Same Old Hope: This Bubble Is Different

This time is different.

That’s what people argue every time a bubble inflates, and what they think every time they lose money when it pops. But year after year, decade after decade, century after century the process repeats all over again.

Not long ago, the housing bubble burst and brought the global economy to a standstill. Now investors, recognizing that bubbles tend to come in bunches, are on the lookout for the next market to fizzle. Possible candidates are the capital markets in China, commodities like gold and oil, and government bonds in heavily indebted countries like the United States.

Bubbles are episodes of collective human madness — euphoria over investments whose skyrocketing values are unsustainable. They tend to arise from perceptions of pending shortages (as happened last year, with the oil bubble); from glamorized new technologies or investment frontiers (like the dot-com bubble of the 1990s, the multiple railroad bubbles of the 19th century); or from faddish cultural obsessions (like the Dutch tulip bubble of the 17th century).

Often they are based on legitimate expectations of high growth that are “extrapolated into the stratosphere”. Such is the fear over investment in emerging markets like China. “I am a long-term bull on Asia, but right now it’s premature to be celebrating the ‘Asian Century,’ like some investors seem to be doing,” said Stephen Roach, chairman of Morgan Stanley Asia.

But a sovereign debt bubble — which many argue is driving the acceleration in gold prices — could prove far more dangerous. So many countries, like the United States, are running up such large national debts as a percentage of their overall economies that they could risk eventual default. Even without outright default on their obligations, the value of government bonds sold to finance these deficits could plunge, costing investors a lot. Debt crises are usually associated with developing countries, like Brazil, Argentina or Zimbabwe. But they can affect big, rich economies too, where the scale of global damage can be much greater.

The depth and breadth of the pain unleashed by the recent housing bust have led political leaders and central bankers to reconsider their duties to preempt, rather than just respond to, potential bubbles, and the same is true with the potential bubbles that economists foresee today. China has started to tighten monetary policy to rein in the hype surrounding its equities. Politicians in the United States, while torn over the means, are discussing ways to bring the deficit until control. The G20, at its coming meeting in Pittsburgh, is expected to address ways to calm financial frenzies. The solution may involve additional regulation, guidelines for financial compensation and possibly requirements for more market transparency so that, at least in theory, investors can better judge what they are taking on.

But however stringent such new regulations may be, economists say, they cannot completely defeat human nature. Investors will continue to be hypnotized by get-rich-quick deals, seeking investments that magically double, triple even quadruple without toil or trouble.

Ultimately, bubbles are a human phenomenon. Sometimes, people just get a little crazy.

PS: This is a summary of an article from the New York Times. View the original here (Registration required)