GOLD is the money of the KINGS, SILVER is the money of the GENTLEMEN, BARTER is the money of the PEASANTS, but DEBT is the money of the SLAVES!!!

Wednesday, September 3, 2014

The Bubble Economy and How to Prevent Financial Disasters in the Future (2009)






Popular among laymen but not fully confirmed by empirical research, greater fool theory portrays bubbles as driven by the behavior of a perennially optimistic market participants (the fools) who buy overvalued assets in anticipation of selling it to other speculators (the greater fools) at a much higher price. According to this unsupported explanation, the bubbles continue as long as the fools can find greater fools to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price.

Extrapolation is projecting historical data into the future on the same basis; if prices have risen at a certain rate in the past, they will continue to rise at that rate forever. The argument is that investors tend to extrapolate past extraordinary returns on investment of certain assets into the future, causing them to overbid those risky assets in order to attempt to continue to capture those same rates of return.

Overbidding on certain assets will at some point result in uneconomic rates of return for investors; only then the asset price deflation will begin. When investors feel that they are no longer well compensated for holding those risky assets, they will start to demand higher rates of return on their investments.

Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. A person's belief that they are responsible for the consequences of their own actions is an essential aspect of rational behavior. An investor must balance the possibility of making a return on their investment with the risk of making a loss -- the risk-return relationship. A moral hazard can occur when this relationship is interfered with, often via government policy.

A recent example is the Troubled Asset Relief Program (TARP), signed into law by U.S. President George W. Bush on October 3, 2008 to provide a Government bailout for many financial and non-financial institutions who speculated in high-risk financial instruments during the housing boom condemned by a 2005 story in The Economist titled "The worldwide rise in house prices is the biggest bubble in history".[22] A historical example was intervention by the Dutch Parliament during the great Tulip Mania of 1637.

Other causes of perceived insulation from risk may derive from a given entity's predominance in a market relative to other players, and not from state intervention or market regulation. A firm -- or several large firms acting in concert (see cartel, oligopoly and collusion) -- with very large holdings and capital reserves could instigate a market bubble by investing heavily in a given asset, creating a relative scarcity which drives up that asset's price. Because of the signaling power of the large firm or group of colluding firms, the firm's smaller competitors will follow suit, similarly investing in the asset due to its price gains.

However, in relation to the party instigating the bubble, these smaller competitors are insufficiently leveraged to withstand a similarly rapid decline in the asset's price. When the large firm, cartel or de facto collusive body perceives a maximal peak has been reached in the traded asset's price, it can then proceed to rapidly sell or "dump" its holdings of this asset on the market, precipitating a price decline that forces its competitors into insolvency, bankruptcy or foreclosure.

The large firm or cartel -- which has intentionally leveraged itself to withstand the price decline it engineered -- can then acquire the capital of its failing or devalued competitors at a low price as well as capture a greater market share (e.g., via a merger or acquisition which expands the dominant firm's distribution chain). If the bubble-instigating party is itself a lending institution, it can combine its knowledge of its borrowers' leveraging positions with publicly available information on their stock holdings, and strategically shield or expose them to default.
http://en.wikipedia.org/wiki/Bubble_e...

No comments:

Post a Comment

Related Posts Plugin for WordPress, Blogger...