The Price of Everything (35 page)

Ehrlich sent Simon his winnings: a check for $576.07—which amounted to the extent of the fall in the basket’s price. Ever since, the wager has provided a victorious narrative for the school of thought that we can ride global warming out without enormous sacrifices. Opponents of efforts to reduce emissions of carbon into the atmosphere wield Simon’s wager as a weapon. After his death in 1998, the Competitive Enterprise Institute in Washington, which spends much of its time and resources in denying climate change, created the Julian L. Simon Memorial Award to bestow upon fellow skeptics.

 

 

IT SEEMS RISKY
to trust our ingenuity at this stage. Around the world, the planet is showing signs of stress to sustain 7 billion humans living on it.

It was barely over two years ago, in the spring and summer of 2008, just before banks across the rich world started buckling under the weight of bad mortgages, that the price of corn, wheat, and soybeans shot to unprecedented heights on the board of the Chicago Mercantile Exchange. There were food riots in Egypt and Bangladesh. In Haiti’s sprawling slum of Cité Soleil, mud cookies—a mixture of dirt, salt, and vegetable shortening—became the food of choice as the price of rice soared out of most Haitians’ reach. Prices of iron and steel jumped too. On July 3, Brent crude oil from the North Sea peaked at $143.95 a barrel—94 percent higher than its price just twelve months before.

We were momentarily saved from this catastrophe by a global recession of which we had not seen the like since the 1930s. But as soon as the world started growing again, we started hitting some of the same constraints. Oil prices, which dropped to a trough of $33.73 a barrel after Christmas in 2008, were back above $80 in April of 2010. In August, on fears of a global shortage, the Food and Agriculture Organization’s food price index surged to its highest level since September 2008. Martin Wolf, the usually serene economic columnist for the
Financial Times
, wrote that limits to economic growth could topple civilization. A world that over the past two hundred years had grown itself out of many of its problems could easily slip back to a zero-sum reality in which one group’s gain would result in another’s loss, in which the only chance to get ahead would be to steal, repress, and plunder. Democracy and peace work in a world of increasing opportunities where people can invest and trade their way to prosperity. If there are limits to growth, Wolf warned, “The political underpinning of our world falls apart.”

And if there is any doubt that resources in the future will be more expensive than they were in the past, one need go no further than Ehrlich’s basket. Between 1990 and 2008 the basket roughly doubled in price, after inflation. The price of tungsten zoomed up 150 percent. The price of chromium jumped 138 percent. Simon got lucky in his choice of decade. But it would seem foolhardy for us to trust that our luck will hold forever.

THERE’S A WEB SITE
called Zillow that will spit out a price estimate for pretty much any house in the country. Its algorithm, based on the sales history, the prices of homes sold nearby, and other public data, has a fair track record. In New York and Los Angeles, its estimates have a median error of about 12 percent.

I used to visit Zillow to keep an eye on the Los Angeles condo that my wife and I lived in before moving to New York in 2004. It’s a pretty town house a ten-minute walk from the beach, with a wind-swept roof deck full of cacti and a view of the ocean. But it’s not the house I pined over. I was nostalgic about the financial gamble, possibly the best deal I will ever make. We bought the place for $369,000 and sold it for $575,000 less than three years later. That is a $206,000 return, on a down payment of only $70,000. Like looking at the worn snapshot of a loved one, keeping an eye on the price of my old home brought me closer to that odd burst of luck. Perversely, it taunted me with the hint that I could have made more.

Financial ruminations of this sort can produce whiplash, however. I felt a pang of envy as the place zoomed past $800,000 a year after we sold it. Then it dipped, reassuringly, seesawed, shot back up past $900,000, dropped precipitously, bounced, and ended 2009 around $700,000. The roller-coaster ride has taught me one thing: it’s hard to tell how much a home is worth. The rise and fall of my former L.A. condo offers a bigger lesson: prices can fail. They can get it wrong in a very big way, in fact—steering our decisions in unprofitable directions.

These decisions can be very costly. Skyrocketing house prices persuaded many to spend all their money on homes they would never be able to sell at a profit. Billions of dollars coursed through the Los Angeles real estate market every day. The fortunes of millions of people depended on the price of their homes. But evidently nobody had a clue about what houses in Los Angeles were really worth. So it was across the country, as house prices went for a feverish ride and took our prosperity with them.

The financial disaster unleashed by the collapse of housing led to the sharpest economic contraction in the United States since the 1930s—pushing unemployment above 10 percent for the first time in more than a quarter century. Ricocheting around the world, it knocked $3.3 trillion off the world economy in 2009. Who knew the price of houses could pack such destructive power?

 

 

PRICES DO A
pretty decent job organizing the world, much of the time. Both shaping human behavior and shaped by it, prices distill people’s knowledge, beliefs, and preferences about the choices that lie before them. A quarter century ago, an economist at UCLA published a study titled “Orange Juice and Weather,” which showed that the prices of orange-juice concentrate futures did a better job predicting the weather in Florida than the National Weather Service. Concentrate prices incorporated what investors knew about the prospects for the orange crop. If they had reliable data that the weather would be favorable, they would bet on low prices. If instead it seemed a cold snap was around the corner, they would bet prices of concentrate would rise. Distilled from a large set of investors’ decisions, the prices amalgamated the world’s collective knowledge about Florida’s weather.

Prices provide the most important signals in an economy, guiding people’s decisions on where to invest their resources to get the best return they can. People who shop around to get the best possible price for their plasma TV are doing us all a favor. They get a better machine, have more money left over to buy other things, and improve the odds of success of the company that makes good products for less, boosting the economy’s efficiency. Successful technology companies that profit from the work of highly qualified workers will offer higher wages—a higher price—to attract better-qualified applicants. Workers will keep raising their qualifications as long as the return—measured in better wages—is worth the investment in time, money, and effort.

This virtuous cycle, however, depends on relative prices being right. They must do a good job assessing the relative costs and benefits of different types of TVs. When prices go wrong, these decisions are distorted, often to devastating effect. This, unfortunately, happens depressingly often. Between 2000 and 2006, housing sucked in an unprecedented share of U.S. resources, as Americans rushed to buy a home in the belief that home prices would rise forever. The rush of money boosted house prices by some 70 percent on average. Builders rushed to build more. Then the bubble popped. Home prices fell almost a third from their peak in the spring of 2006 to their trough in early 2009.

The enormous bubble that lifted home prices skyward before slamming them down again didn’t do much for homeownership. The share of Americans who owned their home increased by 1.5 percentage points between 2000 and 2004, to a peak of 69.4 percent. By the end of 2009 it had fallen back to 67.3 percent, where it was in the spring of 2000 before the party started. The fall, however, was devastating. For a few scary months, the world economy tottered perilously near disaster. The most hallowed institutions of American capitalism were humbled. The share prices of Citigroup and Bank of America fell more than 90 percent from their peaks. General Motors, whose chief executive had claimed more than half a century earlier that “what was good for the country was good for General Motors and vice versa,” collapsed into the government’s arms—unable to borrow money or sell cars.

And this wasn’t an exclusively American drama. Between 2000 and 2007 house prices rose by some 90 percent in Britain and Spain. By the end of 2009, British home prices had fallen about 16 percent from their peak and Spanish homes about 13 percent.

The housing bubble might be the most painful case of financial excess in recent memory, but it surely isn’t the only one. Through the ages, virtually every potentially profitable new frontier opened up to investment has led to a speculative bubble, as investors have scrambled to tap into its promise only to stampede in retreat a few years later. A decade before the housing crisis we experienced the dot-com bubble. The NASDAQ index, heavy with technology stocks, quadrupled between 1996 and March of 2000. Drunk on information technology’s promise, people poured retirement savings into companies like
Pets.com
, which achieved fame, though never profit, on the strength of a cute ad with a sock puppet. In 2000, AOL could use its pricey stock to take over media goliath Time Warner, which had more than five times its revenue. By October of 2002 the NASDAQ was back where it had been in 1996. In 2010, Time Warner quietly spun off AOL for a tiny fraction of its price a decade before.

The dot-com crash was preceded by the Asian financial crisis, with subsidiary bubblettes from Russia to Brazil, when a surge of money into promising “emerging markets” abruptly went into reverse. Similar dynamics caused investors to pummel the Mexican peso during the tequila crisis a few years before. Japan’s Nikkei 225 stock index tripled in real terms between January 1985 and December 1989, only to fall 60 percent over the next two and a half years.

The very concept of a financial bubble is three hundred years old, added to the vernacular of finance in 1720 when French, Dutch, and British investors succumbed to euphoria over the potential of new trade routes across the Atlantic—pushing up stock prices before they ended in a precipitous crash. The British South Seas Company was established to buy the debt of the crown. To make money, it was given a royal charter to exploit trade routes between Africa, Europe, and Spain’s colonies in America. Spain and Britain being at war, the routes were of dubious value. But that didn’t stop investors from jumping on the vaunted opportunity. The share price of the South Seas Company soared. So did the shares of the maritime insurers covering its trips. Pretty soon, every investment looked like a great deal. Newspaper ads were offering a chance to invest in “a company for carrying out an undertaking of great advantage, but nobody to know what it is.”

In a move ostensibly implemented to curb the rampant speculation but aimed in fact at protecting the royally chartered trading companies and maritime insurers from competition, in June of 1720 the British Parliament passed a law barring companies that didn’t have a license from the Crown from raising money on the stock market. It also barred chartered companies from changing the purpose of their charter. The law was officially called “An Act to Restrain the Extravagant and Unwarrantable Practice of Raising Money by Voluntary Subscription For Carrying on Projects Dangerous to the Trade and Subjects of the United Kingdom.” But it came to be known as the Bubble Act. And many analysts have suggested that this single act precipitated the bubble’s rupturing. By September it had crashed, and in December, Jonathan Swift penned “The South-Sea Project,” which started: