Bubbles, Recession and Music Industry
April 11th, 2008 | by Jose Miguel Cansado |
“Más dura será la caída” is a Spanish saying that could translate “the higher the rise, the harder the fall”.
Economic cycles are a fact acknowledged by economists, that have written a lot about them. Simply google the term and e.g. see the definition from Wikinvest:
“Theoretically, any deviation from average growth is considered an economic cycle, whether growth of GDP, household income, employment rates, etc. In practice, economic cycles are divided into two main categories: booms and recessions. Booms are associated with a strong economy, while recessions are characterized by below-trend economic growth. The National Bureau of Economic Research (NBER) defines economic cycles a bit differently […]it classifies the economy as being in expansion or contraction. […]
The basic idea behind economic cycles is that […] in the long term, the highs and lows average out to form the trend, or average, economic growth rate. This trend growth rate […]has remained relatively steady in the past”
Economists are very good at making predictions a posteriori, and have developed all sort of theories, including: (1) that the government/central banks interventions somehow incentive the creation of cycles, (2) that the stock market anticipates the cycles and can be used to predict them or (3) that consumer expectations are the best indicator of the coming cycle. And many more.
While there is true in these explanations, one important root cause of recession or crisis are bubbles: The bigger the bubble, the sharper the recession.
- The Internet bubble of the late 90s with dotcom stocks irrationally valued, even with no business case
- The UMTS license bids in UK and Germany that sent the telecom industry into a severe crisis, after licenses were bought at 6000 Euros per inhabitant!
- The house market in UK, US or Spain, with valuations that are not sustainable compared to average earnings (see graphic above from the Economist, and guess its projection).
Future expectations are a clear factor in feeding booms and recessions in the cycles. In year 2000 we could read articles in Wired, explaining how the IT revolution had created a source of permanent growth that would end with the cycles. And so Wired predicted that Bill Gates would be the first trillionaire, based on Microsoft Stock continuing its late 90s price surge over twenty years. Similar rationale went into the UMTS licenses, predicting that wireless data and Machine2Machine would increase revenues by orders of magnitude.
So what is the tipping point after which expectations change and so the cycle? Couldn’t have we all kept the faith in IT revolution powers, so that Bill Gates was by now trillionaire? What if investors had kept (more) faith in mobile operators? wouldn’t we have by now wireless connected machines (fridge, microwaves ovens, washing-machines..) everywhere? What made the bubbles burst?
At some point in time there needs to be some fundamentals to sustain prices and valuations. Whether stocks, spectrum licenses or housing, an investment needs a return according to its valuation. Big crisis comes when the expectations have irrationally led to high prices/valuations that can not be sustained by fundamentals. Faith is lost and the sharp adjustment comes as a crash, crisis or recession.
Free market and its law of supply and demand are the best invented system to set prices. It only needs healthy competition, transparent information and the assumption that human beings are rational in their decision. The last point is not always obvious.
So what does the Music Industry has to do with all this? Not much, except that they are going through a tough crisis, once their bubble of high prices burst, due to digital distribution. Music was over-priced thanks to the tyranny of physical distribution - CD, vinyls, scarce shelf space -. Adjustment is just coming.
