The Anatomy of a Bubble 3-4-08

When the dot.com bubble burst in 2000, trillions of dollars of value vanished yet the expected severe recession arrived as a minor downturn. We were spared the full effects because the housing bubble followed quickly and re-created the fictitious wealth and debt necessary to refund the system.

The recession that we are just now entering could be an economic disaster, unless we float another bubble, create the fictitious value necessary to refund the system and we get well along within the next nine months. Then we just might get by again with a short and shallow "soft landing".

Economists do not pretend to understand financial bubbles. They have treated these periods of irrationality as some kind of oddity specific to some peculiar time and place. Economists like to cite the financial bubble in tulip bulbs in the 17th-century and segue into the dot.com firms of the late 20th. That was the way things were.

Now financial bubbles are coming at us one after the other, not decades or even centuries apart. And they are showing some consistent but disturbing patterns, as though they are now a necessary part of modern capitalism and the business cycle.

In the old days, a business cycle was described as a sequence of boom and bust: businesses over-produced, slowed up production to work off excess inventory, and the economy slowed bringing on a minor recession. That simple world is in the past.

Now the economy is suffering from a bipolar disorder where each manic bubble is supposed to be followed by a depressionary collapse. Only the last two times, something strange happened: a new bubble arose to provide the finance necessary to keep the economy going.

The Internet-based dot.com bubble was funded by a feedback mechanism inherent in the recurring round of IPOs. The baby-boom demand for housing and its bubble were based on securitization -- turning home mortgages into tradable instruments where cities, pension funds and school boards could "safely" park their money.

When a bubble bursts, the funds are no longer in the pipeline to finance a new school building, to pay the necessary amount to the pension fund or to permit the normal funding of business activity. This cessation of spending would have brought on a recession except that each bubble produced a new source of funding.

We are now in the down portion of our bipolar world and trillions are again being lost. We need a new manic stage of debt and fictitious value and it could come from any number of sources: alternative energy, the environment including global climate change or even infrastructure and education. There is a clear economic agenda of needs.

There is a problem; these options may have already been preempted. This system of chained financial disasters is, unfortunately, occurring in parallel with and feeding into a series of military and political shocks. In this scenario, the attacks of 9/11 provided the excuse for a "disaster capitalism" bubble.

According to a recent book, The Shock Doctrine by Naomi Klein, the forces favoring globalization of the economy and privatization of the government have used shocks like bursting bubbles, 9/11 or Katrina to impose the neo-con economic agenda of war, tax cuts, de-funding of social services and the erosion of civil rights. Klein notes that the neo-cons quite explicitly want to use the turmoil and chaos of these disasters as the opportunity to impose their agenda.

The Iraq war, homeland security and the general privatization of government functions clearly offer the opportunity for a bubble. In addition, the $1 trillion a year budget of the military-security complex is available to the US financial community via China and the U. S. Treasury.

It could well be that we are already in the midst of a disaster capitalism bubble. In that case, we will not get a chance this time around to address energy, the environment and infrastructure and thereby do something to bolster our failing international competitiveness. It all depends on who we elect.