A market bubble is commonly understood as a large asset segment overvalued by speculation.

Speculators in related assets are primarily concerned with reselling to a “greater fool” at a higher price. The underlying assumption is that prices will continue to rise.

An expanding bubble of air eventually deflates. Irrationally inflated asset prices must do something similar.

As the asset supply becomes excessive, prices drop. Incentives change well before the situation can become a crisis. Price changes communicate market incentives. Misallocated capital must then be liquidated and invested elsewhere. Losses must be rebuilt by alternative employment, savings and investment.

That is what would ordinarily happen in a market economy in which government does not intervene. Political action changes things by distorting incentives normally set by the market.

Capital it should be noted is not just money. Capital is always in a state of flux because it also represents the decisions and actions of entrepreneurs, investors, employees and consumers. This is why alleged economic “imbalances” cannot be corrected by government simply throwing money at them.

In this context, it would be worthwhile to consider the excess investment present in the automobile manufacturing, financial, education and government industries in the United States. The economy is virtually a carbonated beverage of effervescent bubbles.

General Motors should have been allowed to fail. Taxpayers have financed the inflated pensions and union contracts of the automobile workers. Greater fools will be sought in the planned IPO by the reorganized “Government Motors”.

More financial firms should have gone the way of Lehman Bros. Instead, banks are the initial beneficiaries of massive money expansion by the central bank—with more inflation on the way.

Public education should be scrapped in favour of a market-based system. How can any sane parent think they cannot get a better job done privately for far less than the current escalating cost per pupil?

Government employees receive more in average income than employees in the private sector. Any society which rewards its least productive segment cannot expect to prosper in the long run. (Hint: the answer to this problem is not to raise the minimum wage.)

Things could be better, but Americans must demand that their government cut the extravagant spending and borrowing. This contributes the perverse incentives that create unsustainable bubbles. It’s like shaking the bottle.

©Copyright 2010 Edward Podritske