I have been reading about the worsening housing/rental market, COL and worrying inflation figures as a whole. Seeing lots of talk about this mythical “bubble”- people saying things like “the bubble is about to pop”, and “welcome to the bubble” blahblahblah **BUBBLE**. Seems like this is a common term/knowledge in economics but I don’t fully understand… please eli5 🙂
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“Bubble” is a term for a growing trend that seems out of proportion and likely to fail. It’s meant as a metaphor for the fragility of an actual bubble, and how easily it breaks, leaving nothing behind.
In the case of the housing bubble (most well known recent case) in 2008, home prices rose dramatically high, outpacing the reality of supply and backing of actual value. When it “burst” aka everyone realized what was happening and panic sold their positions, many, many people lost jobs and homes, leaving devastation.
Bubbles are really common, there was the internet bubble in the 90s/early 2000s, the recent tech start up bubble in the 2010s etc….most of the time there’s a minor dip and nothing major happens.
Think of a bubble as the inflation of price in a market. The price rapidly increasing is the bubble growing, and eventually the bubble will pop, which is the collapse of the market. Then you slowly start blowing up a new bubble and it’s something much smaller, and will eventually begin to be much larger again.
It’s more or less when the market is assessing a thing as a lot more expensive than it is actually worth. Being “on the bubble” is when someone invests heavily into that thing, and there’s a large gap between what the market says it’s worth, and where it’s true value actually is.
The most recent and extreme example is NFT’s. Their real-world value is practically nonexistent. They don’t have a physical form, aren’t accepted as tender, can’t be traded outside of the NFT marketplace, etc. But those marketplaces value them, and used to value them by quite a bit, with some going for many thousands of dollars worth of cryptocurrency. But the bubble is in the process of bursting. Right now, NFT’s are worth about 1/3 of what they were just three months ago. And because there isn’t a solid floor, the NFT market will continue to deflate. (Unlike say the housing market, where national or local policies can artificially inflate the value of housing well beyond what it costs to build….but housing is still is worth quite a bit without the artificially high prices.)
The inflate and deflating, as well as the gap between market value and hard/real world value gives the metaphor of having a bubble sitting on a surface.
A bubble occurs when people are buying something not because they think it’s actually worth the price, but because they think they will be able to sell it for more than they paid. The price goes up and up and up, each successive owner selling it for more than they paid, until eventually someone isn’t able to find any buyers–at which point they’re left holding something whose actual value is a tiny fraction of what they paid for it.
People buy in because the price *is* going up, and so as long as they get out in time they *will* make money. But inevitably someone isn’t going to get out in time. It’s functionally equivalent to a pyramid scheme, but is something that happens naturally without anybody necessarily intending it.
It’s also worth noting what is NOT a bubble!
* Some [[thing]] or part of the economy is overpriced, but that alone does NOT make it a bubble.
* Some [[thing]] or part of the economy is seeing higher-than-normal trading volume, but that alone does NOT make it a bubble.
A key part of being a bubble is that some person who wants to Get Rich Quick buys some [[thing]] at some price, not because he wants or needs it; rather, the SOLE purpose to resell (as quickly as possible, usually!) to someone else who -also- hopes to sell it onward and Get Rich Quick.
The [[thing]] in question can be houses, or pork bellies, or silver ingots. High price doesn’t matter (because someone else will pay more than you did); large volume is actually good (indicating there are still people out there -willing- to pay more than you did); but all of those together means that “something” is going to go **Pop!** when volume dries up and there are no more buyers for the now-overpriced [[thing]].
It’s the combination of factors, not just one single thing.
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*Edit to add:* When things go Pop!, if it’s just the last guy left holding the bag — everybody else got paid — then damage is limited to that last guy (figuratively).
But **if** the chain of purchases was funded by -borrowing- money, such that Person A (who sold [[thing]] to Person B) doesn’t get paid until Person B sells to Person C, **then** a whole lotta people are not getting paid, and that’s when things REALLY go to hell in a handbasket.
A bubble is a situation where something only has value because you expect to be able to sell it to another buyer in the near future. This incentivizes people to buy that thing as an investment, since it increases in value. But as more people buy it as an investment, the faster it increases in value, and then that draws more people to invest.
Eventually you run out of investors and whoever bought at the peak of the bubble is in trouble. They can’t find someone willing to buy their share of that thing for any higher than what they paid, which effectively makes their ownership stake worthless, since the only reason they bought it was to sell it for more. So they’re gonna start selling at a low price to try and cut their losses, which then triggers other investors to sell at a low price to try and cut losses, since this signals that the market price has stopped going up and this thing is no longer a good investment.
Things that can generate money for you by just holding them, like stocks, bonds, and real estate, are less likely to create bubbles, although it’s still possible. If you can make money just by holding your investment, then there’s no need to find a buyer at a higher price. You’re perfectly content to just wait and collect your steady profit from holding.
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