Bubble

A bubble is when the price of financial assets increases in an irrational way after a long period of optimistic expectations and high profits. When a bubble inflates, "specula- tors invest only because the asset price is rising" (Rapp, 2009, p. vi). Asset prices grow irrationally and speculators increase their purchases until the bubble bursts; this is when stock prices start decreasing (Fisher, 1933). Referring to the dangers induced by bubbles, Keynes (1936, p. 159) maintained that "speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation". According to Galbraith (1990 [1994], p. 13), the factors contributing to the euphoria inflating a bubble are manifold: "The first is the extreme brevity of the financial memory. In consequence, financial disaster is quickly forgotten. [. . .] The second factor contributing to speculative eupho- ria and programmed collapse is the specious association of money and intelligence". In this regard, Kindleberger (1996, p. 13) noted that "[t]he word mania emphasizes the irrationality; bubble foreshadows the bursting. [. . .] [A] bubble is an upward price movement over an extended range that then implodes. An extended negative bubble is a crash".

Bubbles are inherent to a capitalist system. They are the result of a structural change in financial circuits, where various elements come into play, including short-term profit expectations, interest rate and decreased profits in production activities. The transforma- tion of the financial system after the demise of the Bretton Woods regime induced small bubbles that in a number of cases led to a crisis, which is a recurrent characteristic of the period from the 1970s up to the global financial crisis that erupted in 2008. Financial deregulation and liberalization processes, along with financial innovation and financial intermediaries, propitiated a shadow financial system that grew stronger until it exploded in 2008, after the collapse of Lehman Brothers, a US-based investment bank. A recent example of a financial bubble is the tremendous price increase of financial assets before the global financial crisis that burst in 2008.

The first point to an understanding of asset bubbles is financial fragility and insta- bility in the business cycle. "Instability emerges as a period of relative tranquil growth transformed into a speculative boom" (Minsky, 1986, p. 173). Financial fragility, inherent to the capitalist system itself, propitiates bubbles via Ponzi financing in order to earn ephemeral profits. When the bubble bursts, a credit crunch occurs and, with that, a long recessionary period, deflation, and massive losses of employment. Creative destruction invites new investors again, so that a further business cycle begins anew (see Schumpeter, 1934).

See also:

Asset price inflation; Bretton Woods regime; Bubble Act; Financial bubble; Financial crisis; Financial innovation; Financial instability; Housing bubble; Investment banking; Shadow banking.