Well-Behaved Bubbles Often Make History

When prices are zooming up and people are getting rich, critiquing a bubble can turn into a kind of weaponized FOMO: the easiest way to tolerate other people getting rich is to assume that it’s because they’re getting temporarily rewarded for stupidity. On the way down, bubbles generate even more commentary; the pessimists were vindicated, and many of the participants have spare time to tell their side of the story. It’s not a coincidence that some of the most detailed business books are about failures rather than successes. Former employees of Enron, Theranos, Long-Term Capital Management, and Countrywide Financial had a lot more time to talk to authors when they weren’t busy at their jobs, and a stronger incentive to do so, too.

But even though the term “bubble” is usually pejorative, the right kind of bubble, at the right time, can exert a powerful positive effect on the world. A bubble is an objectively irrational shared belief in a better potential future … but that doesn’t just describe someone bidding up asset prices; it also describes anyone who chooses to build that kind of future. (And it’s not a coincidence that the other social sense of “bubble” is a filter bubble — a fact- and criticism-proof barrier that keeps a set of people convinced against all external evidence that they’re right.) 

The first big smartphone bubble didn’t show up in stock prices; it was Apple’s conviction that a fully featured, touch-based, internet-connected device could be put in the hands of millions of consumers for a few hundred dollars. When Apple started working on the iPhone, this conviction wasn’t fully supported by the facts. The first demos of the touch interface, for example, were incredibly clunky (The One Device describes an early internal demo of “a table-sized contraption with a projector pointed at a white piece of paper,” an unpromising beginning for something that needs to fit in a pocket), but it was rapidly refined into something that worked the way it should.

The more implausible it is to achieve a given combination of useful product features, the more impressive the result will be. So part of the task of any organization doing deep research and/or development is to keep the team convinced, against all odds, that they’re not wasting their time. This puts another perspective on Apple’s vaunted secrecy: It wasn’t just that they wanted the launch to be a big deal, but that they didn’t want the iPhone team to get honest and informed feedback from people who didn’t think it could happen. It also helps to explain the long hours these projects require; the benefit is not just the work, but the absence of non-work feedback. 

If we’re all the average of the five people we spend the most time with, then the only way to remain a true believer in a seemingly impossible goal is to spend all of your time with other true believers.

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The dynamics of a bubble show up in other places, too. In politics, many successful movements go through a long period of obscurity or even persecution, and surviving these tends to make organizations almost superhumanly tough. The party that rules China today is descended from the organization that survived the Long March. Someone who is motivated enough to spend over a year retreating more than five thousand miles through difficult terrain is probably quite committed to the cause, and under different circumstances will likely be loyal. In Eastern Europe, the successors to communist governments were often people who had survived persecution and imprisonment from those same governments. In a U.S. context, political tendencies like neoconservatism and modern monetary theory have (under much more pleasant circumstances!) spent long periods out of power, biding their time and refining their ideas. 

There’s a sunk cost to this loyalty, though: Once you’ve bought into a cause enough to suffer for it, you’re less likely to change your mind — it would mean you’d suffered for no good reason after all. 

The bubble dynamic even applies to personal relationships. Buying stock in Amazon or Pets.com in 2000 was a bet on how the next decade would look, but getting married can be a bet on how you’ll feel about someone over the next half-century. It’s a pretty big deal, and an utterly irrational move without some blinding level of idealism. 

But, as with other bubbles, the irrationality is a coordinating mechanism. It’s a way for one person to tell another that they take their plans seriously, and a small number of seriously committed, arguably irrational people can accomplish a surprising amount.

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The usual discourse about bubbles focuses on financial ones, and for a very good reason: Since finance consists of explicit promises of future cash flows from owning various assets, it entails a lot of thorough record-keeping. An economy weighted toward trading pieces of paper around has its drawbacks, sure, but for historians it’s a bonanza; you can read all those pieces of paper well after the fact. 

So while we don’t know all the gritty operating details of the South Sea Company, or what its managers were really thinking, we do have incredibly detailed records of who paid how much for shares, and how they funded it. (This has allowed retrospective studies like this one, which shows, among other things, that women made more profitable trades than men during a bubble that popped 300 years ago. These records also help to illustrate that asset prices are connected to the real world, even outside of IPOs and other capital-raising events: High stock prices for particular companies tell people that something important is happening; they’re a signal that there are adjacent businesses to build.)

Financial markets have another benefit for students of bubbles and irrationality: They encourage people to write down what they’re thinking and why. An investment memorandum is a valuable document, especially when it turns out to be wrong; since it’s written to justify a particular investment at some specific price, it includes plenty of assumptions about exactly what kind of future will make the investment a profitable one. So a good investment memo is a genre of science fiction that’s meant to come true — not out of the question, since robots, online forums, cryptocurrency, nuclear weapons, space travel, and many other technologies were discussed in sci-fi well before they were actually developed.

Sometimes, science fiction has revealing anachronisms. Star Trek and Star Wars have computers, but their universes assume a Moore’s Law for spaceships and the 1970-2010 space stagnation for computers. Star Trek was right about some parts of the future: Material goods got very cheap indeed, and Amazon’s price and delivery speed are rapidly approaching the Replicator. But they got other things wrong. An optimist who bought Amazon in 2000 would have eventually done well, but it would have been partly a matter of luck; no one buying it then would have dreamed of how much of Amazon’s value would come from AWS rather than from selling physical goods. (There had been dreamers in that vein beforehand; part of the early appeal of ARPANET was the idea of open access to more powerful computers and programs, not just to static information, which at least gestures in the direction of cloud computing.) 

In fact, raising money is a form of statistical time travel, teleporting money from a probable future to the definite present, at a cost. But the other form of tech time travel is to be very quiet about which futuristic products are about to become available to everyone. So managing bubble-like expectations means being a careful time traveler, and ensuring that the future looks exactly how it’s supposed to, and that the company doing the time travel can survive the trip by not running out of cash, or hyping itself into a corner, in the meantime.

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Bubbles can be directly beneficial, or at least lead to positive spillover effects: The telecom bubble in the ’90s created cheap fiber, and when the world was ready for YouTube, that fiber made it more viable. Even the housing bubble had some upside: It created more housing inventory, and since the new houses were quite standardized, that made it great training data for “iBuying” algorithms — the rare case where the bubble is low-tech but the consequences are higher-tech. But, even so, there’s always the question of price: how can you tell when it’s worth the hype?

Bubble valuation arguments often boil down to disputes about frameworks. Specifically, they take two roughly equivalent forms:

Questions about how long a trend can last: Is videoconferencing something we’ll all look back on with annoyance, or is it an increasingly viable substitute for in-person interaction? Will on-demand video take share from TV, or completely replace it (and expand the market)? 

If a trend is just a blip, then a company’s current growth rate just represents the crest of a wave before the crash. E-commerce stocks had nice-looking charts in 1999, but so did Beanie Babies, and it took some judgment to decide which trend was more likely to keep going. But because compound interest is so powerful, a trend that’s just a little more durable than it looks can be an order of magnitude more impactful. 

Questions about unit economics and feedback loops: When a company succeeds in launching one product, does that make it much better at launching the next one? 

Angry Birds and Candy Crush had a hard time turning their first big hit into a franchise-manufacturing machine, despite their parent companies’ best efforts. And it’s hard to turn one hit movie into a series, although Disney seems to have made this something close to a science. But each time Amazon added a category, they acquired users who would spend on their existing categories, and, later, merchants who could offer newer categories. Each search tweak Google made gave them a new set of tools to monetize clicks, but also reinforced the instinct to perform lots of searches. Facebook’s marketplace is partly a way to monetize the site, but it also gives buyers and sellers one more reason to log in every day; as it turns out, one of the most addictive games ever launched on the Facebook platform is called “Affordable Exercise Equipment Quest,” and I’m a daily active user.

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The two things that kill a company during a bubble are excessive optimism, and the unwillingness to be sufficiently optimistic. A realist gets crushed in a bubble, because their competitors can outraise them, and eventually copy and outspend them. But someone who fully buys into the bubble narrative is also going to get ruined, because the companies that best fit the naive, recently backwards-looking version of the bubble narrative won’t survive as the situation evolves; turning back to Amazon, the company worked out great even though the original thesis mutated. 

One way to mitigate this is to build a business around maximizing future, rather than present, hype. 

At the peak of optimism, some companies will be tempted to announce vaporware, to bring investors closer and push competitors further away. The alternative is to consistently work on “stealthware,” new launches that will upend the industry once they’re available — but that are kept secret until then. The first secret can’t be used to attract investors, of course, but when a company has a good record of positive surprises, investors can bank on the fact that they’re statistically likely to excel even if the exact nature of that success isn’t obvious at the time.

The stealth approach makes use of the healthiest aspects of a bubble: A small group of people who think differently about the future are the only ones who can build that future; but announcing its specifics in advance is borrowing credibility from the future instead of banking it. Having a publicly known vision and a very private roadmap for achieving the future is an advantage in fundraising and recruiting (I’ve interviewed at a couple companies not just because I wanted the job but because I was incredibly curious about what they were really up to). 

That vision of the future might be wrong, or the implementation might be mistaken. But it’s not just business; it’s science fiction, too. Participating in a bubble is not just a business endeavor, but an artistic one as well, and science fiction can be good art for its own sake, even if the story doesn’t quite come true.

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  Byrne Hobart is a writer, investor, and consultant in New York. His newsletter, The Diff (diff.substack.com) covers inflection points in finance and technology.

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