Manic Comments
From FT, Alphaville, July 3, 20206
Quoting the front page of the monthly market update written by Joachim Klement and Francisca Reis, of [UK investment bank] Panmure Liberum …
“In 1929, the cyclically-adjusted P/E-ratio (CAPE) of the S&P 500 reached 32.6x according to Prof. Robert Shiller’s data. This was 1.8 standard deviations above trend at the time. In 2000, the CAPE reached 44.2x, or 3.3 standard deviations above trend – a clear sign of a bubble. However, … , earnings in both instances were within normal range, less than one standard deviation above trend.
Today, the CAPE is at 41.0x, or 2.9 standard deviations above trend. Once again, we are clearly in bubble territory for stock market valuations. However, unlike in previous bubbles, we are having extremely high CAPE at a time when earnings themselves are 1.8 standard deviations above trend. In other words, we are in a valuation bubble at a time when earnings are in a bubble themselves.
If we correct for the earnings bubble, the current CAPE would be 67.6x or 4.6 standard deviations above trend, a bubble that surpasses anything ever seen in US history by an extreme margin. If valuations followed a normal distribution (which they don’t, so don’t take this literally), this would happen in 0.00019% of months or once every 43,432 years.”
Bubble anyone?
Or, as they say, cash is king.
__________
Railroads?
Internet?
Surely not the DotCom bubble?
Perhaps even, for the more historically minded, tulips?
Mania obsession is sweeping the commentariat. We are on the road to something or other. It’s just that we have no idea what, where, or when.
I am sure our economists will be able to answer all those questions with both precision and alacrity. After all, the market is all-knowing, information freely and perfectly available, and the arc towards equilibrium so smooth and unrelenting that all will be revealed shortly. There is nothing to say about apparently aberrant behavior. Why? Because the market always speaks the truth.
Or maybe not.
The drumbeat of articles and op-eds warning us about the apparent insanity of the speculative mania unfolding before our incredulous eyes has both picked up in intensity and had practically no impact on that speculation. Yet. The folk who call themselves experts and advisors on how to make money and how to allocate wealth are starting to raise the alarm. Even the technocrats are stirring from their peer-reviewed siloes. We can expect an avalanche of analysis after the crash, but solid forecasts are hard to find. All that pervasive uncertainty so carefully cleared away from orthodoxy devalues the resultant theories and renders them after-fact rather than prescient.
So is this 1873 or is it 1929?
Either way the mania is epically manic. We are living through a conjunction of convulsions. One is the short term mania of a financial system unmoored from reality and unanchored from regulatory restraint. The other, which is far more disruptive, is the end game of neoliberal and neoclassical orthodoxy being played out despite the pleading of its committed devotees who still argue it was never given a chance to turn us all into the individual automatons they perceive us to be. Or, on reflection, they need us to be in order to fulfill our destiny as components of their utopian vision.
Ever since economics fell for the allure of efficiency as the be-all and end-all of social activity it surrendered its capacity to interpret real world social interactions. The world is not efficient. It will never be. Indeed, how can it be?
But, then, nothing ever is. The technocrats may argue they understand the world, but, in truth, their logic only applies to the miniature replica worlds they study. History is open-ended, and it is at its margins that we know the least. So, precisely when we need it most, technocratic analysis is least informative.
So much for economics.
In the last few days we have two instances of manic alarm. In the Financial Times Ruchir Sharma, of Rockefeller International, talked about the “New AI-Based world order” by using all the usual vocabulary of speculation. He littered his commentary with all the fashionable words so in vogue nowadays: “disruption”, “AI-Plays”, “tech-this tech-that and tech the other”, and so on. He acknowledged that the AI mania is sucking investment from every and any alternative use, and that the “winners” will inevitably see their various economies outpace the “losers” by, in his estimation, a percentage point or so. The winners seem to be those with deep tech-sectors, and who are able to muster speculative floods of cash.
But, he assured us, this is not a random mania. Not at all. It is highly targeted. It is a mania only within those winner-nations that are lucky enough to house, well, big-tech. The rest, places like most of Europe, will be left behind, devastated, collapse, and generally be consigned to history as really big losers.
Because they are not swept up in the mania.
He avoided questions of poor asset allocation our over-allocation. Things, it seems, will work out.
He did say, at the end of his article, that the manic speculation, despite its apparent excesses, and just as happened with the railroads, will leave a legacy or imprint on the world. A more balanced and less speculative world will eventually emerge, and, once the dust has settled when we have all figured out how to use all this wondrous tech, life will return to something resembling normal. Except, naturally, there will be losers.
Clearly Ruchir hasn’t ridden on the American railroads recently. They have a distinctly antiquated and inadequate feel to them. All that feverish speculative expenditure way back when hasn’t been refurbished, updated, or otherwise nurtured. Not recently anyway. The system has been left to rot as speculators moved on to other more modern shiny objects — like building a manufacturing sector when electricity became the next big thing. America was a railroad “winner”, but is assuredly a latter-day railroad loser. Meanwhile, some decidedly unfashionable parts of the world, and definitely places that would qualify as early stage “losers”, have fabulous and extremely modern railroads that put America to shame. So who was the long term “winner”?
It isn’t clear who really wins when the dust settles.
Our other correspondent, in the New York Times, was Jennifer Harris, who currently works at the William and Flora Hewlett Foundation. Her take was far less full-throated boosterism and was so sober that it verged on the somber. The mania, in her eyes, is syphoning funds from pretty much everything else, it is driving up land and other prices and thus inflation, and is generally an unregulated menace.
It was from her that I got the reference to 1873. Previously I had focused exclusively on 1929.
The gist of the Harris argument is that the speculative mania currently gripping the financial world is producing a massive misallocation of wealth and will ultimately lead to a weaker, rather than a stronger, economy because of that maldistribution. It will lead, in her words, to a hollowing out of the economy and hobble our attempts to catch up on the shortfall of housing to mention an obvious consequence that speculative boosters like Sharma prefer to ignore.
It is quite easy to infer from her commentary that Harris finds it quite difficult to locate any “winners” in the mania. The average worker is likely to be made irrelevant in the wondrous new economy; their retirement fund will be over-allocated to the tech-sector where it will be prey to its risks and potential downside; and the entire rest of the economy will look shabby and rundown because it was denuded of investment and updating.
Kind of like America’s railroads today.
And this is where I have to restrain myself.
I had half expected that economics would, itself, be refurbished in the aftermath of the Great Recession of 2007/2008. Of course it wasn’t. It is far too path dependent and unable to move towards recognition of its faults. Reputations matter enormously and mere facts cannot be allowed to get in the way of maintaining status within the guild. So here we are a few years later, gripped in a speculative mania that has all the makings of a spectacular wealth destroying moment, and we can get no guidance from economics because its orthodoxy excludes the possibility that markets can be really, truly, stupid. Or that manias can overwhelm analysis. Or that the urge to protect wealth, so often cited as the bedrock of sanity and self-interest, can sink without trace when the fear of missing out reaches fever pitch. Or that the power and influence of a few well-connected players can completely divert attention away from the well-being of the majority.
But I must not go overboard. Whilst it’s clear orthodoxy needs to catch up with reality I also recall that amongst its clutter of irrelevancy there are a few wise words. Such as Solow’s acerbic commentary on the ghostly appearance [or lack thereof!] of productivity provided by all that tech speculation back in the late 20th century. Or, indeed, his even more wise observation concerning the need to re-invest in maintenance of older investment. His worry was that an ever greater proportion of future investment has to go towards maintenance and not towards new and more productive technologies. We are doomed, it seems, to invest ever more in the past. Which, absent some major technological leap forward, implies that growth is inevitably constrained by our need to maintain what we already have. No wonder capitalists are so obsessed with the “next big thing”. They are desperate for continued growth and realize patching up the past produces far less profit that speculating on the future. Despite the risks involved. Making big bets on new technologies is the only way to avoid Solow’s trap, and the more of the past needing to be renovated the greater the impact those new technologies need to have.
Hence our mania. Desperation is reaching fever pitch.
Never fear though. Economics tell us that a good dose of “creative destruction” is healthy for us. Very healthy. Except, naturally, in economic departments where orthodoxy reins supreme and annoying residuals can be rebranded as triumphant discoveries.
I must stop. Why should we expect economists to have all the answers? Although I must admit that rebranding the Solow residual as “total factor productivity” was a marketing masterstroke. The willingness and ability to wordsmith ignorance into brilliant insight is an essential in a discipline so invested, itself, in the past.
Anyway …
The hollowing out Harris discusses has already happened. The neoliberal and neoclassical triumph back in the 1980s deliberately reduced opportunity for workers and boosted profits for asset holders who withdrew capital and hoarded it in ever more obscure niches of the financial markets. The associated downplaying of anything vaguely “social” in the technocratic wonderland of that era capped and then diminished democratic aspirations and shifted society back towards a pre-modern structure dominated by a wealthy few. Something called “the great moderation” was attributed to the cleverness of it all. Inflation was conquered. Interest rates were low. Asset owners flourished. Everything was protected by the self-interest of the rational players in the information dense and vibrantly competitive financial markets which were suitably, nay properly, stripped of unnecessary regulations in order to allow that self-interest to gain traction.
Until it didn’t. In a stunning rebuke of orthodoxy it imploded. And we have been sliding rudderless into the abyss ever since. Our most informed and technocratically sound leaders have repeated their orthodox prescriptions and left us bereft of solutions. So while our capitalists panic about where to locate constant growth and thus pile into AI and fuel one of our contemporary convulsions, our technocrats dither and scramble in ever more obvious failure and irrelevance because they have no framework to apply to a truly digital social setting. Hence the other, and more dangerous, long term convulsion: our knowledge base needs a refurbishment, just as our railroads do.
Just what, exactly, are our academics doing?
In this context I wonder what someone like Solow would make of it all. Are we in a massive wealth destroying moment as such speculative manias usually are? Or is it a great leap forward that will take a generation or two to absorb fully into our social fabric?
Given the short term life ascribed to the technology involved and the pace of obsolescence built into the frantic pace of innovation, I suspect that the legacy of all the R&D that Sharma lauds will be far less observable than he seems to think. Much of the $1 trillion talked about as being spent in 2026 alone will be out-of-date by 2030. Then Solow’s surmise kicks in: it will absorb a great deal of the wealth then available simply in replacement and maintenance. Will the tech become so much cheaper and readily available that our current losers can enter the game as later stage winners? And what, in the name of Solow, do our capitalists have to do then? What new technology will be sufficient to keep the wheels of progress rolling and defy the seeming inevitability of diminishing returns to capital?
An awful lot of destruction seems to be looming on the horizon.
Or, as Harris seems to imply, will the current speculation suck so much out of non-tech, but currently essential investment, that the supposed benefits of what Sharma calls, using his beloved Wall Street jargon, the “AI Play” will be offset by the lack of affordability and excess inflation created by its manic origins? Are we running ever faster just to stay in place?
Are we de-funding the future in order to fund a mania?
Is the present crowding out the future?
Harris seems to think so.
I wonder what economists will have to say.
Something about efficiency, no doubt.
