We all know the downsides of bubbles, but it's not all gloom.
Boom and bust is bad, right? Well, not entirely. A lot of good things happen during a bubble, and society benefits long after the crash is forgotten.
Just to be clear, I'm not ignoring the misery that results from a crash -- foreclosures, bankruptcies, unemployment -- but we're well aware of those problems and read about them daily. Many of us are less aware of the assets that would not have been created without bubbles, and that remain with us for years afterwards.
Irrational exuberance
Asset inflation, such as a house doubling in price, is not growth; in that example it's merely a shift in the relative values of houses and money. But the investment and enterprise that asset inflation inspires does create growth.
Bubbles are caused by irrational exuberance, and exuberant people create stuff and get things done. Not always the right things, from a return-on-investment point of view, but often their creations live on after their businesses have crashed and burned.
They may invest and create because they're deluded as to what their plans are worth, but I'll defend anybody's right to be deluded -- they may, after all, be right.
The 'dot dash' bubble
That term, 'irrational exuberance', is often associated with the dot com bubble, when new equipment and fiber-optic cables were installed as rapidly as possible. And the legacy of that over-investment was, and is, extremely cheap telephone calls and Internet access.
But if we go back another 150 years to the 'dot dash' bubble, crazy dreamers went broke stringing miles of copper cable around the world, bringing down the cost of telegraphy. Decades later the same happened with the railroads in the United States. And after that, there was a property boom that transformed Manhattan.
The recent property bubble in this part of the world led to a lot of over-building too, although more so in Ireland than in the UK. True, it's sad to see shops closed, or building projects on hold, but some brave businesses that couldn't afford the formerly-high rents are now able to get started because of excess floorspace that was built in better times.
Similarly with housing, although it depends very much on where the houses were built -- some towns are better supplied than others, and building on dried-up river beds was never a good idea.
What to do?
We can learn from our mistakes, to some extent, but unless we create a new sort of human there will always be booms and busts.
When we're investing, we need to be able to position ourselves correctly, either 'knowing' when we're going to run out of other people to sell to, or sticking to conventional valuation criteria when the rest of the world tells us it's different this time.
Neither is easy, but if it was everyone would be a millionaire.
Anybody betting on where the next bubble will burst?
More: Being The Second Mouse
