Who Benefits When Bubbles Burst?

January 19, 2015

Blowing speculative bubbles cannot possibly lead to organic growth because speculative bubbles fatally undermine the real economy.

An astute reader recently posed an insightful question: we all know who benefits from asset bubbles in stocks, bonds and real estate--owners of assets, banks, the government (all those luscious capital gains and rising property taxes), pension funds, brokers and so on. But who benefits from the inevitable collapse of these asset bubbles?

If asset bubbles end badly for virtually every participant, then why does the system go to extremes to inflate them? This is an excellent question, as it goes right to the heart of our dysfunctional Status Quo.

Broadly speaking, there are three possible answers:

1. The system has no choice left but to blow serial bubbles.

2. Bubbles are domestic opportunities for Shock Doctrine-type crises that enable further consolidation of power.

3. Those in charge of the Status Quo believe the fantasy that the next bubble will usher in the long-awaited return to organic growth, i.e. expansion that isn't dependent on central bank stimulus, enormous fiscal deficit spending, ginned-up statistics, etc.

Let's consider each possible answer more closely.

1. The system has no choice left but to blow serial bubbles. The financial/fiscal Powers That Be have reluctantly accepted that the era of organic expansion driven by rising public/private debt is over for structural reasons, but they have no alternative to maintaining the current power arrangement (i.e. vested interests operate the system to their own benefit) other than serial bubbles.

In other words, it's not that the vested interests benefit so much from the collapse of the bubble-du-jour; blowing speculative bubbles is the only tool left for maintaining the illusion that the current arrangement is permanent and sustainable.

In this scenario, the Status Quo has no Plan B should the next speculative bubble fail to inflate.

2. Bubbles are domestic opportunities for Shock Doctrine-type crises that enable further consolidation of power. Naomi Klein's landmark study of how manufactured crises are used to justify further consolidation of power in the hands of the few, The Shock Doctrine: The Rise of Disaster Capitalism, provides a blueprint for how the easily predictable crises of financial bubbles popping can be used to extend the power of central and private banks and various government agencies.

In this scenario, the state (government) and the vested interests that control the state are largely immune to the losses generated by the deflation of speculative bubbles, thanks to the state's ability to borrow essentially unlimited sums of money to cover the losses incurred by private speculators.

Profits are privatized, losses are socialized. Banks and other financier speculators reap outsized gains during the bubble's inflation, and the state covers their losses when the bubble pops.

The central banks are able to extend their already vast powers with ease during the financial crisis of a bubble popping, and this expansion of financial power is symptomatic of the general dominance of financialization over the economy's productive assets.

The problem with this scenario is there are limits on the system's ability to inflate speculative bubbles. Eventually the economy is so hollowed out by debt and speculative excess that bubbles can no longer be inflated. The end result is power has been fully consolidated in the hands of a few, who are then responsible for fixing the post-bubble economy they created to further their own power and wealth.

Post-bubble economies cannot be fixed if the current power structure remains intact, so the Powers That Be face an impossible task.

3. Those in charge of the Status Quo believe the fantasy that the next bubble will usher in the long-awaited return to organic growth. As absurd as this may seem, I don't think we should discount the naivete, real-world inexperience and credulity of those in power--not just in the state, but in think-tanks, academia and central banks.

Keep in mind that these organizations ruthlessly select out dissenters and those with real-world experience. Those who question the Status Quo arrangement in academia, think-tanks, state agencies, central banks, etc., are weeded out: passed over for advancement, sent to Siberia, marginalized or fired. Those left in charge have little real-world experience outside the cloistered halls of power, and little willingness to risk their own rise to power by questioning the Keynesian Cargo Cult's serial bubble-blowing as the magic that will spark organic growth.

This quasi-religious faith cannot be questioned, for the simple reason there is no Plan B. There is no official policy alternative to the Keynesian Cargo Cult's serial bubble-blowing, because any alternative would necessarily disrupt the existing power structure.

It doesn't really matter which answer we choose; blowing speculative bubbles cannot possibly lead to organic growth because speculative bubbles fatally undermine the real economy.

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