By James Mackintosh
Recent experience and financial lore have created the impression
that the bursting of market bubbles brings economic destruction.
But it isn't always so. The excess in today's story
stocks--electric cars, clean power and cannabis in
particular--surely poses a threat to the wealth of their
shareholders. Even if there is a wider bubble, it might not be a
catastrophe for the country.
The experience of the past few decades suggests the opposite.
Japan is still scarred by the 1980s property and stock bubble, the
dot-com bubble led to massive losses and the subprime crash created
a global crisis.
But not all bubbles are equal. The economic dangers of a stock
bubble come from people taking on debt to buy shares and from
companies overinvesting. When the bubble pops, overextended
shareholders have to cut spending or go bankrupt. Companies
suddenly faced with investors demanding a return have to lay off
workers and slash investment.
None of this is an issue for the obvious bubbles under way in
the fashionable stocks of the moment. Tesla is valued so highly it
is now the U.S.'s fifth-biggest company by market capitalization.
Even if the electric-car maker vanished tomorrow, it would have an
insignificant effect on the economy, as Tesla's operations are
tiny. It is mostly equity-financed, so its failure wouldn't start a
domino line of bank failures. And while shareholders would be hurt,
there's no reason to think that would lead to a collapse in
spending across the country.
The closest parallel is not the dot-com bubble, for all the
similarities, but the British bicycle mania of the 1890s. Bicycles
were the electric cars of their day: breakthroughs in tire and gear
technology made them into convenient and environmentally friendly
transport, albeit still expensive. Investors rushed in and stock
promoters spotted the opportunity to float any company with a
connection to the industry, mostly in Birmingham. Heavy investment
led to further breakthroughs; and, at the peak, bicycle-related
patents made up 15% of all the patents issued.
Bicycle stocks were helped by what was then the lowest yield
ever on U.K. government bonds, which encouraged further
mini-bubbles in Australian mining and breweries.
In their book "Boom and Bust," academics William Quinn and John
Turner from Queen's University, Belfast, document 671 new bicycle
companies, raising GBP27 million in 1896 alone--equivalent to 1.6%
of British gross domestic product that year. By comparison, the
fast-growing IPO alternative of SPACs raised about 0.4% of U.S. GDP
last year and are running at an annual rate of about 1.3% so far
Half the bicycle companies that joined the market failed by the
end of the decade. The speculators who held when the bubble burst
were hit by a 71% fall in bicycle stocks from their peak in just 18
The regional economy suffered when the stocks collapsed, but
Britain as a whole barely noticed, and the rest of the market
wasn't much affected.
What if today's excesses aren't just in the speculative story
stocks like Tesla, but across the market? I don't think Big
Tech--including Apple, Amazon, Microsoft and Facebook--is a bubble,
because high valuations can be broadly justified by very low
Treasury yields. But if I'm wrong and shares in the highly valued
technology and associated sectors did crash, it probably wouldn't
be that bad.
Sure, investors--that's you and me--would lose money. But with a
few exceptions these companies aren't borrowing or issuing new
stock to fund new investments, and their investors aren't all that
leveraged. If Apple's share price halved, it would make no
difference to the underlying business. That is different from the
dot-coms, which were forced to slash spending when the market
crashed, and they lost the ability to issue expensive new
"The historical lesson is that stock market crashes don't really
cause that much damage," Mr. Quinn says. "Bubbles funded by banks
were the really really destructive ones."
Black Monday in 1987 is a classic example: harrowing for
shareholders, but irrelevant to the economy.
Of course, we shouldn't be too confident that everything will be
fine. So let's go through the risks.
Unlike past episodes, the Federal Reserve can't help out so
easily now. Rates are already on the floor. After the broader
market fell six months after the dot-com bubble burst the Fed
rapidly cut rates from 6.5% to 1.75%, and eventually 1%, helping
protect the economy from the market decline.
Corporate debt is also exceptionally high. Weaker companies have
borrowed to survive the pandemic lockdowns, while stronger
companies have borrowed to buy back stock. Lower rates mean debt is
more affordable than ever before, but if markets lose confidence it
could be harder and more expensive to refinance.
Big falls in stocks can feed through to the economy by making
people feel poorer--and so spend less.
Finally, sentiment is vital. Most workers wouldn't be affected
directly by a big fall in stocks, because relatively few people own
shares, even after last year's boom in trading. But with stock
prices closely followed in the media and by companies, a crash
could create a mood of national gloom, with knock-on effects on
corporate and consumer confidence that in turn hit spending.
I'm not too worried about these risks because I think there's
only a relatively small set of bubble stocks, and they can burst
without serious damage. If I'm wrong and it turns out there's a
bigger bubble--after all, almost everything is very expensive
compared with the past--then I would be more worried. But the
economy would probably still be fine, and surely better off than
when banks were financing a housing bubble.
Write to James Mackintosh at James.Mackintosh@wsj.com
(END) Dow Jones Newswires
February 13, 2021 10:04 ET (15:04 GMT)
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