investor's Business Daily ran an article in, I think, the fall of 2001 about how the stocks of homebuilders had been one of the best performing groups the previous five years.
In 2002 Stephen Roach of Morgan Stanley wrote a report in which he lamented the fact that the Fed had not acted to deflate the stock bubble of the late 1990s by raising margin requirements. Mr. Roach erred in this assessment, however, because raising margin requirements would have had no affect on the monetary base, and in any event it failed to address the bubble's underlying cause, namely a loose monetary policy (and by that I mean a policy that pushes the loan rate of interest far enough below the natural rate for a long enough time to have macroeconomic consequences). Altering margin requirements to deflate stock bubbles is like using price controls to arrest inflation.
When the tech bubble burst in late 1999 and early 2000 (the Goldman Sachs internet index peaked in Dec. 1999 and the Nasdaq peaked in March 2000), the tech partygoers cha-cha-ed down the street to the housing bubble party, which was already underway, albeit in an understated way that drew little attention from bubble watchers and pundits.
Greenspan's bubble blowing continued in a big way in 2003, with the Fed-funds rate bottoming out at 1%, and it was held there for several months while the party heated up. One of the biggest cheerleaders was Pennsylvania-based mutual fund manager Ron Mellenkamp, who was quoted in the Wall Street Journal and Barron's at least half a dozen times saying "if you bring me fresh money, I'll buy homebuilders." (I e-mailed him in the early summer of 2005, opining that the homebuilders would never get to 15x earnings, as he had predicted, and that they were ripe for a fall. He replied to the effect that they were still a good value. The builders peaked in August 2005, then began a long slide. Alas, he hasn't been quoted in the press for a long time. Wonder how his shareholders have fared, assuming he still has any.)
Meanwhile, the mortgage romper room people crashed the party, with names like Countrywide, New Century, and Thornburg. The bankers and brokers joined the fun too, except for boring party poopers like Goldman.
Helicopter Ben replaced Easy Al and proved that Al's ability to bend to political pressure (and blowhards like Cramer) and to hit the panic button had nothing on him.
Going back to Mr. Roach's point about stock bubbles and margin requirements, if the Fed had raised margin requirements, more of the increase in new money would have found its way into the real estate market sooner, and perhaps other assets like cars. (One theory making the rounds is that there is a bubble in the new car market.) In other words, money flows from one bubble to another without a sharp and well-defined break.
All of this was understood by the Austrians, and that's why the ATBC is more relevant that ever. James Grant is maybe the best newsletter writer of anyone on Wall Street. He warned his readers long before the real estate bubble burst to "expect the unexpected"; namely a big fall in the real estate market. He schooled himself in Austrian theory early in his career, and made several prescient market calls because of what he learned from the Austrians.
Posted by: Bill Stepp at Apr 28, 2008 9:09:59 PM
The early 20th century didn't have resource crises. What makes the coming boom or bust so vital is that if we don't invent the post-oil renewable tech before oil runs out, we won't have the resources to do so once there's no oil. Or once topsoil fails, or water resources dwindle, or climate change screws up weather patterns. Pick your resource, we're running low.
Because of resource crunches, there will either be a boom driven by the tech inventions that solve the resource crunches, or a bust as people fight over dwindling stocks. There's no way things will stay as they are.
Posted by: jb at Apr 29, 2008 1:26:41 AM
Thiel's blowing enough hot hair to power several all new bubbles.
Posted by: Mercutio.Mont at Apr 29, 2008 1:28:39 AM
I share nick's cynicism. The reason these bubbles happen is that people forget that financial assets are bound by certain rules that link values to cash flows. Every so often people get it into their heads that an asset can defy these rules indefinitely. They are always proven wrong.
Posted by: James K at Apr 29, 2008 1:47:39 AM
Austrians, I like them.
For any mathematicians out there, without provocation, I am going to give a one sentence summary of 200 years of economic theory.
The economy is a covariance matrix that is trying to diagonalize itself.
The wealth distribution is the diagonal, and is composed of spectral production functions, generally considered to be of rank 5-7.
The operation count needed to diagonalize is of the order n*log(n) or n**2; where n is the rank. The operation count corresponds nearly exactly to the inventory operation count in firms, and within a scale factor, operation counts can be converted into dollars spent managing inventory.
The diagonalization process always seeks to measure the eigenvalues with a fixed precision, about 10, as measured in power spectrum ratios. A total factor productivity increase is equivalent to raising the precision with which eigenvalues are estimated. When the precision exceeds the quantize SNR level, the matrix seeks to reorganize itself from a rank N to rank N+1.
When interest rates are artificially depressed, then a rank N matrix will attempt to become a rank N+1 matrix. The diagonalization process will cycle, and production eigenvalues will cycle as a Hamiltonian energy equation of the form:
M*V = P*T with the association integration limits.
This follows from the NlogN destruction, construction process of moving between rank N and rank N+1, and is equivalent to the Austrian formulation of firm hierarchy.
The yield curve is the direct sum of the spectrum of production functions, or the Fourier transform of their time series output.
The quantized restriction on precision is a result of evolution, the human agent operates efficiently only when its SNR is within a narrow range.
A bubble is the excess volatility of a rank N matrix trying to act as a rank N+1, the diagonalization process will cycle the bubble through each of the production function, one at a time.
This list of items corresponds to a Quantum Mechanical solution to economic equilibrium.
Posted by: Matt at Apr 29, 2008 3:06:21 AM
I don't know about linear algebra, but Thiel makes a lot of good points, regardless of whether you agree with his Pascal's wager on globalization.
He thinks Buffett agrees. But he makes a subtle mistake when analyzing Buffett. Buffett doesn't work hard to predict. He works hard to not predict.
Maybe his best point for the little guy was that people think they are betting on the internet when what they really did was bought stock in Pets.com. Sad sock puppet, sad.
What happens in the extreme case when everyone has their finger on the red button? What are the odds that noone will push it? Does mutually assured destruction turn into act first and hope? Missile defense is a program that is ahead of its time and obsolete, because we are still in the era of MAD and it accelerates the move toward shoot first. And once we have suitcase nukes and fruitcakes willing to commit suicide, missile defense will be obsolete.
Relationships are built on communication. The only way to foster peaceful communication between disparate groups has been to incentivize it through mutually beneficial trade-globalization. It's the problem and the solution. But even if we do a good job, there will still be the fanatics. How do you deal with them? Can't live with them, can't shoot 'em. Can't not buy oil from them (see above about communication, trade, and peaceful relationships), but funneling resources to oppressive regimes doesn't seem smart either.
Luckily, we (as in neocons et. al.) seem to overestimated the number of fanatics. Unfortunately, by acting on their overestimation, they've succeeded in making more. It's a great racket.
Just about everything that sucks in this world are things where authority is not matched to responsibility and reward, i.e. ownership. There is no owner of smooth globalization with minimal dislocations. Creative destruction may need to be modified to creative reinvention and integration to avoid turmoil.
Posted by: Andrew at Apr 29, 2008 6:14:43 AM
Relative to prior periods in history, I think one could already argue that humanity has a achieved "a degree of freedom and prosperity that can scarcely be imagined".
The odds of this prosperity coming to an end are legion.
Posted by: jomama at Apr 29, 2008 10:07:17 AM
The early 20th century didn't have resource crises. What makes the coming boom or bust so vital is that if we don't invent the post-oil renewable tech before oil runs out, we won't have the resources to do so once there's no oil. Or once topsoil fails, or water resources dwindle, or climate change screws up weather patterns. Pick your resource, we're running low.
This is exactly correct. We have at our disposal an energy source that is unrivaled in potency, storability, and ease of discovery. Without this energy source, modern society can't have existed. If we don't make it off planet, if we don't find a way to replace this energy source, we are doomed in the long run. This is our shot. Either we make it this time, or we don't.
It is easy to imagine we don't, because as far as we know, there have been no prior technological societies prior to ours, despite many 10s of thousands of years of stone age living. It is not easy to create new tools. Imagine how someone could create most of the technological breakthroughs we have now, but without easy energy. I can't.
Posted by: mickslam at Apr 29, 2008 1:21:35 PM
The real story comes in footnote #26: the range of possibilities, from great prosperity to total collapse and everything in between, is pretty much the same as it's always been. He tries to make the case that the distribution has changed to make the high-loss possibilities more likely, but there's not really strong evidence for that in his essay.
Posted by: bbass at Apr 29, 2008 2:28:34 PM
What makes the coming boom or bust so vital is that if we don't invent the post-oil renewable tech before oil runs out, we won't have the resources to do so once there's no oil. Or once topsoil fails, or water resources dwindle, or climate change screws up weather patterns. Pick your resource, we're running low.
A quote straight out of the 1970s.
Posted by: nick at Apr 29, 2008 8:54:52 PM
I posted an analysis of the Theil essay back at the beginning of April at James Nicoll's live journal. It's generally a crap article.
Posted by: The New York City Math Teacher at Apr 29, 2008 10:08:11 PM
Well, I'm going to take what appears to be a minority position and state that it was an interesting, thought provoking essay. But granted, I didn't read as much into it as some previous commenters have.
Also
The early 20th century didn't have resource crises.
Well, if you don't count the US 'frontier' closing in 1890 causing 'peak land.'
Plus the whole dust bowl thing.
And world war 1.
Posted by: Kolohe at Apr 30, 2008 10:58:22 PM
Theil's article, as far as I could tell, is a complaint against badly managed economic exchange and a plea for improved economic exchange, because bad economic exchange could destroy the world (he doesn't specify how!) and good economic exchange might save it (also, he doesn't explain how!).
So far, so.... okay. The language is very elevated, and the thesis commonplace and poorly articulated and supported. Where he tries to connect the economic exchange and social analysis piece to the apocalyptic stuff, he is engaging in artful, resonant bullshit, cladistically evocative of seventy years of pre-WWII bullshit. Just because les mots aux modes, like Globalization, get used in the template doesn't mean that it carries any more than impressionistic significance.
This is an extraordinarily bad essay; it is both willfully opaque and rhetorically slimy.
Posted by: The New York City Math Teacher at May 1, 2008 11:27:50 AM
