Bubbles

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When the media talks about the current fiscal crisis, they like to make comparisons to the Great Depression.  Or to the 1982 recession or maybe one of the milder recessions since then.

What they rarely talk about is an event a lot more recent than 1929 or 1982 and in many ways a lot more relevant than either: the dot-com financial bubble.

What’s a financial bubble?  A financial bubble occurs when a lot of people start thinking that something is worth a whole lot more than had been previously expected, and think they can make very easy money buying it now because they believe it will be worth a whole lot more later.  

At first, there may be very good reason to think that, but as more and more people see others making money buying whatever, they jump on the bandwagon not wishing to miss out on a good thing, which eventually pushes prices up past any cold-blooded assessment of the desired item.  Then something or a bunch of things happen, and suddenly people turn from loving the item to hating it, and the price plummets.      

While there were much different reasons why the dot-com and the real estate bubbles occurred, they both shared the characteristics of a particular sector showing legitimate potential, prices rose rapidly for a while, then they staggered a bit and then went into rapid decline.  

The dot.com bubble is long over.  The current crisis is still a developing story.  Can the first teach us something about the second?  

Sure.  The main lesson it teaches us is that we’ll live.  The bursting of the dot-com bubble caused the value of the NASDAQ alone to drop over $5 trillion dollars.  A lot of companies died when the dot.com bubble burst, but the computing industry is still around, bigger than ever.  The Internet is still around, bigger than ever.  Internet commerce is still around, bigger than ever.  Even Amazon eventually made a profit and is still around, bigger than ever. 

Yes, burst bubbles and the financially bad times that usually follow them are painful, but what they really are is a kind of fiscal enema.  They clean the financial system out of excesses and garbage, and unfortunately, there’s a lot of crap to clean out.  A lot of dubious business occurred as the result of hypercheap money sloshing around the world, and that has collapsed or will collapse without that cheap money propping it up.  But, in the long run, that’s not a bad thing, painful as it may seem in the short run.  Hangovers hurt after a bender, but you can’t stay drunk forever. 

Yes, good companies and people can be hurt by bad ones imploding, but if they really are good, they won’t get hurt in the areas that count.  Let’s take Intel as an example.  During the dot-com boom, Intel’s stock price got up to $75 a share.  When that bubble burst, the stock price rapidly declined to the $20-30 level and until recently has pretty much stayed so long as the real business was doing OK.  Yet the bursting of the bubble didn’t hurt Intel to any real degree as a business.  The price of Intel stock will probably never get back to those levels in real terms again, but you can’t say Intel is doomed or has failed as a business.  All that $75 price indicated was temporary insanity.    

Today, Intel’s stock price is less than $15.  That’s not due to anything foolish they did.  Yes, they’ll sell a few million less processors for a few less dollars for a while, which will knock down their profits for a while.  But people will still need CPUs for their computers and lower profits won’t cripple Intel’s ability to make them, so eventually demand will pick up and Intel will go back to making more CPUs for more money and the profits and stock price will recover.  Probably will take a year, might take a few years, but it will happen.  That’s because so long as Intel can make good CPUs that they can sell at a good price, they’re going to make a lot of money, and they don’t need cheap interest rates or people wildly bidding the price of their stock (or for that matter CPUs) to be able to do that. 

It’s only the companies that can’t thrive or even survive without such friendly help that you have to worry about in the long-run.    

Ed

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