Download the article in Forbes January 2013
by Jennie S. Bev
The economic implosion of 2008, tech bubble
bursting in early 2000s and the 1997 Asian Financial Crisis are popped
financial bubbles. Yet such bubbles go back to the tulip mania in 1600s and the
origins of the Great Depression of the1930s are two other such bubbles, further
back in time.
Yale University lecturer and global equity
investor Vikram Mansharamani in “Boombustology: Spotting Financial Bubbles Before They
Burst” proposed five lenses to spot financial
bubbles and make the necessary moves before it’s too late: microeconomics,
macroeconomics, psychology, politics and biology. Every lens provides some
insights into how bubbles are created and any combination of those lenses
spells trouble.
The two elements of microeconomics are supply
and demand, which always find a way to achieve the so-called
“equilibrium.” However, monetary policies often come into picture, which can
tip the balance. Thus, both Milton Friedman and John Maynard Keynes’ arguments
have their own strengths and weaknesses in the creation of financial bubbles.
George Soros’ theory of reflexivity notes that human
limitations come into the picture in shaping people’s thinking. The
delta between the reality and people’s own perception creates an antithesis to
“achieving equilibrium.” In other words, economic “equilibrium” can never be
achieved because people are in constant dynamic “disequilibrium.”
In macroeconomics, debt and deflation affect
asset markets and prices. Hyman Minsky, a professor of economics at Washington
University at St. Louis, posited that income-debt relationships are directly
affected by people’s ability to pay principal and interest. Using the psychology
lens, the assumption that human beings are “rational” is a fallacy. According to studies, people are limited and motivated by cognitive biases. The studies also found
that people are likely to make suboptimal decisions and adopt false
assumptions. Hence, human beings are more irrational than rational. In
addition, studies have found that human beings tend to be overconfident of
their ability and are unaware of their limitations, which why experts offered “rational”
explanations of bubble phenomenon without recognizing that they were already in a bubble.
The fourth lens is politics. A
political-economic system greatly affects the likelihood that a financial bubble will occur. In the former Soviet
Union, no bubble occurred as the state
controlled prices and demands. In contrast, the more
capitalistic a country, the more volatile are the market and prices. In extreme
cases, such volatility will snowball into extreme prices leading to bubbles.
Political will, which is often reflected in tax provisions and protectionism,
further affects the creation of bubbles. For instance, in the U.S.
mortgage interest is tax deductible. These provisions consequently create
asset-class bubbles.
The final lens used is biology. After all,
human beings are animals. The feverish intent to purchase a “McMansion”
during the height of the mortgage fever in early 2000s is a symptom of
financial disease, which spreads like wildfire with its infection. Studies had been done
on large groups, which are called “emergence” and that transform themselves
from chaos into group actions. Studies conducted on groups resulted in three behaviors:
avoidance, alignment and attraction. However, people also show
such behaviors in making economic decisions. Finally,
are there any financial bubbles in 2013? Yes, and including the extent
to which people
are willing to spend on “investments.”[]
Forbes Indonesia, January 2013
