2012-08-22

The Tech Mini-Bubble

Perhaps some of you remember that, late in 2010, everyone was talking about the booming technology sector. For example, there was this article published at SmartMoney.com, which stated:
Tech stocks have gotten an added boost, though, from accelerating growth in overseas markets, which has led to increasing demand for computers and gadgets. As well, the new money that will be injected into the financial system, courtesy of a $600 billion bond-buying program planned by the Fed, has increased investors' appetite for risk, which has driven them to tech stocks.
Emphasis mine. Of course, SmartMoney.com was not the only website propagating that theory, but I leave it to the reader to dig up more instances of the above observation.

Critics of the Austrian description of business cycles and capital flows have repeatedly asked the Austrian economists: If credit expansion causes the business cycle, where is all the inflation? And of course, those who don't anticipate much general price inflation have various ways of making their point.

One important fact that everyone in the where's-the-inflation? crowd all seem to commonly miss, however, is the Austrian school's emphasis on the heterogeneity of capital. See, the Austrian story is not that (1) The Fed prints some money, (2) the whole economy booms, (3) the whole economy crashes. That is the cartoon version of the Austrian Business Cycle Theory (ABCT), the one that use used to over-simplify and strawman the ABCT story out of existence. It's the one used by the Krugman Krowd to make non-Keynesians look ridiculous.

On the contrary, the real story goes like this: (1) The Fed diverts money into the hands of heavy-hitting investors; (2) Faced with a fresh batch of investment liquidity, these heavy-hitters divert the new money into investments that they otherwise never would have purchased; (3) Economic sectors grow that never would have grown in non-expansionary circumstances; (4) Eventually, projects within these sectors dry up because there is no real market demand for the projects; (5) The market that erroneously expanded collapses.

From the above, it is obvious that in many cases a "bubble" is not something that makes a huge impact on the economy at large. Sometimes a bubble occurs in a comparatively small sector of the economy.

The recent major recession happened to involve a bubble that was tightly integrated with all sectors by virtue of the fact that real estate assets provide the collateral for a great many different kinds of investments. If collateral is over-priced, then that means a lot of the value flowing into other investment projects is illusory; when asset prices correct, the collateral disappears, and the loans lose their value. That's big, and economy-wide.

But in the case of the current tech mini-bubble, we are probably not going to see a huge adverse impact on the rest of the economy. Already we have seen Facebook's shares plummet. We also saw investors run away from Groupon this week. We found out today that Dell's forecasts missed the mark. This Business Week article succinctly summarizes a long stream of tech-sector disappointments over the last couple of months.

To put things very diplomatically, a lot of the market expectations for the high-technology sector have turned out to be overly optimistic. Investment money had been poured into the tech sector, but now it is all coming out on news of disappointing industry-wide earnings.

To be clear, this is an Austrian cycle bust. Credit expanded, money flowed into the tech sector, tech projects expanded, now sales are drying up. What is left to be observed is the "unfinished projects" characteristic of any Austrian-style boom. Watch for it. It will happen.

In the meantime, a lot of money leaving the tech sector is now flowing back into more traditional investments. Today my Google News feed shows gains in oil, government bonds, and the US dollar. I also note that most precious metals are up today.

The bottom line here is twofold: First, ABCT is applicable to sectors as well as to the entire macroeconomy, therefore we should not expect that any lack of macroeconomy-wide inflation is a death blow to the theory itself. Second, what we are seeing in the tech sector is precisely what we should have anticipated in light of serious consideration of ABC Theory.