Bubbles bubbles bubbles! The talk continues. Last week the anti-bubble camp was in the ascendency. First we had a massive bubble debate on Branch.com (disclosure: I am an investor in Branch), featuring some of the best minds on the internet: Anil Dash, Dave McClure, Paul Kedrosky, Chris Sacca, Michael Arrington, MG Seigler and more. The rough consensus? No bubble.
In wrapping up the Branch debate, Seigler pointed to First Round Capital’s Josh Kopelman, and his hilarious bubble post – from 2007, no less – mocking those who continuously cry bubble, and failing to grasp the transformational power of the internet. A fair point.
Next we had Business Insider Henry Blodget’s presentation State of Startups 2012 presentation, subtitled “No, it’s not a bubble.” Many charts, graphs and points followed laying out why the bubble doesn’t exist.
I must confess, however, I’m in the pro-bubble camp, and while reading the Branch debate, I found myself jumping up and down with counter arguments on why we actually are in a bubble. And, since I’ve taken a two week vacation from this column, I figured I’d come back with a vengeance, and cogently lay out all the arguments and counter arguments.
I’ll start off by promising the anti-bubble posse that I will barely mention Instagram at all, and when I do, it will be only in a tangental manner. I promise.
What is a bubble?
The definition of a bubble is an important part of this debate. Chris Dixon expresses justified annoyance at this when he says “A bubble is a financial event. I don’t understand people who try to discuss it without bringing financial evidence into the picture.” This is a valid point.
Economists generally agree that three things must be present for a bubble to exist: (1) high trading volumes, (2) prices that are different from their “intrinsic values,” and (3) that said difference between prices and intrinsic value must be considerable.
The Wall Street Journal puts it thusly: “Bubbles emerge at times when investors profoundly disagree about the significance of a big economic development, such as the birth of the Internet.”
Built into that definition are our key three items: disagreement would indicate considerable variance in price, and a big economic development implies high trading volumes. “The internet” or “the railroads” are big economic events. And because they are big events, there will be a lot of trading around them.
What a bubble is not
Just as important is what a bubble is not. A bubble doesn’t have to be in the stock market. Tulip Mania, the first bubble, had nothing to do with stocks. Subsequent examples abound. Many of the anti-bubble defenders base their arguments on metrics around the publicly-traded tech companies, talking about their P/E ratios for example. The P/E ratios of publicly-traded internet companies, such as LinkedIn, are within normal parameters right now. This, however, has nothing to do with “ALL” Internet companies, only the ones that are publicly-traded. No one realistically believes the bubble is in public companies, and the definition of a bubble does not require the bubble to be in publicly-traded companies. Any arguments against a bubble that solely rely on P/E ratios of public companies aren’t really relevant and indeed help obscure the true picture.
Additionally, a bubble is not tied to the economy as a whole. Joseph Schumpeter had a notorious aversion to looking at large economic trends when trying to discern what was really going on. He said “It is, therefore, misleading to reason on aggregative equilibrium as if it displayed the factors which initiate change and as if disturbance in the economic system as a whole could arise only from those aggregates.” (Look to p 36 here).
Economist Carlota Perez, something of a hero of Union Square Venture’s Fred Wilson, takes the point further, stating that bubbles have nothing to do with the economy as a whole. “It is not even likely that the turbulent process by which new paradigms are assimilated should lead to regular up an down trends in the economy as a whole.” (Page 36, of her seminal work Technical Revolutions and Financial Capital).
These are both important points, as many of the arguments against a bubble point to metrics from the stock market as evidence for the lack of bubble. Fact is, economists don’t care whether or not a bubble is in the stock market or trends with or against the larger economy.
It should also be said that bubbles have nothing to do with many of the things we hear about – anecdotal evidence of “founder friendly” terms, bankers going into tech, a bajillion ripoff tech companies managing to get funding, lavish parties, kid founders, etc.