(рук.) к.п.н. Осипова А.В., (студ.) Денисова Т.М.
Ростовский
государственный экономический университет («РИНХ»)
BUBBLE ECONOMY: CAUSES AND EFFECTS
In finance and economics, there
are such things as “bubbles” in the economy. And when bubbles start forming, it
normally isn’t a good thing. Throughout the history of capitalism, economic bubbles have been commonplace. They have emerged wherever
liquid financial markets exist. The range challenges the imagination: from the
iconic tulip bulb bubble, to gold and silver mining bubbles, to bubbles around
the debt of newly established countries of unknowable wealth, to real estate
and stock bubbles.
Bubble Economy is an economy in which trade
takes place in large volumes with a discrepancy between the price and the
intrinsic value of the product. The intrinsic value reflects the fair value,
which takes into account the hypothetical calculation of the risks and future
returns. The prices in economic bubble waver easily and cannot be calculated
only in terms of demand and supply. The economic bubble is normally followed by
a period of deterioration of prices. This crashing phenomenon is known as
bubble burst or crash. The boom and the bust period in bubble economy are
considered to be a positive feedback mechanism. Bubbles
typically refer to a situation where assets or financial instruments see a
rapid increase in price – an increase in price which is driven by speculative
demand and unsustainable in the long run. At a certain price, the bubble “bursts”
and prices come down to a level which more closely reflects the fundamental
economic value.
Bubble economy can lead to disastrous consequence as it occurred in
the 1930s in the form of Great Depression and during the 1990s in Japan. The
condition misallocates resources. The period of crash following this condition
adds to the devastation. It is seen that this economic condition has far fetched
effects.
This phenomenon also casts a negative impact
on the buying capability of the richer class. They spend more for the products
that might be a trifle.
As for types of Bubbles scientists distinguish 1) Market Bubble. It is the situation when a particular market sees a rapid
increase in price. 2) Commodity bubble. It means that the price of one commodity or several commodities
increase in price. For example, we might see speculative bubble in the price of
gold, e.g. in the 1970s and 1980. 3) Stock market bubble: when
the value of stocks and shares increase rapidly, e.g. prices increase faster
than earnings. A stock market bubble is vulnerable to a crash, where market
traders come to feel the bubble prices are over-inflated. 4) Credit bubbles – a
rapid growth in consumer and business credit to finance higher consumer
spending. 5) Economic boom / bubble. It implies that the economy expands at an
un-sustainably fast rate, leading to inflation. Ultimately an economic boom
usually proves unsustainable. There may be a strong link between market bubbles
and an economic boom. For example, a house price bubble may cause rising wealth
and confidence leading to higher consumer spending and economic growth. In
turn, the higher economic growth feeds the housing boom.
Every economic bubble in history started with
reckless expansion of money supply and credit, reckless
manipulation of interest rates, or government promotions of
"low-risk" something for nothing schemes. Throughout the world and economy development we have encountered different examples
of Bubbles. Let’s revise some of them.
·
South Sea Bubble 1711-1720. A company set up to profit from British trade with South America. The
price of shares rose rapidly, but with the company failing to make any real
profit, share prices collapsed in 1720 and returned to pre-issue levels.
·
Tulip
mania of 1630s. When the price of tulips rose to
over 500 times their previous price before collapsing when buyers stopped
entering the market.
·
Dot
Com Bubble. A rapid growth in the share value of internet shares
in 1997-2000.
·
Credit
bubble of 2000s, which saw a rise in asset prices
and bank lending.
But how do they form and what are
their economic impacts? Usually bubbles start
with some good economic reasons. For example in early 2000s, low interest rates
and economic growth encouraged people to buy a house. In 1990s internet stocks
did offer good potential growth for this new business. However, rising prices
and rising demand can create a dynamic where positive news encourages people to
take more risks and prices raise more than they should. Here are some factors that can
cause bubbles.
·
Irrational exuberance. In certain circumstances, investors can buy assets because of strong
psychological pressures which encourage them to ignore the fundamental value of
the asset and believe that prices will keep rising.
·
Herding behaviour. People often assume the majority can’t be wrong. If banks and
well-established financial leaders are buying, they assume it must be a good
investment.
·
Short termism. People make decisions based on
short term rather than the long-term.
·
Hope.
People believe they can beat the market and get out before the bubble pops.
·
Cognitive dissonance – a filtering out of bad news and looking for views which reinforce
their beliefs.
·
Financial
instability hypothesis. The theory that periods of economic prosperity cause investors to be
increasingly reckless leading to financial instability.
·
Monetary policy.
Sometimes bubbles occur as an indirect consequence of monetary policy.
As for bubbles
effects we should say that they can be damaging to the wider economy, especially if
it is the housing or the stock market. A stock market crash can cause a loss of
confidence and lower spending. A bubble in the housing market tends to be more
damaging because housing is the biggest form of wealth. If house prices fall
rapidly, it will cause a significant fall in consumer spending and can cause a
recession. For example, the housing crash of 1991 contributed to UK recession.
The house price bubbles and bust were a strong factor behind recessions in
Ireland and Spain.
For commodity bubbles the economic effect is
more uncertain. For example, a rapid fall in gold and oil prices will mean some
investors lose a lot of money. But, falling oil prices will help increase
consumer disposable income and can actually help the economy.
So, How to beat the Bubble Economy? Keith Fitz-Gerald, seasoned market analyst with decades of experience,
says that in terms of what we do as investors, there are certainly easy
choices. First, the return of your money has to be more important than the
return on your money. Any investment you make has to be made with the concept
of safety in mind and the preservation of value at hand. Second, don't walk but run away from
long-term bonds and fixed-rate investments. That includes many annuities and
whole life insurance at this point. Any rise in interest rates will crater the
value of these instruments and subject your wealth to unnecessary volatility. Short-term
bonds and variable-rate instruments are the different story. There you have at
least a limited capacity to absorb the changes that will come from rising
interest rates and a changing global financial system by continually recycling
into new, higher rate instruments as they become available. Third, make sure
you are equipped to “buy and manage”. Buy and hold has been dead for years and
is unlikely to ever return. Sadly most people don't realize this and continue
to confuse it with buy and “hope”. And fourth, you’ve got to know when to step
back in.
Bibliography
1. Электрон. ресурс. Режим
доступа: http://www.economywatch.com/economy-articles/bubble-economy.html
2. Электрон. ресурс. Режим
доступа: http://blog.roodo.com/ledturninglamp
3. Электрон. ресурс. Режим
доступа: http://moneymorning.com/2012/07/27/four-ways-to-not-lose-money-in-a-bubble-economy/