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The Economic Bubble | Bubbles, Tulips and Gold?

Posted By Robert On Saturday, August 23rd, 2014 With 0 Comments

Addressing the Economic Bubble – the ultimate transfer of wealth.

When assets rise in an uncontrolled way, the situation is called an economic bubble. Like actual bubbles, in an economic bubble prices rise upwards but become more and more fragile – eventually they all burst.

Stock Market Crash

To outline the economic bubble:

Sometimes extraordinary conditions occur that over-inflate prices in an industry. This leads to share/asset prices to rocket.

The situation is widely discussed in the media and at informal gatherings. News of this unusual state of affairs reaches the general public.

Many believe the escalation will continue and get very excited.

They buy hugely over-priced shares (or the over-priced product itself). Prices become unsustainably high, confidence is destroyed and the market crashes.

Tulipmania

Tulipomania

The Dutch tulip mania of the 1960s is one of the earliest and most notorious instances of an economic bubble.

At the beginning of the 17th century, tulips became popular with the wealthy of Holland and Germany and soon everyone wanted them.

Tulips were seen to bestow the qualities of wealth causing the Dutch middle class to become obsessed with collecting rare varieties.

Many individuals grew rich suddenly. People from all walks of life rushed to the Tulip markets all imagining that the passion for tulips would last forever.

One Tulip = Amsterdam Townhouse

When the rich stopped planting tulips in their garden, their appeal diminished and people realised the folly couldn’t continue.

Selling became more frantic, confidence plummeted and the price of tulips collapsed. For those that borrowed money to invest, it was disastrous.

Selling became frantic

How Bubbles Form

“Investors” in these circumstances buy an asset often in full knowledge that the price is far above any “fundamental value” but do so because they expect prices to rise still further before they eventually crash.

Since prices cannot rise for ever, this involves the irrational belief “that the guy you sell to is dumber that you and will not see the crash coming”. This has been labelled “The Greater Fool Theory” sell the asset to the greater fool willing to pay the higher price.

There are always fundamental reasons why there is an initial rise in an assets value, the key is spotting when the price is being fuelled by speculation rather than intrinsic value.

How bubbles form

Our top economic bubble tips!

  • Be suspicious with any rapid rise of an assets price
  • Do not assume a rapid rising price is a bubble!
  • Bubbles can last for quite some time/years
  • With investment “Boring” is beautiful, stick to slow steady returns rather than the next “multi-bagger”
  • Some assets are more prone to economic bubbles than other, any markets that encourage speculation such as shares, property and Gold.
  • Economic bubbles usually ALWAYS look like price pyramids on stock market charts, an obvious up trend followed by a quicker down trend forming a complete pyramid. This is often referred to in the investing community as “pump and dump”. Referring to individuals buying stock with the intention of pushing the price higher only to “dump” it at hugely inflated prices.

Either way – stay away from markets being speculated upon, no matter how tempting it may be.

The most dangerous words an investor can say is ‘This time it will be different’.

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