PBS: Think Tank: Transcript for "Economic Bubbles "

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Economic Bubbles

Dan Gross, welcome to Think Tank. We hope this is the first of many visits.
DANIEL GROSS:
It’s great to be here.
BEN WATTENBERG:
We normally start by asking our guests a little bit about their personal history.

DANIEL GROSS:
Briefly, I’ve been a journalist for about 17, 18 years. I went to Cornell University, have a graduate degree in American history. But I focused largely on-- business and economic history and the links between business and politics-- and the sort of culture of Wall Street, the culture of money. So, I-- a few books, a lot of magazine articles, and I’m now a columnist at Newsweek.
BEN WATTENBERG:
And you have a-- a precocious family also in the economic trades, is that right?
DANIEL GROSS:
Well, not so much in the trades, but-- both of my brothers work in different capacities on Wall Street, and that’s sort of informed some of my understanding of how this world works.
BEN WATTENBERG:
tell us about-- economic bubbles. We hear so much about them. Are they-- what are they? Are they good, are they bad? And then we can argue a little bit.
DANIEL GROSS:
The conventional wisdom is that they’re bad. We went through it with the internet phase, we’ve seen it now with housing. We’re suffering the aftermaths. Communists tend to think that these are explosions of irrational behavior, which is never good. You tend to see a lot of losses, as we saw with, you know, the NASDAQ and all those dot coms melting down.
There’s always a focus when bubbles burst on the people who get hurt, whether those are sub-prime borrowers-- the employees of WorldCom, investors and companies like Global Crossing. But when you look at little deeper in the history-- you see echoes of the dot com boom and bust, the housing boom and bust, you can see them back with stocks in the 1920s, with the telegraph in the 1840s and the 1850s, with the railroad in the 1880s. The exact same kind of language, the exact same kind of culture, of speculation, the exact same bursting of the bubble, bankruptcies, failures, self loathing of the people involved, and that’s usually where the story ends.
BEN WATTENBERG:
You say self loathing? That-- that-- the players themselves don’t like what they’re doing?
DANIEL GROSS:
WE, as a society, look and think, 'How could we have been so stupid--
BEN WATTENBERG:
Oh, you mean-- you mean--
DANIEL GROSS:
--to-- to think that--
BEN WATTENBERG:
--the-- the-- the investors, not the promoters.
DANIEL GROSS:
Exactly. Promoters tend to sort of move on quickly to the next thing.
BEN WATTENBERG:
Well, I-- I think they think they-- they were doing good things. They were developing-- important new goods and services.
DANIEL GROSS:
Absolutely. The upside of bubbles, especially the-- when they revolve around a new kind of infrastructure-- is not in the companies that are created during the bubble. It’s what comes after. In other words, all the people who strung up the telegraph wire went bankrupt. But it set the stage for new types of businesses.
BEN WATTENBERG:
Yeah, but-- but all the people who started Yahoo didn’t go bankrupt. And all the people who started Microsoft didn’t go bankrupt.
DANIEL GROSS:
No, they did quite well.
BEN WATTENBERG:
They-- they did, quite. So, I mean, it’s a-- it’s-- it’s mix and match.
DANIEL GROSS:
Sure. Yahoo is not an infrastructure company per se. A lot of the people who-- who built the excess fiber optic cable capacity-- you know, 2001 only about five percent of the fiber optic cable was in use in this country.
BEN WATTENBERG:
And-- and what percent is now?
DANIEL GROSS:
It’s probably getting-- close to 50. And what that did, you had, you know, Global Crossing and WorldCoM, all these companies building way too much. They couldn’t get-- there wasn’t the traffic. They all went bankrupt. But we didn’t go then and rip out the fiber optic cable. It became very cheap, and other people figured out how to use it very quickly.
Google is a classic example of a company that was built on the wreckage of a bubble. It was able to latch computer servic—servers, that were very cheap, together with the fact that everybody now had broadband, and that everybody was using the internet. And all these businesses, blogs, online advertising, online video, things that didn’t quite work in the ’90s because the infrastructure wasn’t there, have since become significant businesses all built on the cheap infrastructure that was laid down during the bubble.
BEN WATTENBERG:
And, just to go back in history, all the railroads did not go bust. Some of them became-- the-- are-- are still in business. So, I mean, it-- it’s-- I-- I get your point that even when they go bust, it’s-- it can be a-- a success for the society. But sometime it’s a-- a huge success for the investor and the promoter as well.
DANIEL GROSS:
Right. If you go back to the-- the great era of railroad investment was after the Civil War. I mean, the 1880s in particular, a huge amount of network building. Instead of one transcontinental railroad, we ended up with four or five. Chicago had 30 freight lines coming in and out of it. Eighteen ninety-three, 1894 there was a recession-- a lot of these companies went bankrupt. About a quarter of the railroads in this country were bankrupt in 1894. The consolidators, people like JP Morgan-- picked up the remnants of these, cobbled them together--
BEN WATTENBERG:
And-- sticks them together, right.
DANIEL GROSS:
--into large networks. All of a sudden, you had pervasive, cheap freight. So, when a company like Sears or Montgomery Ward came along with a business model that was, 'We’ll send our merchandise via rail anywhere in the country,' the concept of mail-order catalogues, that was not a viable business in the 1870s, when this network hadn’t been built, when freight was not reliable and was still expensive.

The price of rail freight plummeted in the latter part of the 19th century. And it was pervasive, it went everywhere. So that if you wanted to build a business based on sending individual parcels from Chicago to Kansas to California, that made sense. And that created a whole new mode of retail, and that survived.
BEN WATTENBERG:
let me ask you a question. The-- the famous phrase of then-chairman Allan Greenspan-- of the Federal Reserve, 'irrational exuberance,' is sort of a synonym for bubbles. And he uttered that when in-- what year was that, do you recall?
DANIEL GROSS:
Ninety-six.
BEN WATTENBERG:
Ninety-- at-- at a dinner of the American Enterprises night.
DANIEL GROSS:
Uh-huh (AFFIRM).
BEN WATTENBERG:
I was there, did not know what he was talking about! And the Dow was then 6,000. And everyone’s saying, 'Oh my God, Chairman Greenspan said it’s going down!' I remember the Japanese journalists running to the phones. (LAUGHTER) And within a year, the Dow was at 9,000. So-- the-- the idea of-- again, I think this backs up your point of bubbles being bad, is-- is not true in a healthy economy.
DANIEL GROSS:
Well, it shows that the ability of the federal reserve to control what people do, speculation investing, is not what a lot of people think it is. People would attribute to Greenspan and to the Fed kind of these magical qualities. You know, that they can burst the bubble when they want to. I think the history has shown that even if they want to burst the bubble-- it’s very hard to do it. When people get--
BEN WATTENBERG:
Not if it’s got real value to-- to consumers. I mean, if people wanna buy what’s in the bubble, and it-- it’s as real utility, no matter what the Fed does, it’s-- it’s-- it’s gonna grow.
DANIEL GROSS:
But it’s also the psychology. I mean, we see this time and again. Americans have a-- compared with other cultures, have a much more entrepreneurial-- bent. We have a tendency towards optimism, towards risk-taking. And so when these new things come along-- they don’t have the same impact in say, France and Germany, as they would in the US, where the-- the private sector grabs a new innovation and runs with it.

The government is always involved. It was involved in ticking off the telegraph, it was involved in ticking off the railroad, it provided subsidies for the internet. But in each of these instances, it was the private sector kind of picking up the ball and then sprinting down the field--
BEN WATTENBERG:
You know, you’re talking about the American business culture. It-- it’s very interesting. If a entrepreneur starts a company in Japan, in South Korea, in England, France, Germany, and it goes bust, that-- that entrepreneur is going to have a great deal of difficulty in the rest of his life trying to-- because people don’t trust him.

In the United States if you start a-- a dot com or-- or whatever-- and you go bust, you are a hot property. People wanna hire you because they say, 'This guy has gumption, he knows how to start a business. He missed it the first time, he’ll-- he’ll-- he’ll get it the second or third time.' And that’s a very healthy and vibrant feature of our economy in reality.
DANIEL GROSS:
Absolutely, it’s a combination of a bankruptcy system, which is, you know, which is not punitive. Britain, they had debtor’s prisons. You couldn’t pay your bills, you went to jail. Here, we have a system where the debts get-- you give up your equity to the lenders, and everybody moves on with their lives. It’s not a-- it’s certainly a disappointment to go bankrupt, but it is not a scarlet letter. You don’t walk around with a big red B on your lapel that prevents you from functioning in an economic society.
BEN WATTENBERG:
Now, as I-- reading from your book, you had some -- a harsh phrase or two about that-- very controversial book, Dow 36,000 by Jim Glassman, one of my collegues at AEI Jim Glassman, and Kevin Hasset. And what’s your problem with that?
DANIEL GROSS:
Not so much a problem. But it is a symptom of speculative bubbles. I go and I identify the phases. You get a new innovation, you get a new economic assumption. In the 1990s it was both the internet and the new economy. You saw a-- a version of this in the ’20s, when there was this talk of a new era.

Then you get a lot of-- a few years of real growth. And then people latch onto it. It crosses over into the popular culture. And one of the signs, one of the symptoms that it has crossed over into the popular culture is when promotional books-- whether they are from pundits, economists, analysts of all type, come out and make promises that extract-- that extrapolate the recent years of impressive growth indefinitely into the future.
BEN WATTENBERG:
Just hold on a minute. I will say you’re gonna hit-- Dow 36,000 within 13 years.
DANIEL GROSS:
Thirteen years from now?
BEN WATTENBERG:
Yeah, and we can bet a dollar--
DANIEL GROSS:
Two thousand twenty?
BEN WATTENBERG:
--we-- we can bet a dollar on it.
DANIEL GROSS:
Thirteen thousand?
BEN WATTENBERG:
And-- and-- and remember, each succeeding thousand is easier than the previous--
DANIEL GROSS:
I understand that
BEN WATTENBERG:
in every, Dan this is Jeremy Seals book, in every ten year period, if you-- invested in the Dow and re-invested the dividends, you came out ahead. In other words, even from 1929 to 1939, not by much-- but even then, in the middle of this terrible depression, you ended up plus. And-- some years, obviously some decades, you could triple your money or more than that.
DANIEL GROSS:
Right.
BEN WATTENBERG:
So, I mean-- the-- the only point I’m-- I’m trying to get to is-- is the basic axiom, never sell America short. I don’t think you would disagree with it.
DANIEL GROSS:
Right.
BEN WATTENBERG:
I mean-- this is a remarkably free and healthy economy. And it’s-- its’ healthy because-- the way I see it-- because our political culture is liberty. We have a lot of regulations, which we need. But when you let free people do their thing, they do pretty well.
I wanted to talk about this-- alternative energy thing.
DANIEL GROSS:
Okay.
BEN WATTENBERG:
Now, there is one-- my own sense is that the cheapest way and most effective way, still, to produce a BTU of energy is hydro-carbon fuel, hydro-power and nuclear. The other things, there are bio-mass, ethanol, wind mills, are essentially uncompetitive. They are highly subsidized-- and if you’re lookin’ for a bubble, if I had to guess, unless the government keeps propping it up, that’s where you’re gonna get a collapse.

DANIEL GROSS:
Well, it’s true that, you know, ethanol without the subsidy is not necessarily competitive with oil. It’s true that solar without the subsidy is-- certainly not as reliable as gas-fired plants. It’s true that wind is still not there.

One of the things that happens in bubbles, however, is that, you know, you get all this capacity. And when the companies behind that capacity go bankrupt-- bankrupt, somebody takes them over at a much lower cost basis. So, that tends to bring the price down.

The second is that when these things evolve from cottage industries into massive global industries, which is now happening with wind and solar, it’s-- happens with everything in mass production, the price tends to come down. You know, engineers work their magic, just as we’ve seen with computers and the price of computers, really deflate year after year after year after year, I think it’s a safe bet that over time, the cost of a solar panel installation, the effectiveness of a wind turbine that GE is building, those will get better.
BEN WATTENBERG:
Yeah, but-- but--
DANIEL GROSS:
So that the cost--
BEN WATTENBERG:
But they’re--
DANIEL GROSS:
--of generally--
BEN WATTENBERG:
--there are also engineers working on-- on coal and on nuclear. And I-- I’m not saying-- I mean, the-- look, the Dutch used windmills. If you can harness it-- and the-- they’ve used tithes and-- you know, it-- I’m not against those things. But ultimately, the-- the low-cost, clean provider will prevail. In my judgment-- nuclear has gotten a shabby deal.
DANIEL GROSS:
Yeah, well the-- yeah, the challenge with the US is where you’re gonna put those nuclear plants. Because no community at this point seems to want it. But I do agree that is the--
BEN WATTENBERG:
So-- so-- so-- so--
DANIEL GROSS:
--the quickest way to get electricity from sources that are not coal, gas or oil, would be nuclear.
BEN WATTENBERG:
So-- so-- in our-- in our wisdom, instead of putting them in one safe place, we put ’em in lots of unsafe places. I mean, you’ve got these slap board, these-- pools all around the country. And-- what the French do is sink ’em-- vitrify it, enclose it in glass, and sink ’em into deep wells
DANIEL GROSS:
Part of the trick with solar-- and I think one of the issues is-- or not just solar, but all sorts of alternative energy is that people say, you know, compared with coal or gas-- you know, it’s not cost effective. Frequently, that assumes that the prices of these will remain-- stable. The price of oil-- if the price of oil goes to $80, $90, $100 a barrel, and, you know, keep in mind a few years ago people would’ve said the notion of $70-- a barrel of oil persisting for a period of years was unthinkable.

If those prices continue to rise, then a lot of these alternative energy sources tend to make more sense. And if the cost of using coal is increased, not because coal gets scarce but because of something like a carbon tax, caps on emissions, things that have the effect of raising the price of coal, then alternative energy sources tend to make a little more economic sense. And there are places in the world, like Brazil, where they produce ethanol from sugarcane--
BEN WATTENBERG:
Right.
DANIEL GROSS:
--where they harvest, they make a ton of it, they have cheap labor, they make it-- they refine it on the site so the cost is not that great. They’re producing an alternative source of energy that is competitive with oil right now.
BEN WATTENBERG:
what is your take in this context of the role of government?
DANIEL GROSS:
I think the role of government is something that’s kind of misunderstood when it comes to bubbles. We like to think of them as these outbursts of entrepreneurial id-- you know, the private sector latching onto something and doing its thing. When you look back on all these bubbles, the telegraph, the railroad, the internet, housing, government policy always plays a very important role.

We have subsidies today for ethanol. Without the subsidies and the tariff on foreign ethanol, we wouldn’t have anywhere near the level of investment in ethanol and all sorts of alternative energy. You know, Congress commissioned the first telegraph line, went from Washington to Maryland. They gave all sorts of land grants and financing for the railroads. There’s a huge amount of subsidies in the form of mortgage, interest deduction for housing, Fannie Mae, Freddy Mack.

All these government programs over the years have helped channel investment into certain areas. And I think that is generally underappreciated. The second role is the role that the government plays in helping clean up the mess, whether it was-- the FDIC and all the stuff from the New Deal that created a new economic infrastructure, the FCC, after the bust of the ’20s-- whether it’s the bankruptcy system, which enables for an orderly workout of these problems.

You see time and again that the network of kind of regulations, backstops, social insurance that we have provides a safety net. And a lot of people say that the safety net in the US isn’t what it should be. But it clearly provides something of a shock absorber to enable people after the failure, after the bubble bursts--
BEN WATTENBERG:
Yeah, and-- and-- and--
DANIEL GROSS:
--to get up and move on.
BEN WATTENBERG:
--and we saw what happened in the 1930s without a-- FCC and a Federal Deposit Insurance Corporation and things like that. I mean-- the government can sometimes do some pretty stupid things, but it-- it can also provide that-- that stability, which is the rock upon which every financial market must rest.
DANIEL GROSS:
Absolutely-- Ben Bernanke, the Chairman of the Federal Reserve, has written a book of essays about the Great Depression and what we can learn from that. And he has a line in there where he talks about, you know, how the economy got going again. And, you know, clearly not everything that FDR proposed worked or made sense, but he writes very clearly that it was only with the advent of the New Deal kind of-- regul-- regulatory scheme, the SEC, the housing and there’s sort of the banking acts, it was only after that that the economy started to come back to life. People had the confidence to invest, to save, to put money in the banks again.
BEN WATTENBERG:
Now-- let’s go back to-- housing. How-- how does that-- how do you see that shaking out?
DANIEL GROSS:
You know, it’s always hardest to see the upside of bubbles right after they pop. Think back to 2001 with the internet. We had convinced ourselves that the whole thing was a scam. All these bankrupt companies, these businesses weren’t real. No one in 2001 would’ve said, you know, Google is going to be a $150 billion market cap company come 2006.
BEN WATTENBERG:
That’s a lot of billions.
DANIEL GROSS:
So, right when the bubble pops, when it’s darkest, it’s hardest to see the upside. Clearly, with housing, you know, a lot of the speculation was financial. That doesn’t leave behind a whole lot you can use. But, you know, none of the housing that was built-- we got a lot of new housing stock, a lot of renovations. That’s not gonna get torn down.
BEN WATTENBERG:
Well, and-- and also, you-- you’ve got the roads, the sewers, the-- the telephone lines--
DANIEL GROSS:
All the infrastructure.
BEN WATTENBERG:
--and-- and you’ve got the building. So, if-- if one builder goes bust or one-- one person can’t pay his mortgage, as you’ve written so eloquently, the next guy comes in and gets a bargain.
DANIEL GROSS:
That is one of the upsides. A second is this whole culture of re-financing, you know, a lot of the press today is about people who got in trouble by re-financing, by going to, you know, these weird mortgages that re-set at higher rates--
BEN WATTENBERG:
Right.
DANIEL GROSS:
--for every person that got caught up in that, there was another person or perhaps more who did very well by simply exchanging a fixed rate mortgage for one at a lower rate and doing it again and again and saving themselves--
BEN WATTENBERG:
--that’s what I used to do, just keep rolling it over.
DANIEL GROSS:
--upwards of thousands of dollars. The mechanisms to do that, the mentality to do that, the idea that, the idea that individuals watch interest rates, if they fall 50 basis points, 100 basis points, you re-finance. And that the mechanisms are there to do that quickly, which did not exist in the ’80s or even the early 1990s. Going forward, that has to be a big econom-- economic positive.
I think the big trend we’re going to see, and we should see more of, is the notion of global indexes. Right now, you know, so many 401K options, which is the vehicle through which most people invest and other things like these college savings programs, many of them are limited to, you know, S&P 500 funds, to US indexes. As we see, the US, we’re still the biggest economy in the world. But every year, we’re a shrinking component of the overall whole. And with market capitalism growing in India, China, Russia, all over the world, with companies emerging from these places, with the biggest IPOs now happening in China, I think the theme we’re going to see--
BEN WATTENBERG:
IPO stands for what?
DANIEL GROSS:
I’m sorry, initial public offerings.
BEN WATTENBERG:
Right.
DANIEL GROSS:
New issues of stock. The biggest ones these days are happening, not in New York, Chinese companies. A lot of the wealth creation is going on in these parts of the world. And I think what we’re going to see is advisors telling their clients-- their wealthy clients, the clients of modest means, not to be so parochial. That if you wanna participate in the upside of equity ownership, like we’ve seen in the US the last 30 years-- you are going to have to start looking more global.
BEN WATTENBERG:
How-- how do you-- I mean, there’s been a lot written now about America has reached its peak, and we’re gonna go downhill and manage our decline gracefully. Where do you see America economically in ten, 20, 30 years?
DANIEL GROSS:
Well, clearly I think our-- our growth is probably going to slow. Allan Greenspan has his new memoir out, and the last chapter is him speculating about what will happen to the economy in the next 25 years. And he looks at things like-- demographic trends with our aging population, productivity trends. You know, we may have gotten the most juice out of this hugely forward and information technology. And see is basically the economy growing at a somewhat slower pace, somewhat less productivity.
BEN WATTENBERG:
But it-- it’s been growing at historically high three and a half, four percent. If it-- I mean, even at a moderate rate of growth, two and a half, two seven five, you’re going to have-- in the 19-- in the 2020s a 25 trillion dollar economy.
DANIEL GROSS:
Sure.
BEN WATTENBERG:
I mean, it-- it is a-- those things are compound. And my own view is that Allan Greenspan has been wrong before.
DANIEL GROSS:
That’s heresy!
BEN WATTENBERG:
No, it’s not. I-- listen-- go ahead.
DANIEL GROSS:
I was going to say one more thing is the-- you know, we are already much more a player in this global economy than we like to think. You look at the S&P 500, 500 biggest stocks. For a typical one, they’re already getting about 40 percent of their revenues from overseas. The notion that economic growth in India and China will be seven or eight percent a year, and we’ll only be three percent a year is not necessarily damaging to the United States or to our stature in the global economy.

Because we have the infrastructure that can plug into that. We have the companies that are global brands. We have open markets, we have a history of exporting and importing. We have brands that can establish themselves in there. So, global growth is good news for the US even if it results in us, rather than accounting for a quarter of the world’s economy, only accounting for 15 percent.
BEN WATTENBERG:
No question that. And-- and there’s something else. We are the only major democratic country or-- or major country that is-- has a demographic glide path upwards. We have-- India, China, all the European countries, Russia, are all going that way. And that is essentially in my view-- a healthy phenomenon. I mean, you-- you are going to see an America which is still a vastly under populated country in a couple hundred years at 500 billion people.
Dan Gross, thank you-- very much for joining us on Think Tank. I have to check my Blackberry and see how the markets are doing. and-- thank you. Please send us your comments via e-mail. We think it-- helps our program. For Think Tank, I’m Ben Wattenberg.
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