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What is a bubble in financial terms? Here are 5 bubbles that wrecked markets

Jan 04, 2019 | 1 year ago | Read Time: 4 minutes | By iKnowledge Team

An economic bubble or asset bubble is change in a commodity at a price or price range that highly exceeds the asset’s original value.

A bubble occurs when the value of an asset or stock rises to such a degree that is entirely over both historical standards and its principal amount, or even one. The problem arises when the inherent worth of an asset can have a vast range, the asset’s original value itself has skyrocketed or, in simple words, the asset is worth much more than it was in the past.

Some bubbles are easier to detect than others, for instance with stock exchange bubbles, because the traditional costs can be used to identify excessive over-valuation. Example, an investment index that is trading at a cost-to-earnings ratio that is thrice the past aggregate is probably in bubble boundary, although further investigation may be needed to make a definitive decision. Other bubbles are difficult to identify and may be recognized only in hindsight.

A simple factor that runs through most bubbles is the eagerness of shareholders to reject their doubt and to overlook the growing uproar of cautionary signs. Another trait of bubbles is that the bigger a bubble, the more significant the damage it wreaks when it explodes.

Below listed are five of the most significant bubbles in history:-

  1. The Dutch Tulip Bubble: The Tulipmania that grasped Holland in the 1630s is the example of the earliest documented evidence of a fallacious bubble. According to retired UCLA professor Earl A. Thompson, Tulip prices multiplied 20-fold within November 1636 and February 1637, before diving by 99 per cent by May 1637. Tulipmania ravaged a large section of the Dutch community, and at its peak, some tulip bulbs crossed rates higher than the price of luxury houses.
  2. The South Sea Bubble: This bubble occurred because of more complicated conditions than the Dutch Tulipmania. It still has left a mark in history as another exemplary case of a financial bubble. In 1711, The South Sea Company was established, and the British government awarded it with a monopoly on all business with the Spanish provinces in South America. Presuming the replicated success of the East India Company, which had already established trade with India, investors gained interest in shares of the South Sea Company. As its executives advertised far-fetched exaggerations of incredible wealth in South America, shares of the corporation climbed more than eight-fold in 1720, from 128 pounds in January to 1050 pounds in June, before dropping in following months and creating a severe financial disaster.
  • Japan’s Stock Market and Real Estate Bubble: In the early 1980s, excessive simulative monetary policy ignited the Japanese bubble. A 50 percent boost in the Japanese currency, the yen, caused a recession in 1986. Furthermore, in response, the government led a program of financial and fiscal inducement. These steps worked so vigorously that they cultivated uncontrolled gambling, resulting in stocks and urban land values of Japan to increase three-fold from 1985 to 1989. At the top of the property bubble in 1989, the cost of the Imperial Palace area in Tokyo was costlier than that of the real estate of entire California. The bubble finally fractured in early 1990, setting Japan towards decades of financial trouble.
  1. The Dot-Com Bubble: The debut of the Internet started a massive ripple of gambling in “New Economy” companies. As a result, a large number of dot-com corporations reached a multi-billion dollar value, shortly after going public. The NASDAQ (home of these dot-com businesses), flew from 500 at the start of 1990 to a height of more than 5,000 in March 2000. It plunged nearly 80 per cent by October 2002 and began the United States recession. The NASDAQ Composite finally touched a new level in 2015.
  2. The US Housing Bubble: Some experts consider that the NASDAQ bubble drove US investors to hoard into real estate in the misguided hope that this was a secure investment. According to a report from the US Bureau of Labor Statistics, US house values almost grew twice the traditional value from 1996 to 2006. Even though, the real estate prices were increasing at record speed; there were signs of extreme mortgage fraud as sub-prime borrowers were buying condo houses. US real estate prices topped in 2006 and then tumbling that resulted in the average house losing one-third of its cost by 2009. The US housing growth and failure, and its ripple effects ended with a worldwide economic recession that was the biggest since the 1930s the “Great Recession.

The bubbles as mentioned above are among the most influential in history and hold good lessons that should be noticed by all investors.
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II/Dec 2018/4710


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