Speculation Bubbles
A speculation bubble is an economic abnormality that occurs during periods of rapid asset price appreciation. Speculative bubbles occur when a rapid increase in asset prices that is not supported by underlying value suddenly erupts, followed by a dramatic decline. It has been argued that speculation bubbles are responsible for exacerbating or even triggering major economic recessions.
The most famous example of a bubble is the stock market crash of 1929. This crash was preceded by a large number of investors buying stocks at prices well above their actual worth and was followed by a prolonged economic depression throughout the United States. Other more modern bubbles include the dot-com bubble of the late 1990s, where internet stocks were overvalued leading to a collapse in stock prices, as well as the more recent housing bubble, in which home prices rose to unsustainable levels before precipitously falling.
While the stock market crash of 1929 is the most visible example, speculation bubbles occur in many different asset markets. Art, real estate, commodities, and even currencies can be subject to speculative bubbles. In general, speculation bubbles are caused by a combination of factors. These include perceived potential for large returns, a limited supply of the asset, new technology or innovation that increases the asset’s value, and general market optimism.
Unfortunately, speculation bubbles can be difficult to predict and identify. In some cases, there are warning signs that may indicate an upcoming bust, such as a rapid increase in prices, an increase in the number of speculators, and a loosening of lending standards. However, as a bubble continues to inflate, people often become increasingly bullish about the asset and assume that prices will continue to go up. Thus, even when the warning signs are present, it may be difficult to identify the approaching bust until it is too late.
Once a speculation bubble bursts, it can have dramatic and widespread effects, particularly in debt markets. When asset prices plummet, the value of securities and collateral that was used to secure debt also drops. Therefore, lenders may be unable to repay the debt and face bankruptcy. This can cause a financial contagion, where the failure of one market triggers a domino-like effect of failures in other markets. The effects of the bubble may also be felt in other sectors of the economy and can last for many years.
Speculation bubbles, and their accompanying busts, are an unfortunate but common occurrence in many asset markets. While it may be difficult to identify an upcoming bubble and its eventual collapse, it is important to be aware of the risk of potential bubbles in order to best protect your investments.