Thursday, October 16, 2008

Solar Bubble

I have heard people say that clean energy is the next bubble - over-investment in solar, etc. will cause a bust.

The thing is, bubbles have gotten a bad name, just because this one nearly destroyed the world economy.

Consider the dot-com bubble. Looking back we remember the idiotic stock prices for companies whose business plan was "take random consumer good X, grab 1% of the market via, become bajillionaires", or better yet "lose money on every tranasaction, make it up in volume".

But there is another aspect to an investment bubble. A technology bubble simply means we have overshot and put too much capital to work on the new frontier, whether that be railroads, the internet, or solar panels.

One result of the mis-allocation of capital is chaos in the financial markets; if you look up bank panics on wikipedia, you'll see that what we have now is a period of relative calm compared to the second half of the 19th century, during which we have the bank panics of 1873, 1893, 1901, and 1907. One of the main cause of those first panics was massive overinvestment in railroads and the instability of stock prices linked to that sector. (Really rich people doing really naughty stuff is another cause.)

But another result is really cheap infrastructure! In the case of the 19th century, all the railroads you can eat and then some - in our case, really cheap fast internet. (You'll hear bloggers talk about "dark fiber" - that's fiber optic line put down during the dot-com bubble that still hasn't been used, waiting for someone to buy it at bottom dollar.)

The solar people are talking about reaching "grid parity" - that is, the day that solar becomes as cheap as fossil fuels. What would happen if we over-invest and they over shoot? Cheap solar panels for all! To me, this would not be a bad thing. A glut in production would help make solar significantly more competitive - we'd effectively have market-driven dumping of solar panels which would help drive a conversion to renewable energy (which I believe is in the long term very good for the US, and even the whole world).

The housing bubble is so destructive because we all depend on our houses having relatively constant value to keep our lives running. Sector bubbles are only destructive if:
  • The sector long-term over-extends. This did not happen in the dot-com bubble. For about a year I had a lot of friends emailing me about work, but the surplus of software labor got mopped up surprisingly quickly. The investors were right about the growth of the web, just not exactly right.
  • The asset price is tied to people's financial security.
On this second point, I see it like this: people's retirement security should not be tied to stocks, because stocks sometimes lose a ton of value very rapidly, and don't get it back for a long time. We used to say people should be 100% out of stocks by retirement age; then the 1982-2000 bull market tempted us with greed and complacency.

Food for thought: can you imagine what would have happened if we had gone through with Bush's (idiotic) plan to let people treat their social security taxes as a 401K (and invest it in stocks)?
  • For one thing, a lot of that money would have flooded into the stock market, pushing up peak valuations significantly higher than the 14k dow* we saw.
  • We would still have had the pull-back when the debt markets blew up. We would have just fallen a lot further.
  • That would mean an even larger contraction in bank would have been this credit crisis on steroids. Would we have survived it?
If there are two lessons for retirement finance from this whole mess, I think it is this:
  1. Given 50% of stocks held by those over 50 and the massive volatility in the market, I question whether it makes sense to give the average American more choice in how he or she allocates his or her retirement money. I'm all for freedom, but we have to ask: were we all better off when we got defined-benefit pensions? Have we just been tempted by the possibility of riches into accepting the risk of losing all of our retirement? When the market tanks, do a lot of people not say "thank God for social security"?
  2. The financial industry is really good at taking our money....see all of the fees and other such rip-offs that go along with 401ks. The only winners of privatizing social security would have been the mutual funds that got to take 2% of our retirement money every year.
I realize there are serious philosophical questions here about personal and collective responsibility...a crisis like this makes us re-evaluate our principles. This is good! Our previous principles might not be wrong, but it's good to question them and think hard about them; the rules of the finance game are set by all of us to meet a greater good - they are not immutable laws of physics. We all need to think hard abou what kind of world we want to participate in creating.

* I don't think the dow is a very good measure of the stock market (and the stock market is not a very good indicator of much of anything, except for the current market price of stocks), but the numbers (14k, above 10k, below 10k) are easy to remember.


Anonymous said...

Bubbles are natural, and being a product of evolution ourselves, we are susceptible to them. Nature is not in balance; it just looks that way from the perspective of human time. The earth changes; species thrive or decline according to opportunity and competition. As human beings we are one of the most threatening species in terms of our ability to affect nature on a large scale both by our technology and our sheer numbers. We also have the ability to be rational and think ahead.

Being rational to some extent, we elect governments to maintain social order and our wellbeing - that is one of their primary functions - and it includes protecting citizens from criminal or irresponsible agents, as well as natural or man-made disasters. For such purposes we make laws, create institutions and appoint overseers.

In the subprime mortgage fiasco, these institutions and overseers failed to understand risks associated with repackaged mortgages, not to mention measure its extent and maintain some control by sensible regulation. We need the best brains in government and its institutions; people with the smarts, humility and fortitude to ask the right questions, find the right answers and stand up to the pressure of greed and politics. Sadly, it's not what we've been getting. Even sadder, the press and analysts are even more clueless and parochial.

A bubble is a great investment opportunity; the trick is to recognize when to be out of the market. Getting on board early makes it relatively safe; get in late and the downside risk increases, becoming almost suicidal at some point. Miss it and you'll see everyone around you laughing all the way to the bank. At such times it takes discipline to fight the herd instinct and stay away, or sell into the rise.

More bubbles are on the way, with promises of compelling benefits in health, energy and labor saving technologies. As usual, they'll over-inflate and burst, but we'll eventually benefit from the technologies (if we don't go broke in the meantime). I say, bring 'em on!

LATWTTB (laughing...)

instigator-ash said...

The problem with fixed-benefit pension funds is that underneath them is an investment company. It's just like a 401k, with your hands further from the levers. It has the same has the same weakness in terms of operating cost, and the added disadvantage of a fund manager trying to make money for you (increasing operating costs) and heavy rules forcing divestment in a fallen market.

That said, I'm glad Social Security isn't in the stock market.

(This is your brother's account from a random roleplaying game, btw.)