how does an economic bubble\speculative bubble work?
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Economic bubbles generally occur when there’s a disconnect between the intrinsic value and the price of something.
*Usually* it’s due to some piece of information being inaccurate that starts it, either mistakenly or deliberately, and then it feeds off of itself.
Sometimes it is because the market is overly optimistic about something–the Dot Com bubble is an example, as people threw a lot of money at a lot of internet companies. It made sense–the internet was just beginning to be a commercial force in the 90s, so anyone on the ground floor was due to make a *lot* of money. And a lot of people did! But there were also a *lot* of companies people threw money at, hoping to be the next eBay or Amazon. The disconnect in information began–“dot com business means money” started off true, but as more and more companies with less and less justification were created, that statement was more often untrue than true.
It could be speculation, which is basically assuming a good will increase in price *because* people think it will increase in price. There’s no *inherent* change in value; it’s the same good with the same utility, the only think that has changed is that for whatever reason people *think* it’s going to be more valuable in the future. This happens with land, raw resources, or collectables.
It could be misinformation. The housing crisis in 2008 is a prime example; the mortgages were being sold as having a high rating, but in reality were not. (Some people wouldn’t consider this a bubble but just regular fraud, but people continued to ride it out even after this became obvious, which classifies it as a bubble.)
(There are other reasons, but these are the big three.)
The main thing about all of them is that the bubble feeds on itself. After a certain point, something is increasing in price *only because* it increased in price in the past, and there doesn’t seem to be any reason it would stop. It’s super easy to make a quick buck buying some and then selling it off…right up until the point where it doesn’t. While *some* of it is psychological, a lot of it is perfectly standard risk-taking. A lot of people with a lot of charts and econometrics might still buy into a bubble because they’ve done the math, and even if they lose it was worth the risk.
The last thing that that people call a lot of things speculation/bubble that really aren’t. The defining feature is that towards the end, the reason for the price increase is the price increase itself, not any change in supply or the intrinsic value of the good. A lot of people just look at the normal flow of supply and demand and call it a “bubble” but that’s just reflecting reality.
Like, we’re not in a housing bubble right now; house prices are crazy because we stopped building houses during the pandemic and only started to rebuild them relatively recently (and houses take a while to build), but also the price of lumber tripled at one point so the intrinsic value is, indeed, higher. Now, at some point, it *might* become a bubble, and maybe already is in certain areas, but that’s the thing about bubbles–there’s no immediate way to tell if it’s a bubble or just the normal price change due to supply and demand.
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