The Causes of Economic Bubbles

This article explores some of the factors that contribute to the creation of economic bubbles. The subprime bubble is the most recent bubble, but it is not an isolated case. It comes as the latest in a long line of economic bubbles. Over the last 50 years we have seen major bubbles in things like conglomerates, inflation, commodities, Japanese real estate, dotcom, and subprime mortgages. Clearly, there is something intrinsic to human nature which creates bubbles.

Bubbles in themselves are not a problem. The real problem is caused by the increase in relative pricing levels. This causes misallocations of capital towards the areas achieving high price rises. The subsequent correction (as the trend proves unsustainable) causes severe structural difficulties in the economy.

A lot of books and ‘after the event’ wisdom has been published on the subject of bubbles. However, very few of them, go into explaining how you can actually profit from future situations. This article looks at some of the mechanisms by which bubbles takes place. It outlines some examples of the causes and, suggests ways in which investors can recognise bubbles.


Anchoring is the behavioural finance perspective whereby people have the tendency to over emphasise one specific value and then adjust to that value. That ‘anchor’ is laid down and decisions are made with a bias towards that value.

A classic example would be with the housing market, whereby whole neighbourhoods ‘adjust’ to rising home prices. The price becomes the anchor, to then spur prices higher, as everybody focuses on rising prices. However, what they are not focusing on are values such as house price to income, house price to monthly mortgage payments and other mortgage affordability metrics. The result is a severe dislocation in the allocation of resources with an economy. This can be seen in the continuing oversupply of housing in the US.

Soros’ Reflexivity in Markets

Reflexivity in bubbles is the process whereby the fact that prices are rising causes the underlying fundamentals to improve, which then feeds back into higher prices as agents see better fundamentals. This positive feedback loop grows until, at some point, this relationship breaks down and, the positive feedback loop then becomes a negative one. It is easy to confuse this process with anchoring-in fact anchoring contributes to reflexivity-however it should be noted that with reflexivity, the underlying fundamentals are, in fact, improving. This makes this type of bubble, even more dangerous.

An example of this can be seen with gold, whereby increasing prices have seen sentiment shift towards gold being seen as a ‘safe haven,’ uncorrelated asset class, for investors. Similarly, rising prices have seen an increase in Exchange Traded Funds ETF issuance, which has encouraged new investment. The increase in ETF investment then fuels further higher prices and the positive feedback loop goes on.

Structural and Cultural Causes

Not all economies are driven by free market supply and demand. Furthermore, different cultures value economic ends differently. Furthermore, many countries are at different stages of development to each other, In other words, economies and asset prices are driven by other considerations than purely supply and demand. This can create a bubble if the marginal increase in demand from one culture or country causes price inelasticity.

For example, consider that most of the Far East Asian countries (particularly China and India) are in early stage development. In these countries, significant social unrest would ensue if employment or living conditions got noticeably worse for the large poorer section of their populations. Therefore, as oil prices rose in 2008, many of these countries (China, India, Malaysia) continued to use their public surplus to subsidise Oil prices for the poorer segments of their populations. The subsidies helped mask the underlying price rise and this caused global Oil demand to be price inelastic. Whether this is sustainable longer term is another question.

Corporate Necessity, Fear and Greed

Corporate decision making isn’t necessarily driven by profit maximisation, or following shareholder interests, or even adherence to the underlying fundamental metrics in their industry. Directors may decide to acquire companies simply because they want to further their own careers (conglomerate boom) or they fall foul to the latest fad (dotcom boom).

Furthermore, they could driven by their own self-interest in grabbing short term profit, even if they know it is detrimental to the long term interests (subprime mortgage, SIVs and mortgage bonds) of their shareholders. Similarly, the staff of these companies could be made aware that if they do not adhere to this mania, then they will be replaced by someone who does!

Another factor is that corporations could be forced to exacerbate bubble conditions further, even if they know that their industry is on an unsustainable trend. An example of this was the issuance of 3G licences in the UK. This is seen as the pinnacle of the dotcom bubble, but what else were the incumbent mobile telecom companies supposed to do?

Their raison d’etre is to offer upgraded services to their customers. The licences were limited in number and, they had to have them, even if the price they paid (to outbid newcomers who were flush with investor cash) might have been seen as ‘bubbly.’ They weren’t paying what they thought was fundamentally sound, but rather what they had to pay in order to keep their company offering updated 3G services.

Behavioural Finance Explains Bubbles

All of the factors outlined in this article are intrinsic to human behaviour and, illustrative of the point that human behaviour creates bubbles. Therefore, bubble behaviour will always be around. Greater understanding of these causes can create opportunity for investors to take advantage and avoid potential bubble scenarios.

Sudden Job Loss and Needing Money Fast

Unemployment benefits are processed relatively quickly, but there is still a time frame where the unemployed sit without incoming monies. What can you do until you get your first unemployment check? Well, first and foremost, don’t panic. Calm down. A mind that is in panic mode is incapable of rational thinking. After grasping and accepting the situation, sit down with those you love to discuss your course of action. A job loss in a household affects every member of that household.

With the rent or mortgage payments looming, utility companies needing to be paid, car payments, credits cards, and many other recurring debts, the quest in finding monetary sources can be daunting.

Avenues to Making Money Fast – Legally

The following list identifies resources for those occasions when money is scarce and fleeting.

  • Have a yard sale. Every American household has something somewhere in their home of which they no longer use, forgot was there, or have simply outgrown. The popularity of yard sales has greatly increased during these difficult economic times. Many families are in similar situations and look for bargains on gently pre-loved clothing, which will help stretch every dollar.
  • Borrow money for the short-term from friends or relatives, but always pay it back to preserve your relationships. It is wise to handle these transactions as regular business transactions by completing a written agreement with your friend or relative to stipulate all conditions of repayment. This will ensure that both parties are in agreement based on the terms of the loan.
  • Sell your second car. When finances are tight, why saddle what little budget exists with a car payment, insurance, and maintenance costs when one vehicle can be shared? The monthly savings can easily be substantial. According to Mark Solheim of Kiplinger’s Personal Finance Magazine, the average monthly vehicle loan payment in the U.S. is $479.00. Plus, add the cost of insurance, fuel, and maintenance, and the total cost can easily equal a house payment. Put the saved monies into your pocket, not the auto loan company.
  • Advertise to sell unwanted items on Craigslist, e-bay, or the local city classified ads.
  • Sell your gold and other jewelry. There are on-line and fixed location companies that advertise to buy gold and other precious metals.
  • Pawn some items. I only recommend this option after exhausting every other possibility. Pawn shops have negative reputations regarding their business practices of providing collateral loans at up to 25% interest rates. The typical loan is between 30 to 60 days whereby the original loan amount plus interest will be due and payable. If the items are not redeemed within that timeframe, ownership of the collateral reverts to the pawnshop.

When the sudden loss of a job occurs, the recently unemployed must act quickly to preserve their finances. Begin by applying for benefits of which you qualify, communicate with your family members, and let go of unneeded materialistic items to have an additional source of money to use.

Student Finance: Setting up a Student Account with an Overdraft

On deciding to undertake further study at University, many students will be offered a wide range of financing options from banks and other financial institutions. Products include student loans, credit cards and overdraft facilities. The student overdraft can be a useful tool. However, it is also one which can lead to significant long term financial problems, if not used right.

What is an Overdraft Loan Facility

Simply put, an overdraft is a form of short term loan between the bank and an account holder. The overdraft facility allows the account holder to run a negative bank balance to a pre-agreed level, without incurring penalties. Overdrafts typically do not have repayment dates, as with standard long term loans, and may be seen as an “ongoing” source of finance. Many student overdrafts however, are required to be paid back within a specified period of time after graduation.

Setting up a Student Account with an Overdraft Loans Facility

Generally most banks offer an overdraft facility as a standard feature of a student account. In order to obtain the feature a student usually needs only to “opt in” when setting up the account in the normal way. In order to qualify for a student bank account, most banks will require proof of either current attendance on a full time course. Alternatively, proof of an upcoming placement may be accepted.

In choosing an overdraft there are a wide range of limits and options available, in the first case one should ensure that the overdraft is interest free and has no associated charges. Secondary conditions worth bearing in mind are, “can the overdraft be increased after the first year?” and “how soon does the overdraft have to be paid back after graduation?” Banks often offer a variety of incentives to sign students up to accounts with overdraft facilities, whilst one should take advantage of these offers, they should not be used as the basis for serious financial decisions. In making a decision, the terms and conditions of an account and its features are much more important.

The Pros and Cons of an Overdraft Facility

The major advantage of a student overdraft facility is that they are usually provided at a 0% interest rate, with no additional charges. As such the student overdraft is one of the cheapest forms of finance available, even when compared to an SLC student loan. As such, even if the extra finance is not required it may be worth considering the profit which can be made from using the overdraft limit to invest in an interest bearing investment, such as a cash ISA.

The overdraft facility does however, have its negative points. Like all overdrafts, the facility is a short term credit agreement. Technically a bank can call in an overdraft with very little notice, although this is unusual with a student overdraft.

Additionally one should also consider the penalties associated with an overdraft. Whilst regulators have taken a keen interest recently, penalties for exceeding overdraft limits can still be extremely high. Dependent on the terms and conditions, penalties may be applied on daily basis, leading to significant financial problems for those who misuse the facility.

Whilst an interest free overdraft represents a good cheap source of finance, many students often taking out multiple overdrafts, find themselves in the position of having to take out a student consolidation loan. A student consolidation loan is essentially a loan taken out, which consolidates the overdraft into a regular loan with repayments. Here, interest rates will apply and the prospect can become an unattractive one as personal debt it increased.

Problems Caused by Lying About Finances in Marriage

Financial problems often become apparent in the early days of marriage when spouses are adjusting to sharing each other’s lives. In her book, Lies at the Altar, Dr. Robin L Smith states that couples may lie to each other about their income and spending habits.

Financial Lies That Spouses Tell each Other

Money is a highly emotive issue and often involves control and domination issues. The partner who earns more may feel that he or she is entitled to be in charge of the finances. Common lies concerning money and spending include the following:

  • Hiding a purchase to avoid arguments about the cost and necessity of it
  • Lying about the cost of a purchase to avoid an angry reaction from a partner
  • Putting aside money in a secret account or a hiding place
  • Bringing debt into marriage without informing a partner
  • Using money set aside for bills for something unnecessary such as impulse buys
  • Wasting money on alcohol, drugs or other addictions
  • Loaning money to friends or family without discussing it with or telling a spouse
  • Keeping an increase or bonus as a secret and using the money for personal enjoyment

Financial Lies in Marriages can Harm Relationships

Any kind of lie can damage a marriage and cause emotional pain. The spouse who has been lied to feels betrayed and trust is broken. These effects are amplified if they discover the truth by accident rather than through an admission of guilt and an apology.

Marriage partners lie about money for various reasons but most of these can be linked back to the fear of a partner’s reaction. Typically lies told are for the following reasons:

  • Selfishness – wanting personal spending money with no accountability
  • Avoidance – not wanting to endure endless arguments over small luxury purchases
  • Independence – wanting to retain individuality and some power over decision making
  • Fear – of going without or lowering living standards

How to Solve the Issues of Financial Lies in Marriage

Good financial management in marriage is essential to keep the household running smoothly. The best way to do this is confront problems as they arise and communicate openly about feelings and solutions. Talk to a spouse and find out what motivated the lies about their spending. It is essential that couples show respect to each other and aim at reaching an agreement that suits them both. Personal spending money is important but the amount needs to be agreed upon. It is also important to forgive past mistakes and not drag them up into future conversations.

Financial lies in marriage can cause a lot of strife and strong emotions such as anger, fear and hurt. If spouses can learn to communicate openly about spending and other money issues, they will learn to handle money better as well as respecting and understanding the other person’s needs and desires.

How to Track Your Finances

The following is a post from Brabble director of business development Patrick Mackaronis. Patrick is a thought leader and subject matter expert in the fields of entrepreneurship, finance and startups, and has been a self-starting businessman for years.

In life, we either work for money, or have our money work for us. You can either live as a slave or a plantation owner in the financial world. In order to live a free life without bowing down to the slavery of debt and credit loans, find a way to keep your finances in order. A key way to do this lies in the ability to track your finances and budget properly. Without this skill, you are doomed to work for your money as a slave, barely making payments. However, regardless of your income, with proper planning and financial tracking, you can use you money in a way that it works for you. Relieve unneeded stress by following these simple tips.

Organize Finances

Organization goes a long way. If you have no idea the due dates of bills, the amount of money in your account or the payments you owe each month, you will constantly fight with earning the money you need to live comfortably. Purchase a binder. Many office supply stores offer these in the form of a financial organizer. Within these organizers, you will find areas for bills, spreadsheets and creditor information.

Create a chart to track the print copies of your bills. Format an Excel spreadsheet to look like a check register. In the supplied section write any relevant information regarding the creditor. You should include name, telephone, address, website of the creditor as well your account number. This will help you keep track of vital information should you need to reach the creditor at any time.

Additionally, if you prefer to go paperless, keep all of this information in virtual spreadsheets using computer software. Make a folder specifically dedicated to your financial information. Keep the information just as you would in physical form, only transpose it to virtual material. Your word processing program should offer formatting options for a variety of spreadsheets and document layouts.

Track Your Finances

Once all of your bills, payments and creditor information has been organized properly, diligently track the information on a regular basis. When bill payments are due, write it down or place it in the document. For those who do not know where all their income goes, write everything you spend into a document or notebook. This will show you where every penny of your income goes. Once you know this, you will have the ability to budget more efficiently in the upcoming months. Track your finances properly to efficiently spend the money you have.