Economic bubble

A letter representing the bubble of the South Seas or South Sea Bubble 1720.

An economic bubble (also called a speculative bubble, market bubble or financial bubble) is a phenomenon that occurs in the markets, largely due to speculation, which is characterized by an abnormal, uncontrolled and prolonged rise in the price of an asset or product. The speculative process leads new buyers to buy in order to sell at a higher price in the future, causing a continuous upward spiral that is far from any factual basis. The price of the asset reaches absurdly high levels until the bubble ends up bursting (in English crack), due to the beginning of the massive sale of the asset when there are few buyers willing to acquire it. This causes a sudden and sharp drop in prices, driving you to very low prices, leaving behind a lot of debt. This is known as a crash.

The bubble economy is often a stock market phenomenon that occurs whenever "high volumes are traded at prices that differ significantly from intrinsic values". The causes of bubbles remain a challenge for economic theory. Although many explanations have been suggested, bubbles have recently been shown to appear even without uncertainty, speculation, or bounded rationality. More recently, it has been proposed that bubbles may be caused by price coordination processes or social norms. emerging.

Because intrinsic values are often difficult to observe in real-life markets, bubbles are often identified only retrospectively, when a sudden drop in prices appears. Such a fall is known as a crash or the "burst of the bubble". Both the boom and bust phases of the bubble are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price under normal market circumstances. Prices in a bubble economy can fluctuate chaotically and become impossible to predict based on supply and demand alone.

It is usually considered that economic bubbles are negative because they entail an inadequate allocation of resources, a good part of which is used for unproductive purposes: feeding the bubble. But in addition, the crash that ends the economic bubble can destroy a large amount of wealth and produce continued malaise, as happened with the Dutch tulip mania, the Great Depression of the 1930s and the real estate bubble in Japan in the 1990s.

Financial bubbles were studied by Hyman Minsky, who linked them to credit, technological innovations and interest rate fluctuations.

Possible causes

The cause of the bubbles is unknown. It has been proposed that bubbles may be rational, intrinsic, and contagious. To date, there is no widely accepted theory to explain their occurrence.

Puzzlingly, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants must be able to calculate the intrinsic value of assets simply by examining the expected dividend stream. However, Bubbles have been repeatedly observed in experimental markets, even with sophisticated participants such as managers and professional traders. Experimental bubbles have proven their strength against a variety of conditions.

While what causes the bubbles is not clear, there is evidence to suggest that they are not caused by bounded rationality or assumptions about the irrationality of others, as assumed by the dumbest theory. Bubbles have also been shown to appear even when market participants are able to price goods correctly. Furthermore, bubbles have been shown to appear even when speculation is not possible or when price is absent. overconfidence.

Psychological and social factors

Very popular among laymen, but not fully confirmed by empirical research, "the dumbest theory" describes bubbles as driven by the perennially optimistic behavior of market participants (the fools) who buy overvalued assets in anticipation of their sale to rapacious speculators (the fools) at a much higher price. According to this unsupported explanation, bubbles continue as long as suckers can find more suckers to pay them for overvalued assets. The bubbles will end only when the dummiest becomes the dumbest who pays the premium price for the overvalued good and cannot find another buyer who will pay a higher price for it.

Stages of a bubble economy

According to economist Charles P. Kindleberger, the basic structure of a speculative bubble can be divided into 5 phases:

• Replacement (replacement)displacement): increase in the value of an asset
• Wake up.take off): speculative purchases (buy now to sell to the future at a higher price and get a profit)
• Exuberance (Exuberance)exuberance)
• Critical stage (critical stage): buyers begin to be scarce, some begin to sell.
• Shut up.crash): Fall in the price.

Most known economic bubbles

• Tulipomany (speculation with the Dutch tulips in the seventeenth century)
• Bubble of the South Seas
• Crack of 1929
• Financial and real estate bubble in Japan
• Asian financial crisis
• Bubble point com
• 2008 economic crisis
• Real estate agencies in Spain
• Mississippi Company
• Crack of the 2018 cryptocurrencies