Asset Bubble

What Is An Asset Bubble? An Introduction.

An Asset Bubble, is where the price of an asset is over inflated; usually due to high demand. They become over valued and these overvaluations can persist for many years until eventually bursting and causing the assets price to fall lower than its fair value. High money supply and liquidity in the financial system fuels a bubbles growth as it allows people to invest more money and allows investors to leverage their capital (borrowing from the banks and further investing in the asset). They are detrimental to the economy as when the bubble bursts it often bring wealth destruction and negative social, political and economical consequences.

Bubbles form when excessive speculation circulates in a market and instead of investors looking at the intrinsic value of an asset they instead chase prices and focus on the resale value of the asset. Investors see the trend of rising prices and buy quantities of the assets in hope of profiting from the increase in value over the coming weeks/months. A sure warning sign of an Asset Bubble is when the general public are investing their money on the asset and there are many first-time investors entering the market; there may be articles in the newspaper about how e.g. a taxi driver has made thousands on the Stock Market.

Prevention Of Asset Bubbles

Intervention to prevent the formation of Asset Bubbles by the Fed, Governments or Central Banks is hard because Asset Bubbles are not easy to identify. A common argument is if professional investors and the finance industry as a whole cannot spot a Bubble growing then how could any other party know better. Bubbles growth are fuelled when there is excessive money supply in the market> Governments can utilize their Fiscal and Monetary Policies to discourage Bubbles from forming; if interest rates are increased money will become more expensive to borrow and the demand for capital will fall, investors will find it harder to get loans to buy the asset in question.

Perhaps the most famous example of an asset bubble is the ‘Dutch Tulip’ which occurred in the 1593. This is where a virus mutated tulips to feature a flame patter on the petals. The value of the tulips rose by a twenty-fold value is the course of one month. This vast over valuation of Tulips was then realised by the Dutch population and prices fell overnight. Apart from the lucky few who had made a quick profit and left the market, the rest of the investors were left financially devastated. A depression swiftly followed and caused the country many economic problems for years to follow. Find out more about the ‘Dutch Tulip Asset Bubble’ and other historic bubbles on the ‘Famous Examples’ page.

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