Understanding the Meaning of Economic Bubbles

There is a phenomenon in economic studies called economic bubbles or bubble economy . This phenomenon occurs in many countries and has a long history. In this article we will study the general definition of a bubble economy or economic bubbles and some of the events in which the phenomenon of economic bubbles occurs.

According to its basic concept, economic bubbles or bubble economy refers to a situation where the price of a product or asset in a certain market segment experiences an unusual or unnatural increase in value/price, and occurs in a relatively fast time.

There are many examples of economic bubble phenomena that occur and involve different economic sectors, including the housing sector or better known as housing bubbles and the stock market or stock bubbles .

In its development, there have been many studies that examine more comprehensively the concept of the bubble economy , including the question of what is meant by an unreasonable price increase and how to categorize time as relatively fast. However, we will not discuss this in this paper.

The following are some examples of events that illustrate the phenomenon of economic bubbles .

One of the classic examples of the bubble economy phenomenon occurred in the 1637’an era known as The Tulip Mania .

Since the late 1590s, tulips have become one of the commodities imported from Turkey to the Netherlands. Later, this flower became phenomenal in the Netherlands and became one of the trendsetters , especially as a decoration on clothing. Because of the high charm of tulips in the eyes of the public, the demand for these flowers soared rapidly with increasing public demand, until its peak in the early 1637’s.

The high demand, which is not matched by the availability of tulips, has made the price of tulips soar to the equivalent of 40 times the average salary of Dutch workers per year. Unfortunately this did not last long, especially when market participants holding tulips started selling the flowers to the market and other market participants followed suit, causing the price of tulips to plummet within a month. It is said that after the incident, the price of tulips was not more expensive than the price of a red seed.

Economic bubbles in the 1997-1998 Asian economic crisis.

Not a few studies have stated that the 1997-1998 Asian economic crisis was caused, among other things, by the bursting of the economic bubble, considering that in the late 1980s and mid-1990s, interest rates in developing countries in the Asian region tended to be high, far above interest rates. interest offered by developed countries.

The high interest rate is seen as an attraction by investors, resulting in a very large capital inflow to developing countries, including South Korea, the Philippines, Indonesia, Thailand, and Malaysia. As a result, the economic growth of these countries increased rapidly to be in the range of 8% to 12%.

Even so, the high growth was solely due to the large inflows of capital, not supported by investment in the real sector and productive assets owned by these countries. In other words, the economic fundamentals of these countries can be said to be porous.

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As a result, when the Central Bank of the United States began to raise the benchmark interest rate ( Fed rate ) after being able to recover from the domestic economic recession, the flow of funds that previously existed in Asia began to move rapidly towards the US market which was considered more stable.

In addition, the higher the interest rate ( Fed rate ), the stronger the US$ exchange rate against other countries’ currencies. These two factors led to massive capital flight from Asia. In the end, this caused a panic rush in the banking sector, when many people collectively withdrew the cash they had stored in commercial banks, resulting in the collapse of Asian currencies.

The case of the economic bubble that hit internet-based companies ( .com companies ) in the mid-1990s to early 2000s.

Another example of the occurrence of economic bubbles in the modern world is the period from the mid-1990s to the early 2000s. At that time technological developments entered a new phase, where there was a boom in internet-based technology companies. This period is also known as the era of The New Economy , which was marked by the emergence of internet – based companies or better known as . com companies .

When these companies began to go public , the value of their shares skyrocketed many times over, offset by high expectations of market participants and the general public for the success of the new economic era. At that time, all issues related to the internet and online became the main topic of every conversation with optimistic tones.

Unfortunately, all of these things are not followed by prudent company management , solid financial foundations, and optimal analysis of operating profit/loss calculations; in other words, the focus of attention is the marketing factor alone.

Until when the United States Central Bank ( the Federal Reserve ) again raised its benchmark interest rate in the 1999-2000 range, these companies began to lose financial strength. This was exacerbated by the number of start-up companies that posted large losses in their financial statements.

In the end, all public expectations did not materialize, and the economic bubble burst. Records say there is more than US$ 8 trillion evaporated in the market. Even big companies like Amazon.com, Cisco System, Priceline.com, to Yahoo! experienced a decline in stock prices by more than 90% (Jimenez, Alvaro, Understanding Economic Bubbles , 2011).

Furthermore, there are several theories that try to explain the characteristics of the economic bubble, one of which is the research conducted by Thompson and Hickson.

The study conducted by the two mentioned two types of bubbles , namely short -term informational monopoly bubbles . This type of economic bubble is usually characterized by the absence of an increase in the supply of products/assets. These bubble characteristics are also known as mini bubbles .

These bubbles tend to occur through market manipulation mechanisms by market participants who have information about certain assets/products. With financial strength, certain market participants began to speculate on the asset. This attracted the attention of other market participants and began to hunt for similar assets, resulting in a drastic increase in the value/price of the asset in the market.

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This condition is usually unpredictable from the start and it is not known how long it will last. Therefore, this phenomenon is not accompanied by an increase in supply to offset demand .

Furthermore, the bubble will burst when the perpetrator performs a massive asset disposal, thereby dropping the price/value of the asset.

As we know, there are at least two behaviors ( economic behavior ) that we can find in market participants, namely those who make decisions with a long-term horizon and prioritize the fundamental factors of an asset, and market participants who focus more on short-term profits, by making purchases. asset at a low price and release it again when the price is high (market participants of this type are known as speculators).

In this case, the phenomenon of The Tulip Mania can be categorized as short-term informational monopoly bubbles .

Meanwhile , the next bubble is a long-term government involved bubble , which tends to last longer and is characterized by an increase in product/asset inventory.

Bubbles like this usually occur as a consequence of taking or changing economic policies (monetary and/or fiscal) and other policies by the relevant authorities.

However, different from the first type of bubble , here policy makers have calculated and calculated the impact of implementing the policy, both positively and negatively, thus including anticipatory steps as compensation for these impacts.

The case of .com companies is an example of long-term government induced bubbles . This is evidenced by the growing number of .com -based companies even today, but with capitalization that is not accelerating as fast as in this case (Thompson, E., and Charles R. Hickson, Predicting bubbles, Global Business and Economic Review , Vol 8, 2006).

In closing, the phenomenon of economic bubbles ( economic bubbles or bubble economy ) has occurred since several centuries ago until now. These bubbles can occur due to purely speculative factors, but can also be caused by the emergence of consequences for economic policies taken by policy-making authorities. **