Thursday, March 13, 2014

The Ideas Factory: So, bubbles anyone?

The Ideas Factory: So, bubbles anyone?: What causes a bubble? And by bubble I mean a financial one. One of my favorite books, Manias and Panics (and some other word, I can’t rem...

Wednesday, March 12, 2014

So, bubbles anyone?

What causes a bubble? And by bubble I mean a financial one. One of my favorite books, Manias and Panics (and some other word, I can’t remember what it was) by Charles Kindleberger, an Economic historian at MIT said that perhaps when newer technologies come around, there is a tendency to end overpricing newer assets, as nobody knows what the inherent value is. When the South Sea company trading at the London Stock Exchange ended up falling from a massive cliff, it was because the concept of stock trading was somewhat new. Similarly a bubble occurred when new tech companies came along. Setting aside new economy BS going around that time, it could be seen that people and media hyped in a romantic sense what the changing technology could bring about. With housing I am not really that sure. And in any case Kindleberger didn’t stay alive to see the bursting of this bubble. So can’t really a deadman what his opinion was (would be?) about the housing bubble.

The key thing though is that bubbles do end up occurring in a common occurrence. Just take a look at the current shale boom happening. It is a bubble. Oil companies involved with it are issuing rosy guidance for the future, while under stressing the fact that the yield of a horizontal oil well keeps goes down by 40% - 50%; bottom line? They just have to keep drilling more and more and more just to breakeven. And guess what? Shale oil is spread out over miles of land. So it is more of a hit and trial game. Yeah right, the US is going to achieve the 18.5 millions of barrels in a self-sufficient manner.

I am an economics student in training, but the more I think about bubbles (it is amongst my favorite areas of topic) the more obvious one fact becomes- for a bubble to even exist, almost everyone has to believe in the story itself. I mean, think about it; an economy depends on what all of its constituents are thinking and believing in the first place. The people who kept believing the housing market would forever keep going more were the ones who were pushing the prices upwards. Sure, you had cheap credit available. But you wouldn’t have taken the credit in the first place if you didn’t want to buy a house in the first place. And this is why a bubble is similar to a spiral; it is sustained by people believing the story. Not enough people believed the house prices would start to collapse in the first place, that’s why you didn’t have any selling which would have kept the house prices somewhat stable. And I think that’s the key for a bubble to exist. We all like to believe that the economy is always impacted by “some other suckers”, but the truth is that you’re part of it. And collective behavior impacts the economy. The government issues guidelines but the buying and selling is done by us. And by us I mean you, me, my roommate. And when something ends up being believed in by pretty much everyone, of course you’re going to have a “bubble”.

That’s one of the reasons I somewhat find it hard to believe that the stock market is in a bubble. The mere fact that so many people are talking about it, somewhat hints that there isn’t one.

But there is one in oil and gas. And I am going shopping once it bursts. After all I missed my would-be Christmas in 2008.