WHAT WE CAN LEARN FROM BUBBLES

Jerry Harkins

I’m forever blowing bubbles,

Pretty bubbles in the air

They fly so high

Nearly reach the sky

Then, like my dreams,

They fade and die.

                         —Jaan Kenbrovin, 1918

Bubbles always explode;  they never either fade away or implode.  Because air must be blown into a film that will form the surface of a spheroid, the pressure of the air trapped inside is greater than that outside.  As the bubble expands the pressure differential increases and, ultimately, the internal pressure overcomes the surface tension causing the bubble to pop. In other words, the death of the bubble is inherent in the remorseless working of its physics.  If you wanted to write a play about this, it would have to be a classical tragedy.  The hero is born to die.

I’ve been thinking about bubbles ever since the so-called dot com bubble blew up in 2000, sending a couple of trillion dollars to the landfill.  Just a few years earlier, it had been fashionable to believe that the laws of nature had been set aside for the benefit of technology investors.  There was, it was said, a “new economy” abroad in the world, one where sales and earnings had become hopelessly obsolete as measures of a company’s value.  In its place there was a vision of infinite happiness in the global village aborning.  Like the promise of heaven or the ancient dream of perpetual motion, the idea of a business where net equals gross captured the imaginations of serious people.  Stock prices soared in a frenzy of what Chairman Greenspan famously called “excessive exuberance.”

Then we were once again rudely reminded that new technology is unpredictable.  We should have remembered the turn of the last century when it was becoming clear that the automobile was about to revolutionize the world.  By 1900, there were 300 American companies making cars using three competing technologies. [1]  An investor comparing them would almost surely have bet on steam engines which were quiet and easy to handle and maintain.  The technology was already mature having been commercialized in 1776. Steam engines could burn almost any fuel.  They had already achieved a 50% share of the automobile market.  True they took about 15 minutes to warm up (i.e., “get up to speed”) and they could go only about 50 miles before they needed water, but these were minor irritations compared to the cost of electricity and the unreliability of gasoline engines. [2] But as automobiles of all kinds proliferated, the once ubiquitous roadside troughs which had been placed there for horses disappeared.  Drivers could no longer count on having water everywhere to top off their boilers.  Thus, by replacing the horse, the steamer magnified its own major flaw.  Still, early on, steam was the way to bet.  Stanley, the industry leader, maintained a profitable business until 1927 but it was Henry Ford who built the IBM of his day and John D. Rockefeller, Sr. who created the Microsoft.

A similar story can be told about the computer industry in the 1950’s.  Everyone knew electronic brains were the coming thing.  This time there were two competing technologies, and, as early as 1949, it was widely known that ENIAC, a 30-ton digital machine with 19,000 vacuum tubes, was 180 times faster than its analog counterparts.  But you could solve far more complex problems with a much smaller and more elegant analog machine.  You could also put it on the back of a truck and run it off a field generator.  Given that the United States Army Artillery Corps was the largest customer, it was not surprising that most people bet on analog. [3]  The IBM 360, introduced in 1964, should have given fair warning.  It was by no means suitable for outdoor use but it was so powerful, so fast and so flexible that it could work complex problems by simply overpowering them in “real time.” [4] The 360/67 was a time sharing machine which meant you could hang 20-pound “dumb” terminals off it and use it anywhere you had access to a phone line.  The big analog players (Philbrick Researches, Inc., MB Electronics, Nicolet Scientific, Fox Technology and Liberty Technologies) were quickly left behind. You are probably a lot more familiar with the digital competitors known as IBM and the seven dwarfs. [5]

It has never been easy to predict the course of a technology.  Eli Whitney patented the cotton gin in 1793 enabling King Cotton to rule the American South.  It was an instant success but Whitney went bankrupt because it was so simple any farmer who needed one could build one and Whitney could not enforce his patent. Thomas Edison was arguably the greatest of all inventors and his world-changing genius was evident early in his career.  But an investor who bet on him in 1885 was also betting on direct current and against the alternating current being promoted by Nikola Tesla. [6]

Similar stories can be told about photography, color television, rocketry, convenience copying and other common technologies. So it should not come as a surprise that the internet bubble burst.  Still, information technology is one of the great themes of history and the collapse of Silicon Valley did not mean a return to the world of typewriters, carbon paper, slide rules and MonroMatic calculators.  Hundreds of companies went under but the Valley revived thanks to the irresistible force of the internet and the courage and foresight of people like Bill Gates and Steve Jobs.

What worries people about the dot com bomb today was its suddenness.  But, again, there were precedents such as the devastating railroad panic of the 1870’s. The logic of the transcontinental railroads was impeccable.  It combined Manifest Destiny, Yankee engineering ingenuity and national unity in the aftermath of the Civil War.  Of course  it passed through thousands of miles of beautiful if largely empty scenery but the financial types had a theory.  The feds would back the project with vast land grants.  The roads could borrow against this real estate and then settle it with pioneers, thereby creating their own markets.  The theory turned out to be faultless except that it unfolded at a snail’s pace.  The few equity investors made profits only by giving themselves exorbitant construction contracts and bribing Congress to accelerate the land grants.  They then issued bonds secured by the same grants, selling most of them to serious English investors.  In the summer of 1873, the firm of Jay Cooke and Co. led an effort to place $100,000,000 in new bonds for the Northern Pacific.  It was selling into an oversold market and the issue failed.  On September 18, Cooke closed its doors and within days the country’s largest banks became illiquid.  Before the end of the year, 89 railroads went bankrupt and the United States and Europe went into a depression that lasted for nearly a decade.

The Great Global Recession of 2008 followed a similar course.  A small group of Wall Street “rocket scientists” set out to make silk purses out of sows’ ears by bundling and “securitizing” large packages of sub-par mortgages whose riskiness was known and could be priced into the new securities.  Profits were virtually guaranteed and they were snapped up by big bank asset-liability managers and dentists with more money than brains.  The idea spread to small business loans, credit card receivables,  payday loans and commodity futures and options.  The latter were so complex, it was widely believed that even their creators did not understand them.  But at least part of the problem was obvious.  A lot of money was being made on bad mortgage loans which, naturally, stimulated the market for such loans.  Banks had been writing “adjustable rate” mortgages at extremely attractive initial interest rates.  These were packaged and sold to suckers including some of the world’s largest and most sophisticated investors.  As profits expanded, the adjustable interest rates adjusted upward and suddenly many more people than  expected were forced to forfeit.  Everyone had known the bubble would burst sooner or later but everyone wanted to be the last man out before the deluge.  Millions of lives were damaged and, again, trillions of dollars went down the drain.

It is said that armies are always prepared to fight the last war.  Our financial system, on the other hand, never learns anything from the last disaster and, like Sisyphus, is condemned to fight the same crisis over and over again down through the centuries.  The “system” of course is a creature of human nature which is called upon to detect and honor the fine line between necessary personal incentives and corrosive greed. We have not quite reached that skill level in our evolution.

Notes

1. Carroll, Glenn R., Stanislav D. Dobrev, Tai-Young Kim; “The Evolution of Organizational Niches: U.S. Automobile Manufacturers, 1885-1981,” Administrative Science Quarterly, Vol. 47, 2002.  Only 30 of the 300 were producing cars commercially and all of these were privately financed “skunk works.”  Total production in 1900 was 4,192 units.

2.  Electricity, when available, cost about twenty cents per kilowatt hour in 1900.  Counting inflation through 2001, that comes to $4.09 in current dollars.  Today the actual price is a little more than fourteen cents.  The first commercial electric car could travel about 182 miles on a single charge (14 hours at 13 miles per hour) but later models were not nearly so efficient. They were quieter than steamers and easier to drive, but they had trouble climbing even modest grades.  

3.  The many problems of firing long-range artillery shells at an unseen target contributed greatly to the advance of mathematics in the eighteenth century.  The immortal Pierre Simon Laplace was in fact the French army’s artillery examiner and one of his pupils was Napoleon Bonaparte who was trained as an artillery officer.  It is said that Napoleon read Laplace’s treatise on celestial mechanics and asked him where that left a role for God.  Laplace replied that he no longer needed the God hypothesis.

4.  Well, not really.  First, since these first 360 machines could only do one thing at a time, you had to get your project in a queue.  You did this by handing in your punch cards with the data and the program you wanted run.  The clerk gave you an estimated time, rarely less than 24 hours away.  Actual “run time” was measured in minutes and charged at $1,000 per minute.  The dumb terminals of the 360/67 all did things like issuing airline tickets at places called “ticket counters.”

5.  The names of the seven dwarfs varied over time, but the first list included Burroughs, Control Data, General Electric, Honeywell, RCA, Scientific Data Systems and Univac.  There remain trace elements of all these companies but not in the computer business.  To say they were strategically unfocused is to point at the folly of competing with Big Blue in its prime.  Univac, for example acquired the computer operations of RCA in 1971 and then bought Sperry which had bought Remington Rand.  Fifteen years later, Burroughs bought Sperry Rand in 1986, calling the combined businesses Unisys.  Eventually, Honeywell’s computer operations were acquired by Bull which was nationalized by the French government and then privatized again in 1994 when NEC became the principal shareholder with the French government as a junior partner. The saddest story of all is that of SDS. Founded by Max Palevsky, it developed powerful minicomputers and was acquired in 1969 by Xerox which soon discovered it did not know how to sell computers.  SDS next became the seed of Xerox’s Palo Alto Research Center, a beehive of invention.  Everybody but Xerox profited hugely from PARC’s innovations which included the Graphic User Interface and Ethernet.

6.  Ah, yes, but in spite of a century of world-changing innovations, Westinghouse somehow managed always to play second fiddle to Thomas Edison’s General Electric.  Today, the Westinghouse name survives as a subsidiary of Toshiba providing nuclear power plants and related services.  Ironically, GE and Westinghouse both became famous for AC appliances while DC went on to power the Information Revolution in such things as cell phones and portable computers.