dow 7000?

Mr. Smith, a professor of economics and a Nobel Laureate wrote an editorial in today's WSJ. It is entitled, "There's no easy way out of the bubble." Mr. Smith tries to clarify how we get into bubbles, and why it is so hard to get out of them. Like a true academic he references a paper he wrote in 1987 that showed through simulation how boom and bust cycles are inevitable. I wonder how many readers will go back to that November 17 issue of the WSJ to read up on bubbles. You never know.

Boom and bust cycles are an example of overshoots. People try to optimize their returns and in doing so they inevitably overshoot. As more people enter the market prices go up, attracting even more buying. Eventually we run out of headroom, but people are still buying. By the time these people realize what is happening, the situation is badly out of control.

Then suddenly, a few leave and everyone follows at once driven by ever increasing fear. The fear makes matters worse and leads to a severe and prolonged drop. Overshoots are at least partly due to lags, these inevitable time delays that are part and parcel of everything we do.

I have described these phenomena before in the context of pollution and greenhouse gases. The same mechanisms are at work there, and people will reproduce, waste resources, and pollute until their whole habitat collapses. Like the housing bubble, that will happen when enthusiasm and optimism are at their highest. Things will look up and people will tell one another how they will always keep getting better. And then one day, the "buyers" will disappear.

These societal collapses too, it seems, are inevitable, and there is plenty of evidence around to illustrate that point. Angkor Wat, Easter Island, the Maya, you name it. All these civilizations went into a big bubble and then collapsed. Only here, it wasn't the collapse of some real estate and paper, it was paid for in blood. It wasn't the equivalent of the Dow collapsing, it was the actual population.

Will people learn? I doubt it. The only thing we see over and over again, is always expanding bubbles that do ever more damage. The same applies to the environment. Now we are or very close to on a planet-wide scale. When that bubble collapses, it will be a disaster of unheard of proportions. We may not even survive as a species.

But why worry? Let's get back to the "real stuff" and worry about our 401k's. With the Dow heading for 7,000, there will be plenty to worry about for most of us.