Pop! Did the bubble burst?

When I say ‘Bubbles‘, what are the first things that pop in your head? Maybe you are visualizing the smile on a toddler's face playing in the bath tub or the “wow” from youngsters when they witness the froth coming out while opening a soda can or even the sense of accomplishment that a bubble gum addict experiences.

Now here is a mind blowing revelation. If you were to look at these bubbles from an economist's point of view, you'll know that they are capable of destructing an entire economy , bringing it to shambles!

Let me explain this phenomenon through one of the greatest mishaps of history: the tulip mania! For this I ask you to picture 17th century Holland bustling with merchants, traders, markets and a prosperous economy. Tulips were being imported all the way from Turkey and sure enough, they soon became a rage among the Dutch.

The primary reason for this was that, tulips weren't like any other ordinary indigenous flower. Even today they are extremely fragile in nature so transplanting becomes a herculean task. Not this this, tulip bulbs once sown take an average of 7 to 12 years to bloom. So possessing a tulip garden came to be increasingly associated with affluence and authority.

People went on a buying spree, exhausting their entire purchase power on stocking up

these tulips. There was a speculative demand so naturally prices shot up. When I say this, I literally mean that rates were skyrocketing. According to reports, the best of the tulip bulbs could cost around 4000 to 5000 gold coins. In the present day, this amount is equivalent to around 7,50,000 dollars or 1008 gallons of beer. With bidding happening at exuberant rates and loans being sanctioned for purchasing tulips,

It was no surprise that they were included in the stock market of Amsterdam.

This situation is called a market bubble. It is basically a case where there is a sudden surge in the asset price. You could also say that the price of the asset increases at an increasing rate in contrast to the diminishing rate at which such products ( tulips) generally rise. In this situation a herd mentality of sorts sets in with people rapidly buying up a certain commodity or asset so that they can sell it for a higher price in the future.

So what really happens now? To answer this ,economists classify bubbles into various stages such as stealth or the entry of the commodity, awareness which is the part where the market and investors start noticing it, mania and blow offs . Evidently, mania is the most precarious stage and in order to ensure that all is not lost, the economy has to come out of it quickly.

However, the main question that sets in our mind at this point is till when this folly will continue? Don't worry, Like any normal bubble, there comes a stage where it has to burst and prices contract by a very steep level. This primarily happens when realisation sets in.

Coming back to the tulip example, the ordinary middle classes started wondering. It was a reality check for them as they realized how they were spending all their hard earned money on something that wasn't going to reap any benefit. Demand all of a sudden crashed and traders became bankrupt. The entire economy came to a standstill. In all of this wonder what happened to the tulips? Consumption reached a negative scale with people trying to dispose all their tulips for pennies. Now when we contemplate, it all seems like a huge irony.

One might think that humanity put a full stop to this mess after its experience with tulips but the reality is that these bubbles have repeatedly occurred . The dotcom bubble that took place in the last decade of the 20th century is a classic example of this situation. ‘Internet’ had just been introduced back then and the stock market witnessed a crash as several investors were heavily bidding for the newly introduced internet companies.

Similarly, in the early 2000's we had the real estate bubble. Once again, people were trying to stock pile or buy as many properties as they could with the hope that prices would plummet in the future. The sad part in a bubble is that people invest millions in a few assets hoping to get high returns. While initially the grass looks green, things go for a toss as the economy crumbles and they end up losing much more than they ever hoped to ever gain.

On a concluding note, here is a quote about these bubbles from a famous economist:-

"Double, treble, quadruple bubble, watch the economy get into trouble."