to produce .” The Economist characterised investors during the 1896 British Bicycle Mania as having “ no intention of holding whatever they are allotted if they can secure a premium .”
However , historians have debated the extent to which these reports reflected reality . Much stronger evidence of speculation comes from surveys of investors that were conducted during more recent bubbles . A study by Robert Shiller , Fumiko Kon-Ya and Yoshiro Tsutsui found that in 1989 , when the Japanese bubble was at its peak , 39 % of Japanese institutional investors were advising investors to buy shares despite expecting prices to fall in the long term . The strategy of chasing short-term capital gains had become widespread , even among professionals .
With these elements in place , the spark for a bubble can come from one of two places : technology or politics . Technological innovation can spark a bubble by generating abnormal profits at firms that use the new technology , leading to large capital gains in their shares . These capital gains then attract the attention of momentum traders , who begin to buy shares in the firms because their price has risen . At this stage , many new companies that use ( or purport to use ) the new technology often go public to take advantage of these high valuations .
While valuations may appear unreasonably high to experienced observers , they often persist for two reasons . First , the technology is new , and its economic impact is highly uncertain . This means that there is limited information with which to value the shares accurately . Second , excitement surrounding technology leads to high levels of media attention , drawing in additional investors . This is often accompanied by the emergence of a “ new era ” narrative , in which the worldchanging magic of the new technology renders old valuation metrics obsolete , justifying very high prices .
The clearest example of a technological bubble is the dot-com boom , which was driven primarily by the emergence of the internet . The British Bicycle Mania was sparked by a series of innovations in bicycle design , the most important of which was the pneumatic tire . The US stock market bubble of the 1920s was also technologically driven , with a series of major innovations , particularly in electricity and mass production , generating impressive corporate profits throughout the decade .
Alternatively , the spark can be provided by government policies that cause asset prices to rise . Usually , but not always , the rise in asset prices is engineered deliberately in the pursuit of a particular goal . This goal could be the enrichment of a politically important group , or of politicians themselves . The Australian land boom of the 1890s was notable for the extensive involvement of politicians , who routinely used their positions to evade losses when the bubble burst . Other bubbles have resulted from an attempt to reshape society in a way that the government deems desirable . The housing bubbles of the 2000s , for example , were sparked by the desire of governments in several countries to increase levels of homeownership .
While bubbles are typically seen as negative events , their economic consequences vary . The key variable is how vulnerable the financial system is to the bubble bursting . In the worst-case scenario , the bubble asset is deeply integrated into the economy , often bought using borrowed money , and exposes systemically important banks to major losses . This is often the case for land and housing bubbles , making these bubbles particularly destructive . On the other hand , when bubble investors are using their own money , the bubble asset is not integrated with many important supply chains , and the financial system has no exposure , the bursting of a bubble can be relatively benign . Some investors will lose money , but the overall economy is unlikely to suffer .
When will the next bubble occur ? Are we in a bubble right now ? The necessary conditions of marketability , money , credit and speculation are all present , so we should expect bubbles to be frequent in the modern world . The hard part is predicting the sparks . One could make a case that several recent developments constitute sparks , but this part of the bubble triangle is the most subjective . Individual investors will need to use their judgement and come to their own conclusions .
Those who insisted that there was no bubble right before a crash have often become legendary figures of fun . Irving Fisher ’ s statement that stocks had reached “ a permanently high plateau ” on the eve of the Crash of 1929 is one of financial history ’ s most famous quotes . A less wellknown feature of past bubbles is that their early stages were often characterised by an abundance of equally bad pessimistic predictions . Investors in the Netscape IPO of 1995 were dismissed as “ juvenile ” by The New York Times , while the Financial Times accused them of having “ abandoned reality .” Those who bought Netscape at its opening day closing price earned an annualized return of 35 % until it was acquired by AOL in 1999 .
Identifying bubbles is never as easy as it looks in hindsight . Even when an asset is overvalued , it can be impossible to know what will happen to its price in the future . History can ’ t tell us what the stock market is going to do tomorrow — but it can tell us what warning signs to look out for .
William Quinn is a lecturer in finance at Queen ’ s University Belfast , where he conducts research on market manipulation , stock markets and , above all , bubbles . He is the co-author , with John D . Turner , of Boom and Bust : A Global History of Financial Bubbles ( Cambridge University Press , 2020 ), on which this article is based .
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