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A little overNASDAQ Your browser does not support the element. a decade ago Seth Klarman, a hedge-fund titan, worried that an asset-price bubble was emerging. He identified Tesla as one of the firms best exemplifying exuberance in the market. At the time, Elon Musk’s electric-vehicle company was worth around $30bn. Today its stockmarket value is $1.3trn.Identifying a speculative frenzy, and when it might end, is a difficult task for even the most talented investor. That does not stop lots of them—talented and untalented alike—from trying. America’s tech-heavy index of share prices has quadrupled over the past decade. With valuations looking steep and excitement about artificial intelligence at extraordinary levels, investors are once again talking about a potential bubble.But what if it is not just investors who get bubbles wrong? Economists usually malign financial manias for misallocating resources, with capital directed to inefficient corners of the economy. Now, though, a growing body of research suggests that bubbles may have advantages, even when many of the investors involved lose money. Byrne Hobart, a financial-newsletter author, and Tobias Huber, a tech investor, make the case in a recently published book, “Boom: Bubbles and the End of Stagnation”. They argue that a culture of risk aversion, shaped by ageing populations, has led to economic stasis. Financial exuberance may help escape this trap, they suggest, by driving investment in technologies that offer potentially spectacular rewards for the world.The economic definition of a bubble is surprisingly loose. One is said to occur when asset prices rise above any plausible underlying value, simply because investors expect to sell the assets at a higher price in the months or years to come. For Charles Kindleberger of the Massachusetts Institute of Technology another factor was crucial: a bubble had to pop. Booms are not typically thought to have wider benefits for society, and the subsequent crashes impose heavy costs on investors who bought into the rally. The worst implosions result in economic downturns.In their book, Messrs Hobart and Huber take unusual turns, touching on René Girard, a French philosopher, and the similarity of financial bubbles to Christian teaching on the revelation. But their argument is grounded in history. Although investors made losses, the railways laid during a British mania for trains in the 1840s ended up being useful, for instance, as did high-speed internet infrastructure built in the dotcom bubble of the late 1990s.The authors are not alone in their view that the social benefit of some bubbles outweighs the costs to investors. Number-crunching by Randall Morck at the University of Alberta finds that corporate research-and-development spending provides much more of a boost to the broader economy than it does to investors’ returns, which suggests that what looks like wasteful capital allocation from a financial perspective is rather more benign from an economic standpoint. Similarly, Bill Janeway, an economist and venture capitalist, has suggested that “productive bubbles” exist. These help explore uses for new technologies even if most of the ventures involved end up failing.A bubble popping is never pleasant for investors who bought into the rally, but not all are equally dangerous for the economy. William Quinn and John Turner, both of Queen’s University Belfast, divide instances of financial mania into categories based on their underlying cause, the source of the market enthusiasm and their size. Instances in which banks become heavily involved and those that are triggered by political shifts, such as changes to regulation or taxation, can leave deep economic scars, the worst of which remain visible for decades (think of America’s housing bubble, which built in the mid-2000s, or Japan’s land and stockmarket frenzy, which emerged in the late 1980s). By contrast, bubbles that suck in little leverage and have an obvious technological spark, such as the British bicycle mania of the 1890s, which led more than 100 initial public offerings by cyclemakers, tend to have much less wounding economic consequences, and sometimes even boost innovative activity. The arrival of speedier personal transport brought important economic benefits.What does this mean for the current artificial-intelligence frenzy? The enthusiasm is very much a stockmarket, rather than a banking, phenomenon, as can be seen in the spectacular recent performance of companies including Broadcom, Microsoft and Nvidia. It is also pretty easy to identify spillovers that could benefit society more widely, whether in the consumer surplus generated by technological advancements or the physical infrastructure provided by associated investment in electrical grids.But the challenge, even for Mr Janeway’s productive bubbles, is that the boundaries of a frenzy are rarely tidy. Market exuberance tends to spread. Heightened growth expectations in one industry buoy those in others. Credit investors are already being enticed by the currentexcitement, for instance. They are rushing to finance the data centres and other commercial-property infrastructure required by fast-growing artificial-intelligence firms. The longer a frenzy lasts and the bigger a bubble grows, the more it will begin to have implications for other parts of the economy.Indeed, a bubble of considerable duration and scale, where asset values are surging and sentiment is excited or even manic, will eventually draw in more staid and conservative investors. If enthusiasm about new tech means that investors everywhere become more excited about the potential for global economic growth, it will influence every facet of financial markets, including bank lending. Apologists for financial frenzies are right to point to the potential upsides of manic episodes. There is, nevertheless, a reason that people more often focus on the downsides.
