Bubbles, Booms, and Busts: 10 Things

“Booms end in busts.” Surprise.

Three macroeconomists caused a bit of a stir this week by coming up with this seemingly absurdist reiteration of a commonplace opinion/hunch.

The good times never last forever. Bubbles go pop. Every process traipsing along just fine, stumbles. Things and thoughts in the universe are cyclical, slaves to time’s attrition. (All right, you physics types: perhaps not in the quantum universe).

Bubbles and Busts
Bubbles and Busts

Ever since the GFC fried large swathes of the global economy, the fear of market bubbles forming and then bursting cataclysmically has prospered. The Australian housing market is an alarmingly/exhilaratingly notable example at present.

But what is a ‘bubble,’ really, aside from the obvious thing that makes up foam?

In deference to current online practice, I address this question below as 10 Random Thoughts About Bubbles. Here goes.

  1. A simple definition of a bubble (metaphorical) would be the build-up of errors in any closed system – for whatever reason – until that system becomes dysfunctional and collapses. And then picks itself up in a changed way, and the cycle starts anew. Differences between any two cycles would result in different time-spans from bubble formation to bubble bursting.
  2. From our perspective as humans with limited lifespans, it would be best – as economic beings – to live out our entire lives between the beginning and end of a happy bubble period, without having to encounter the harshness of the bubble’s end, or even the sharp uncertainties of its beginning. (‘The long run does not matter, because in the long run we are all dead,’ to paraphrase John Maynard Keynes). However, things rarely work in this fortuitous way for the majority of us, despite strenuous efforts by ourselves and our elected (or not) representatives to make the bubbles within which we are happy and content last and last, or to neatly deflate a shaky bubble and glide comfortably into another one. Complexity, cranked by random, pullulating variables, causes messiness.
  3. The metaphor of the ‘bubble’ comes, of course, from foaming liquids. The aptness of the metaphor is apparent even at a cursory glance of scientific papers on bubbles:
    1. Bigger bubbles thrive: “… large bubbles grow at the expense of small bubbles.”
    2. Bubbles are hard to size up, especially given increasing complexity over time: “… as the foam ages, further error may be expected to develop in bubble size measurements at the surface.”
    3. Efforts to manage bubbles can be fraught (as we are seeing in the Sydney and Melbourne property markets): “… at the retaining wall of a liquid foam…the bubbles get distorted.”
  4. Economic bubbles are really distorted information bubbles. As Robert Shiller points out, “We would like to pool the information that others use to arrive at their opinions, but we cannot know where they received their information. In certain circumstances, we may assume that more information underlies their pronouncements than actually exists.” Efforts to be ‘sensible’ about deciphering information may simply end up being ‘conventional’ – and in this lulling conformity with the comforting majority is where the risk lies.
  5. A hard-to-change quirk of human nature that is known to create friction in societies – our tendency to trust those we perceive as more like ourselves than those we see as different from us – can actually reduce the risk of market bubbles forming. To quote from the seminal paper by Levine et al, “Across markets and locations, market prices fit true values 58% better in diverse markets… [while] in homogenous markets, overpricing is higher as traders are more likely to accept speculative prices.” The subconscious devils of cultural/gender/race suspicion can, then, occasionally do a good deed! However, this may, still, result in simply stretching out the time needed for bubbles to form and burst, as the sense of discomfort over diversity and intercultural suspicion tends to decrease over time within a (relatively) closed market.
  6. The explosion in computing power and AI systems has raised hopes that the persistent problem of inadequate and incorrect information that afflicts efforts to predict bubbles and busts may be solved in coming years and decades. (Jean-Pierre Laplace once hypothesised a ‘Brainy Demon’, a being of limitless intelligence, who would be able to see all of the past and present, and so unfailingly predict all of the future). However, these hopes may come a cropper in the face of the limits of physics – just as Laplace’s Brainy Demon was done in by the Uncertainty Principle and Quantum mechanics. “…there are insurmountable limits on what we can know of a physical system’s past, present or future state as long as we are a part of that system,” says David Wolpert of the Santa Fe Institute.
  7. Disorder Increases Over Time in a Closed System
    Disorder Increases Over Time in a Closed System

    While the common perception of bubbles is that of market distortions, bubbles – in the sense of increasing disorder in a system (good old Entropy from the Second Law of Thermodynamics) over time until it goes kaput – are everywhere, from our ageing process (build-up of errors) to the eventual crumbling of civilisations. (This latter triggers a thought: our civilisational-level difficulty of sorting out the ‘sensible’ from the ‘conventional’ was quite apparent last week, in a droll way, when the media reported research that predicted the potentially early ‘End of the Human Race’, only to have the news item pushed way down the Most Read lists, which were salaciously headed by the latest rumoured affair between Mariah Carey and James Packer!)

  8. Steven Pinker’s bestselling book The Better Angels of Our Nature traces the decline in violence in recent centuries, accelerating dramatically in the 20th However, as the study mentioned in 7 above suggests, this prolonged period of relative peace may well be a bubble formed by the temporarily pushed-aside detritus and jetsam of our ‘effluent’ society, only to have it all collapse on us in the looming future. Yes, I realise that the thing is: the ‘us’ above is not really us, but other people somewhere in the foggy future. Keynes’ observation is tenacious. We are happy to bet on living out our entire lives within the confines of this largish bubble in which we have found a sense of eternal order. The future beyond our life-horizon be damned.
  9. To end these frothy thoughts on a highfalutin note: the universe itself is a bubble, as explained to us by the likes of Carl Sagan, Dr Karl, and Bill Nye the Science Guy. (At least the universe in which we exist; now they have suspicions about other universes that exist alongside each other without so much as a hello). But even before the universe ends, Ann Druyan reminds us that “most of what we all hold dearest and cherish most, believing at this very moment, will be revealed at some future time to be merely a product of our age and our history and our understanding of reality.” And whether or not the bigger story will end as memorably as imagined by the great Isaac Asimov in the classic The Last Question, we shall never know.
  10. All right: 7-10 above stray way too much into territory under the shadow of Keynes’ ‘in the long run’ dictum. 1-6 are more LinkedIn-friendly – so apologies, dear reader, if you’ve read up to here already, and are set to accuse me of overindulging in thought bubbles.

(A version of this article was originally published on LinkedIn Pulse).


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