Economic Bubbles: The Vortex of Human Desire and Reality
Let me let you in on a little secret…
An economy is a collective delusion. Do you remember holding a worthless crumpled wad of cloth, only to exchange it for something valuable like food, clothing, or shelter? The cloth itself has no intrinsic value; its worth lies in the collective belief of its value. This is the essence of an economic bubble—when the shared delusion of value leads to a major economic disturbance.
Economic Bubbles in the Real World
Economic bubbles are created by the average citizens and they often burst due to the same citizenry. They are born out of greed and fueled by the delusion of value, which can quickly turn into the opposing delusion of loss.
An economic bubble is a rare phenomenon characterized by extraordinarily high asset values that far exceed any rational valuation. When enough people realize that such high values are just delusions, the bubble bursts. This event is akin to a sudden awakening from a collective euphoria, resulting in catastrophic financial losses.
Economics: More Humanity than Science
Economics is not a pure science; it is a social science. Predicting future economic performance is akin to guessing—an uncertain art form. This is precisely why the COVID-19 pandemic led to a worldwide economic recession. The impact of health crises on human behavior and economy cannot be accurately predicted without significant uncertainties.
Identifying Real Bubbles: A Horizon of Observation
Most events labeled as "bubbles" typically become obvious only after the fact. Prices shoot up significantly, followed by a quick crash. It’s always easy to find people who said the prices were too high before the crash, and it’s equally easy to find reasons afterward that everyone should have known the prices were too high. But what makes a genuine bubble?
According to my perspective, a genuine economic bubble has two key components. First, prices are so high that any plausible set of assumptions cannot justify them. Second, people are buying the asset not because of any fundamental reason, but solely because the price is going up. This behavior is a manifestation of human greed and delusional optimism.
Some researchers have suggested different criteria. Robert Jarrow, for instance, emphasizes increased volatility faster than price and the bankruptcy of short-sellers or others who could moderate the price increase. If we adhere to these more rigorous definitions, bubbles can be seen as a scientific attempt to understand an unforeseen human behavior. However, the vast majority of things labeled as bubbles don't meet these strict criteria.
On the other hand, if we view all bubbles as mere delusions and the madness of crowds, we might as well not dignify the idea with the term "opinion." Many people who use the term "bubble" carelessly lack the knowledge to support their viewpoints, resorting to after-the-fact stories that everyone tells when prices fall. These stories are repetitive and often lack substantive analysis.
Conclusion: A Balanced View of Economic Phenomena
Economic bubbles represent a complex interplay of human desires, rational expectations, and irrational behaviors. While scientific approaches can offer insights, the inherently human nature of an economy means that accurate predictions and assessments remain elusive.
To truly understand and manage economic bubbles, we must embrace a multifaceted approach that combines scientific rigor with a deep understanding of human psychology and behavior. Only then can we hope to navigate the turbulent waters of the economic market.