ECONOMIC BUBBLE

What Are Economic Bubbles, How To Avoid Them?

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The term economic bubble or often also referred to as a speculative bubble or financial bubble. This is one thing to watch out for, especially when you invest.

Determining investment instruments is not an easy thing. Of course, everyone hopes that the chosen investment instrument can increase in price so that it will provide benefits in the future.

There are many things that must be considered so that you are not wrong in choosing an investment instrument. One thing that is quite important and needs to be watched out for is the phenomenon of the economic bubble.

Because this phenomenon can make the value of the investment instrument you choose fall very deeply. So instead of getting a profit, you will actually experience a large amount of loss.

Understanding the term bubble economy

The phenomenon of economic bubbles has occurred in many countries and has a long history. The occurrence of this phenomenon makes many people suffer losses in very large numbers.

The term economic bubble itself refers to the condition of rising asset prices to become unrealistic. Furthermore, the price of these assets experienced a sharp decline in a very fast time.

So that people who have bought assets at high prices, suffer losses due to the decline in prices. This phenomenon can occur in various assets such as stocks, property and other types of assets.

The naming of this phenomenon takes from the reality of bubbles that easily rise to the top. But at a certain point, the bubble will burst very quickly.

This illustrates how the price of an asset can soar to the point of being unrealistic. Until in the end the value of the asset broke and the price fell to a very low level.

The term economic bubble has been known by economists as something to be wary of. Because the occurrence of this phenomenon will have an influence on macroeconomic conditions.

There have been many examples of economic crises caused by the economic bubble phenomenon. One of them is the housing bubble that occurred in 2005 – 2008 in the United States.

In that year, house prices in the United States experienced a very high increase. Until finally in 2008, the bubble burst and caused an economic crisis.

Until finally the American government had to bail out or provide bailout funds to help some companies keep operating. Without the bailout funds, there will be massive layoffs.

Understanding Some of the Causes of Economic Bubbles

In general you have understood the term bubble economy. In fact, this phenomenon refers to the movement of the price of an asset that increases and then at some point will break.

Economists still do not know the exact cause of this phenomenon. However, there are several things that may be the cause of this phenomenon, namely as follows.

Excessive Liquidity in the Financial System

The first thing that may be the cause of an economic bubble is excessive monetary liquidity in the financial system. Simply put, the ease of getting a loan can be the cause of an economic bubble.

Again remember that the term bubble economy refers to a condition in which asset prices increase to the point where it becomes unrealistic. The ease of getting a loan is one of the causes of this.

With the ease of getting a loan, the purchase of an asset will increase. According to the law of supply-demand, more demand will make the price of an asset increase.

At a certain point, the price of the asset becomes unaffordable so it cannot be sold. As a result, the owners of assets will make sales at low prices.

This is done so that they still get income even though they have to suffer losses. Because on the other hand, they still have debts that have the potential to default.

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Investors’ Speculative Behavior

One of the possible causes of the economic bubble phenomenon is the speculative behavior of investors. Because it refers to the term economic bubble, that in fact an increase in asset prices is an expected thing.

The higher the potential increase in the price of an asset, the more attractive it will be. Because these assets are predicted to be able to provide huge profits in the future.

Therefore, an asset that is considered to have a high price in the future must be in great demand. So that more and more investors invest in these assets and make the price increase.

However, if the price increase is not accompanied by an increase in the intrinsic value of the asset, it will have a bad impact. Because in the end, people will realize that the asset price is too expensive.

So the demand for these assets will decrease which will also lower the price. So investors who have bought assets at high prices will experience losses.

The Greater Fool Theory

One theory that is considered to be the cause of the economic bubble is the greater fool theory This theory is in line with the term economic bubble which describes a significant increase in asset value.

In general, this theory states that price increases occur when someone can sell an asset that is overpriced to a “stupid” person. Then the “stupid” person will sell it back to the “stupider”.

This will continue until the price of an asset becomes very high. Until finally the last person could no longer find a “stupider” one to buy the asset.

So that the bubble will burst and make asset prices that were very high fall very low. So the last “stupider” person will receive a large amount of loss.

Extrapolation

Extrapolation is the behavior of equating historical data in the past with the future. This could be the cause of the economic bubble phenomenon considering that the term economic bubble is closely related to price increases.

Indeed, one way to predict the value of an asset is to look at historical data. However, historical data is not the only data because there are other aspects that also need to be taken into account.

Extrapolating behavior does not take this into account. They only see that the value of an asset in the past can rise to a very high which may also happen in the future.

At some point, investors will realize that these assets cannot provide the returns as in the past. So that the bubble burst was marked by a decrease in asset prices.

Lack of Community Financial Literacy

It is undeniable that today many people are starting to realize the importance of investing. Unfortunately, awareness of investment is not accompanied by good financial literacy.

In fact, one of the possible causes of the economic bubble is the lack of public literacy regarding the financial world . In fact, there are still many people who do not know the term economic bubble.

This lack of literacy or knowledge will certainly affect people’s decisions to invest. One of them is in determining the right instrument and can provide benefits in the future.

People who are minimal in financial literacy tend to make decisions on a whim and without careful consideration. As a result, they are more easily trapped in the economic bubble phenomenon so that they will get losses in the future.

Tips to Avoid This Phenomenon

After understanding the term economic bubble and its causes, of course you need to avoid this phenomenon. Because the losses that can be received due to the economic bubble phenomenon can be very large.

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There are several ways you can do to avoid this phenomenon. Here are some tips that can be done so as not to get caught in an economic bubble.

Perform Fundamental Analysis

One of the techniques in investing is fundamental analysis. This technique is done by choosing investment instruments that have good fundamental values. Of course, the fundamental value must be in line with the asset price.

Fundamental analysis techniques are usually used in stock selection. This method is done by looking at the company’s performance and assessing whether the stock price is in accordance with that performance.

But you can apply fundamental analysis techniques not only to stocks. Various other assets also have a fundamental value or intrinsic value on which the price of the asset is based.

Given the term economic bubble is an increase in the value of prices to be unrealistic, then it doesn’t matter as long as the price increase is reasonable. This means that the price increase occurs because the intrinsic value increases.

Don’t follow

One of the problems faced by investors, is the fear of making decisions. So many investors prefer to follow the steps or decisions of other investors.

This is what makes signaling groups very popular  because it makes investors not have to think. The decision to buy or sell an asset simply follows the signals given in the group.

Whereas decisions that only follow the words of others are very vulnerable to bad effects. Because the decision could be wrong and was done to increase the price of a particular asset.

People who are not familiar with the term bubble economy are often used for things like this. When the bubble has burst, then of course the one who feels the loss is yourself.

Improve Financial Literacy

Improving financial literacy is a must to avoid the economic bubble phenomenon. Apart from exploring the investment world, you also need to learn other things such as financial management and macroeconomics.

Because basically, economic activities around the world are interconnected. For example, economic conditions in the United States can have an impact on the economic conditions of other countries.

In addition, it is very important for you to study the economic history of the world. So you can take lessons from history and use them for consideration in the present.

Moreover, the term economic bubble itself is not new. There has been a lot of history from various countries in the world that you can use as a lesson to be able to avoid this phenomenon.

Avoid Excessive Desire (Greedy)

One of the problems that must be avoided by investors is greed. Because greed will make you want the maximum profit to ignore various aspects that must be considered.

Especially now that there are many investment instruments that promise too sweet but end up losing. Excessive desire or greed will encourage you to get stuck in such an investment instrument.

Usually when feelings of greed arise, then someone will forget the term economic bubble. When they see an asset experiencing a rapid increase in price, they buy it without thinking.

As a result, when the bubble burst, they were trapped because they had bought at a high price. Even worse, they can’t sell the assets, so they lose all their investment capital.

One of the things that investors should be wary of is the economic bubble. Especially considering the term economic bubble that makes people suffer huge losses.


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Economics Student of Universitas Gadjah Mada, Indonesia.