Episode #40 - Are we in an economic bubble?
Learning history can provide an answer.
Intro:
In the early 2010s, I made my first foray into the market in the relatively speculative world of 3D printing. Between a combination of investment newsletters and a friend or two who thought these stocks were hot stuff, I poured some money into what seemed like a great opportunity. While I did manage to profit from the investment, by the end I managed to lose a fair amount of money too. The 3D printing mania (fueled by the Motley Fool folks, at least for me) came to an abrupt end. These days the mania typically surrounds meme-stocks and crypto, both things I do not fully understand or personally invest in, but I think this week’s episode will help ground your thinking around manias and opportunity in a helpful way.
If you joined recently or haven’t clicked into the newsletter in a while, one of the “Four Pillars” that Bernstein identifies (that I cover broadly here) is history. Bernstein claims that a lack of knowledge about investment history is the cause of “the most damage” to investors. Chapter 5 effectively takes you on a roller-coaster of misplayed opportunities and tremendous losses. I will pick out a few from the chapter for today’s note, and I encourage you to take a close read to familiarize yourself with the content so you don’t become like me in the world of 3D printing.
Chapter Overview:
On a macro-level this chapter comments on the long-term effect that technological innovation has on society and the economy. Two concepts embedded in two revolutions explain his thesis. First, the impact of technological innovation plays out over a long time horizon before the impact of the technology is fully realized. For example, Bernstein identifies 1820-1850 as the period with the most significant innovations that he considers to be “profoundly affecting the lives of those from the top to the bottom of the social fabric, in ways that can hardly be imagined today.” First was the improvement of transportation, it was basically 10x-ed overnight, and how communication became instantaneous.
Before the invention of the steam engine and the telegraph, “nothing moved faster than the speed of a horse,” to quote historian Stephen Ambrose. Truly remarkable. Effectively transmission of essential news has remained at that breakneck pace, even if the tools we use today aren’t telegraphs.
While these TECHNOLOGICAL change happened quite quickly, Bernstein emphasizes that the “economic and financial effects” did NOT occur immediately.
While this may refer to the history of tech-development, it doesn’t take into account the long-term economic impact of significant innovations.
This brings me to the second macro concept that Bernstein illustrates with a lovely metaphor:
Imagine a well hand pumped by a ponderous handle. Once every several seconds, a gush of water issues from the spout. The water is then funneled into a long pipe. From the perspective of the person at the pump handle - the innovator and wealthy first adopter- the water is clearly coming out in spurts. But to the person at the end of the pipe - the average consumer, and, more importantly, the investor - the water is flowing evenly (p. 131-131).
For Bernstein, the innovations of the mid-19th century are still being felt downstream by users of those technologies as they become more available to more people.
How do you know if something is a bubble?
The full breakdown of market bubbles is beyond the scope of this note, but Bernstein provides a two rules from Herman Minsky (a monetary theorist) and two more of his own that explains the driving factors that make up a bubble (p. 136).
A revolutionary technology or a major shift in financial methods which Minsky labels a “displacement.”
Credit that becomes more easily available, which enables money to be deployed more easily for speculation.
Forgetfulness clause - the last speculative craze has to be forgotten.
Rational investing becomes secondary practice to those trying to buy a plausible story.
Chalking this energy up to “euphoria” is the direction that Bernstein takes with these concepts, and if he was writing this book today, I would be that he’d take a similar stance on meme stocks and likely to much of the crypto market too.
Clock Theory of Tech Benefit
I can’t go through all of the technologies that Bernstein lists in this chapter, but one that got my attention was the advent of the marine chronometer. Effectively this was a clock that could “keep time to within one-quarter of a second per day over a six-week journey- at sea (p. 142).” This enabled sea-farers to greatly improve their craft. They could better tell directions and more effectively reach their targets.
If you were an investor, you might think “quick, buy watch stock.” Surprising, the inventor of this clock, John Harrison, saw nearly no money from this fabulous invention. The clock industry only took off with the emergence of Swatch and Rolex, way after the advent of the watch. The ones who actually made money were the users of the technology, not the makers (p. 143). This disparity of the tech not necessarily yielding fabulous reward strikes me as a helpful way to stay grounded when thinking about new technology. Sometimes the tech isn’t what is most exciting rather it’s the downstream effects.
Takeaway:
The story I didn’t cover in-depth in this letter is the steam-engine phenomenon of the 19th Century. Folks though that trains would change the world, but within 20 years the bubble “blew away.” I always thought the metaphor was burst, but the Times of London introduced the metaphor this way (p. 144). The excitement over the steam engine was premature, the proliferation of train companies fantastical, and the outcome was a large bust.
Another strong takeaway from this chapter is John Templeton’s famous warning: “The four most expensive words in the English language, ‘This time it’s different.’” Bernstein concludes the chapter this way because he recognizes that so often we are excited by the prospect of getting rich quick and a bubble being ours to fly away with, but that does not typically work out.
Interact:
What is a mania that you’ve either invested in or thought about investing in? Respond below in the comments, or just respond directly to this email - I’d love to hear what you’ve bought into!
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