Sunday, February 13, 2011

Varieties of Bubbles

So with companies like Pandora and Groupon and what-have-you starting to seek large valuations, some people are getting antsy, with one writer—Michael Hiltzik of the Los Angeles Times--declaring himself “terrified”:
What's scary about all this, you ask? Simply that the last time valuations soared so high for companies with modest track records, or no track records, the trend line didn't herald a "new world" or a "new paradigm" or whatever they're calling it today. It heralded a crash.

Bit of a false dichotomy there, don’t you think? Either new paradigm or crash-and-burn explosion. Why can’t we just have a nice expansion?

And while this might be an unusual argument to make right now, some crashes and bubbles aren’t so bad. Most of the Western countries experienced a railroad bubble during the Industrial Revolution; the bubble popped, which left most of these countries with neat railroad systems which they proceeded to use until the present day. Similarly, the internet bubble of the previous decade gave us a lot of not-so-great companies, but on the other hand it gave us Google and Amazon. And, by the way, by financial measurements, many of the now-successful companies were indistinguishable from the failed ones—it took Amazon ages to successfully turn a profit.

So while it’s easy to get worried, it’s better to get worried if there’s a good reason. Most of the companies seeking valuations perform valuable services that people actually have reason to use—it’s just a question of figuring out how to make money off of it. The people who are enthusiastic about these internet companies are professionals; there doesn’t seem to be a wider mania, unlike the previous internet bubble or the housing bubble, meaning that the damage should be relatively contained should there be any. So I’m pretty fine with a internet bubble, should one be inflated.

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