Book contents
9 - The necessity of bubbles
from Part III - Understanding the game: the role of bubbles
Published online by Cambridge University Press: 05 November 2012
Summary
Why do bubbles matter, aside from the crashes that their excesses engender? They matter because they not only transfer wealth from greater to less-great fools, and to the knaves who prey on the former. Occasionally – critically – they transfer wealth to fortunate opportunists and insightful entrepreneurs in the market economy who are granted access to cash on favorable terms and put it to work with astounding consequences. Bubbles matter because, as Keynes put it so characteristically well,
The daily revaluations of the Stock Exchange … inevitably exert a decisive influence on the rate of current investment. For there is no sense in building a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; while there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectation of the professional entrepreneur.
A generation later, James Tobin and William Brainard explicitly extended and operationalized Keynes’s insight by defining the ratio q:
the ratio between two valuations of the same physical asset. One, the numerator, is the market valuation: the going price in the market for exchanging existing assets. The other, the denominator, is the replacement or reproduction cost: the price in the market for newly produced commodities.
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- Doing Capitalism in the Innovation EconomyMarkets, Speculation and the State, pp. 181 - 208Publisher: Cambridge University PressPrint publication year: 2012