30 June 2009

From Agricultural to Industrial to .... Bubble Economy?

The problem is not that financial markets are too mature and able to create too much capital and credit. The problem is that the corporation is too immature and unable to create profitable opportunities using that capital and credit. The result? Capital bids up the price of existing assets and we have a series of bubbles. Policy makers looking at financial markets will only see the symptom of this problem. We need to start talking about corporate reform.

James Fallows of the Atlantic talked to Nouriel Roubini, who spoke about the danger and increasing severity of economic bubbles.
“These asset bubbles are increasingly frequent, increasingly dangerous, increasingly virulent, and increasingly costly,” he said. After the housing bubble of the 1980s came the S&L crisis and the recession of 1991. After the tech bubble of the 1990s came the recession of 2001. “Most likely $10 trillion in household wealth [not just housing value but investments and other assets] has been destroyed in this latest crash. Millions of people have lost their jobs. We will probably add $7 trillion to our public debt. Eventually that debt must be serviced, and that may hamper growth.”

After talking about the dynamic of bubbles and how we've been dependent on them for growth, Roubini says,“'The question is, can the U.S. grow in a non-bubble way?'” He asked the question rhetorically, so I [James Fallows] turned it back on him. Can it?"

For me, the core problem is that we’ve created massive potential for financial stimulus but have not created a corresponding potential for translating that into new ventures. So, the financial clout is used to bid up the prices of existing assets rather than create new ones. This can’t help but create a series of bubbles, it seems to me. The problem is not that financial markets are too capable of creating capital. The problem is that business markets are too feeble at using that capital to fund innovation.

Businesses are not that interested in innovation and creativity. They prefer predictability. This is typical of fiefdoms run by the last of the monarchs. The dispersion of power within corporations to employees who would be eager to create equity would not only result in more innovation but would require more capital. Financial markets are capable of creating the credit and capital to finance new ventures at a faster rate: corporations don’t avail themselves of this, more often than not generating cash rather than consuming capital as if they did not operate in a possibility-rich environment.

As long as capital markets are biased towards the purchase of used securities – buying stocks and financial instruments for investments already created – we’re likely to see a series of bubbles. Once we get better at making entrepreneurship a normal part of the daily routine of business, we’ll still have bubbles but I suspect that they won’t be nearly as frequent or pernicious. And the foundational economy upon which financial markets rests will be more diversified and vibrant, offsetting the bubbles that do occur.


Big Al said...

When companies like Apple, with visionary leader Steve Jobs, crank out fantastic products like the iPhone and the iPod that make money hand over fist, people say Apple/Jobs is "visionary".

When other companies attempt to stretch into new ventures away from their core business but end up losing all their investment plus some of their core biz market share, these companies are seen as "losing their way" or "taking on more than they could chew and hurting their core competency".

A lot of companies WANT to be visionary and grow into new market opportunities but can't seem to find the right balance of investing enough and letting the effort incubate while also protecting their core competency. For every Apple success there's plenty of BetaMax or 8-track tape or DEC failures.

Every politician and CEO declares "we MUST innovate and grow new markets!" What they don't voice is the "we" they are referring to is every other biz leader. Innovation is great as long as someone else is paying for it.

David said...

Ron-O, What was Roubini's answer? I agree with you on this one and Al's also right that it's always someone else that should innovate. You know how hard it is to innovate where you are or how hard it was where I was once. George Brown was driven out because he wanted to innovate across-the-board in his arena.

We know the current stimulus spending won't increase innovation to any significant extent and neither will the pork spending attached to every piece of legislation. So how do you propose to provide businesses with incentives to innovate beyond giving them tax breaks for it? Direct investment? Who evaluates?

I don't know that you're advocating it but government intervention or funding isn't going to produce innovation any more than it will to produce better health care for more people.

By the way, check out Obama's shell game remarks today on paying for single payer health care. He's either confused or knows people aren't smart enough to understand.

Why doesn't he just admit the cover of The Economist this week is correct in showing him in doctor's garb with a big needle saying "this is going to hurt."

Life Hiker said...

I see a lot of innovation going on in America, mostly driven by new problems we need to solve. Innovation doesn't just happen out of thin air; there needs to be a market that some smart person can perceive and then develop.

What are the new markets of today? Clean energy and energy efficiency...advanced health care processes and technology...novel approaches to housing and transportation...a whole new way to educate our kids and adults...and I bet you have some ideas, too.

We've got a lot of smart people, some of whom are now at loose ends, and we've still got a lot of capital looking for a good home.

My guess is that America will look a lot different in only 15 years. Onward, entrepreneurs!