Booms, Bubbles, and Ponzis

Booms, Bubbles, and Ponzis


Everyone knows what a boom is; they are wonderful. Everyone makes money, everyone is working, values go up daily, and the future looks bright. Indonesia is in a boom right now.

This is not Indonesia's first boom in recent history. There was another boom in the 1990s, but it ended with the Asian Monetary Crisis in 1998, which eventually led to the fall of Suharto.

In retrospect, that boom appears to have been more of a bubble.

The difference is that a boom brings lasting economic, technological, and social advances, while a bubble eventually bursts

But while in the midst of a boom or a bubble, they appear pretty much the same. They have the same causes: money flows into an economy, workers have more money and so buy more things. Demand increases, more investors come in to build more factories and shops, adding more employment and more wages, and attracting more outside investment.

Economists call this a "virtuous cycle." With moderate growth rates and the ability of a society to absorb the growth and build human capital, it describes the healthy development of an economy.

Bubbles occur when the growth is too fast, and the nation cannot usefully absorb all the money thrown at it, and investors' enthusiasm drives investments into unwise projects which eventually fail.

Once a bubble begins to burst, the collapse is rapid. Workers are laid off, other workers become worried, people start saving their money rather than spending it, stores close, more factories lay off workers, investors decide to move their money elsewhere, or delay projects, or close failing branches.


The U.S. subprime bubble...

The U.S. subprime loan bubble brought the entire world to its knees in the worst recession since the Great Depression of the 1930s.

It was good while it lasted; home values increased steadily for a decade, family wealth grew, and anyone who didn't own their own home wanted to get into the market. Loan originators, and then even normally-conservative banks, extended loans to borrowers who would not ordinarily have qualified for loans, but with the steady growth in home values, it looked like a safe bet—loans could be paid off with second mortgages on the growing value of the homes. And in the meantime, the middlemen—the mortgage brokers and banks—were making great commissions.

In the end, however, reality intruded. Home values were unreasonably inflated, borrowers couldn't pay back the loans, and the poisonous loans which had spread into investment portfolios the world over, collapsed the global economy.


The Indonesian boom...

So is Indonesia now experiencing a boom or a bubble?

Even in a bubble not all the investment necessarily goes to waste. Useful projects still get built, and some have lasting value.

Some participants actually do well in a bubble, some even get extraordinarily rich. Anyone who gets into the bubble early and then gets out before the collapse can enjoy great rewards.

In the U.S. subprime debacle, while millions of homeowners and workers lost their life's savings, mortgage brokers and Wall Street traders pocketed hundreds of millions of dollars in commissions.

Some Notes for Caution

Indonesia's current boom contains large components of:

  • unusually high credit card debt,
  • high fuel subsidies cutting into domestic investment (attempts to raise fuel prices in 1998 caused riots which ended in the fall of the Suharto government),
  • and glowing projections of Indonesia's economic outlook based on consumer spending (as boosted by credit cards and fuel subsidies) such as “sectors in ‘basic need’ sector in 2013 will enter culmination period...sectors which in ‘secondary need’ sector will become new blue ocean market in Indonesia. These sectors consist of (i) education, (ii) healthcare, (iii) lifestyle, and (iv) entertainment.”

Credit cards fuel domestic consumption in Indonesia - IndoSight, Dec 2011

Indonesia's fuel subsidy must be cut, top economists say - Jakarta Globe, April 2012

Indonesia Expects to Overshoot Subsidy Budget by Rp 100 Trillion - Jakarta Globe, July 2012

Indonesia Oeave Open Door Slightly to Fuel Price Rise - Jakarta Globe, October 2012

Indonesia Investment Outlook 2013 - Finance Indonesia, Dec 2012

In that sense a bubble is like a Ponzi. In fact a bubble and a Ponzi are pretty much identical from the point of view of investors; they want to get in and take advantage of the extraordinary returns on investment that everyone else seems to be enjoying. The only question is knowing whether or when it is all going to end.

The excitement of extraordinary returns can cause even normally cautious investors to ignore the warning signs. Bernie Madoff's investors were for the most part unusually bright people. Some obServers had doubted Madoff's investment fund for years; the returns were impossibly high, his explanations of how he did it were implausible. But most of his investors didn't want to hear about it—they were making big money. Then they reinvested their returns back into his fund to make even more money.

The problem was that many of them had major portions of their life's savings with Madoff, and they didn't know when to get out.


Booms, bubbles, Ponzis, and the law.

Booms are wonderful, bubbles are irrational, Ponzis are illegal. But for investors in the midst of them, they can be hard to tell apart.

This is a website about Indonesian law, so of course we return to the issue of law. Personally, I have trouble with the plausibility of so many investments in villas, land, and businesses in Indonesia given the weak rule of law protecting them.

I know there are plenty of boosters who disagree with me. But my reservation is that so many of them are middlemen with commissions to gain in the transactions. I don't know how many will be around to pick up the pieces if it all turns out to be a bubble or Ponzi.