Archives for March 13, 2009

A few weeks ago, I was talking about the job market in academics with a colleague. Naturally, we eventually got around to the larger economic mess. Since speculating about the cause of the economic woes has become a national pastime, I thought I’d throw in my one cent (the expression has changed from “two cents” because of the tough times).

In the course of the discussion, I came up with a metaphor involving bricks and balloons. One way to build up wealth is like piling up bricks: in the most basic form, you have a solid good or item of value that you accumulate and use to build a sturdy foundation. For example, having real assets such as land, oil, weapons, or gold would be an example of such wealth building. Such items of value typically also have worth apart from their mere financial value-that is, there are useful in other ways. For example, you can use oil for fuel or weapons to protect yourself. Such a solid structure tends to produce wealth relatively slowly (though there are exceptions). This is often seen as the “old way” of building wealth, the sort of thing done by selling a product such as oil or steel (and then getting a monopoly on it…). While such bricks can be “destroyed” and the structures built from them can collapse (like the decay of the steel and auto industries in the United States), they tend to be reasonably secure. Naturally, what might seem to be a brick might turn out to be nothing more than crumbling sand.

Another way to build up wealth is like inflating a balloon. When a balloon is inflated, it grows larger but really gains little in term of substance. It is also vulnerable in that it can be popped rather easily. This makes a nice metaphor for much that happened in the lead up to crisis. Rather than creating new bricks to add to the foundation of the economy, much of the wealth was created out of thin air by re-packing loans and through clever financial instruments. Or, in some cases, by outright fraud such as Ponzi schemes. Continuing the metaphor, balloons do not hold up weight as well as bricks do-hence a pop was to be expected.

Speaking of Ponzi schemes, it might be suspected that much of the economic growth in recent years (that is to say profits) rested on just such a scheme. A classic Poniz scheme works by paying off early participants with money taken from the newer participants. The scheme falls apart when those running it cannot get enough money from new participants. To use the balloon metaphor, to keep a leaky balloon inflated (the leaks are the payouts) air must be constantly coming in. In the case of the economy, it seemed to be going well as long as more “air” was found to be pumped into the leaky balloon. Of course, some of those involved also seemed to excel at creating air (value) out of nothing-literally inflating the value of houses so as to pump more air (money) into the big balloon of the economy.

Apparently there is a limit to just how much value can be created by inflating and clever repackaging. We, obviously enough, reached that limit and the economy went kaboom. Perhaps there are economic laws analogous to those of physics. Then again, perhaps not. After all, the economic system is a human creation, although people do very much love to reify it and pretend it has a life of its own.

Perhaps those running the show just could no longer hide the fact that many companies were built upon balloons rather than bricks.

Obviously, these economic approaches are not really like bricks or balloons-these are just metaphors. However, they do create, I think, some useful images for trying to get an idea about what might have happened. I am, of course, not an expert on the economy and I’m just tossing out some random thoughts on the matter.

Fortunately, there have been some signs of good news. Hopefully, that will continue.