August 8, 2007
When asset prices soar, is it a bubble? No, prices move sharply up and down for many valid reasons. For me, intuitively, a bubble is when a certain percentage of assets are held by speculators who aren’t concerned about real market values. Instead, they are waiting for the greater fool to come along with a fist full of cash. This becomes a pyramid scheme, which eventually collapses when you run out of fools. Today’s housing market is a bubble in some urban areas, especially for condos, because speculators were hoping to flip for quick profits. The markets in India and China are probably bubbles because reports say that lots of people are opening brokerage accounts hoping to get rich quick, much like the Tech bubble. There are always speculators, so what percentage signals trouble? I don’t know, it depends on the market. When do you run out of fools? I don’t know, but interest rates play an important role here. If it goes up, it shrinks the number of fools who can afford outrageous sums for housing. It also dampens trading on margin.
The reason bubbles are hard to detect is because the speculators must convince the ignorant masses that there are good reasons for asset prices to continue to climb in the future. Moron reporters repeat these lies on TV, creating a cult-like echo chamber. Personally, I become very suspicious when people say “this time is different”. When they invent new metrics to revalue an asset, it’s likely a bubble. So far I’ve been right about the bubbles in the past decade. But I can’t make any money from my prognostications because I don’t know when we’ll run out of idiots to fuel these pyramid schemes. All I can do is rub it in after the morons lose their money.