The U.S. Economy: Is it the Next Bubble to Burst?

CAMBRIDGE: There is a reasonable chance that the U.S. economy is living through a speculative bubble of the same kind that has burst for so many other economies this past decade - Japan, Korea, Mexico, to name a few. These financial bubbles were all powered by an underlying myth of economic invisibility. The Japanese thought they had it ten years ago. Hard to believe, but many serious analysts thought Japan was on the verge of conquering the world economy at that time . . . that is, just before the Japanese stock market fell by more than 50 percent. Then Mexico thought that its new free trade arrangements with the U.S. would lead to a surge in economic growth . . . just months before the economy collapsed in the worst crisis in a generation.

Many in the U.S. now think that the U.S. economy is unstoppable, that the Internet revolution underway in the United States is the greatest thing since the industrial revolution itself. Such hyperbole, and the surging U.S. stock market based on these super-bullish views, should immediately give us pause. Is hubris at work here, as it was in earlier bubbles? If the U.S. stock market surge were indeed to end, or to reverse itself, what would be the consequences for the rest of the world?

The U.S. is surely powered by two real strengths - great flexibility of its market system, and great prowess in developing new technologies. The recent U.S. boom is heavily based on enormous investments of U.S. companies in the new information technologies. With its special mix of markets and innovation, the U.S. economy is indeed remaking itself with amazing speed. But financial bubbles are often founded on true economic strengths. A bubble occurs when those very real strengths suddenly take on exaggerated, even mythic, proportions in the eyes of investors, who are then prepared to throw vast amounts of money into the stock market without attention to realistic prospects for future earnings.

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