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Why the world’s economy could collapse

“What we know about the global financial crisis is that we don’t know very much”- Paul Samuelson

Introduction to Economic bubbles:

An economic bubble is a economic cycle started when the trade of an asset exceeds its inherent value. An easy example is a stock; when a stock starts to be overpriced yet investors still buy it, expecting to sell the stock at a higher price, a stock market bubble arises. Economic bubbles form unintentionally in some markets as it is hard to understand an asset’s value. A bubble can only be identified in hindsight after a sudden drop of prices. The sudden drop of prices signifies that the bubble has “burst” (King, Lahart, Shiller).

(Aziz).

U.S. households lost on average nearly $5,800 in income due to reduced economic growth during the acute stage of the financial crisis from September 2008 through the end of 2009 (“The Impact of the September 2008 Economic Collapse”). Economic bubbles like the housing crisis of 2007 have the possibility of sending the US economy back into a depression and today, bubbles are particularly extreme and powerful in the stock and housing markets. United States equity (stock) markets and housing prices are at their highest levels ever and if both bubbles were to collapse the U.S. economy would suddenly have a gigantic problem.

(Bertozzi).

 

Interest:

I took an interest in this topic because my father has always had a financial background and my mother teaches a marketing class, so I have always wanted to learn more about finances. When I was 6 the 2007/2008 housing market crashed causing many people to move; luckily my family did not but some of our family friends did, starting my interest in economic bubbles. I also wanted to study a topic that would benefit me later on in life while still being something that I liked.

Brief Background:

Tulip Mania:

 The problem of bubbles started in 1630’s Holland with the first recorded economic bubble known as Tulip Mania. During Tulip Mania, the prices of Tulip bulbs rose to incredible heights then suddenly crashed in February of 1637. Ever since, the term “Tulip Mania” or “Manias” has been used to refer to large economic bubbles, particularly those that grow out of sheer speculation, and not out of an assessment of future value. At the peak of Tulip Mania, some rare Tulip bulbs were selling for ten times the annual salary of a skilled worker. As a result, many people got rich very quick while others lost all of their money following the crash (Kanopiadmin).

South Sea Bubble:

The term “bubble” comes from another early financial crisis, the South Sea Bubble in Britain during the 1720. The South Sea Company was granted a monopoly on trade from Britain to South America which suddenly and dramatically boosted the company’s stock. In 1720 the company’s stock collapsed because England got into a war with Spain, who controlled South America. Afterwards the Bubble Act was enacted to require companies to have a royal charter in order to issue tradable stocks (“South Sea Bubble Short History”).

Housing Bubble:

The significance of the 2008 Housing bubble is that the negative effects were not limited to one country in particular. In 2006 United States housing prices reached their peak and then began to decline into one of the worst recessions the world has seen since the Great Depression of the 1930’s. Lenders ignored the decline in 2006 and continued to let high risk homeowners take out subprime mortgages (Amadeo). In 2008 the bubble burst and housing markets throughout the world followed the United States’s because their housing markets had also risen and with the United States not spending as much the economy was slow (Landler).

Japan Real Estate Bubble:

The next chapter of economic bubbles came in the late 1900’s with the Japan Asset Price Bubble also known as the Japan Real Estate Bubble. The significance of the Japan Asset Price bubble is that it illustrated that the tendency to overvalue a company or economy was going to be a continuing problem throughout the world because while people humans had built stronger economies and developed more systematic financial markets since the days of tulip Mania they still periodically struggled with overvaluation. In the Japan Asset Price Bubble, both stocks and housing prices rose due to an overheated Japanese economy, an uncontrolled money supply and rampant speculation. By 1991 Japanese asset prices were on a downturn and in 1992 the bubble collapsed completely. The economy continued to be in a rut for another decade (Tsutsui and Mazzotta). In 1999 the interest rates of housing was brought down to 0% and the country’s economy growth decreased to 1% versus 4% in the previous decade (Bayoumi and Collyns).

The Dot-Com Bubble:

The next notable bubble was the Dot Com bubble in United States from the late 1990’s to the early 2000’s. The particular significance of this bubble is that while people continue to build more complex economies, they aren’t effectively regulating them to avoid dramatic losses. The dot-com boom started with the rapid excitement and sudden growth of consumers and business using the internet for the first time. Seeming to be a transformative innovation, excitement about the Internet lead to extreme speculation in the stocks of “Dot-Com” companies (internet based companies like pets.com, ebay.com, etoys.com and amazon.com). How the Internet worked was not public knowledge and because of this lack of knowledge investors put their money in companies that were poorly designed and thus unlikely to succeed (“Dot-com Bubble”). Many investors wanted to get in on the “next big thing” and because there was so much hype created around any Dot Com company, Initial Public Offerings (IPOs) had a tendency to soar as soon as they hit the market (“The Dot Com Bubble”). We might compare this time to now with the rise of of cryptocurrencies and blockchain technologies. Multiple companies have been seen to change their name to incorporate the word ‘blockchain’ in an attempt to cash into the mania. The dot-com bubble began to burst March, 2000 and many of the leading companies collapsed or their stock declined significantly i.e. Cisco which dropped 86% (“Dot-com Bubble”).

(Faola).

Present Day:

Since his election Donald Trump has worked to reduce government regulations and since regulations cost companies money to follow, the expected elimination of many of them has sent the stock market soaring. according to a job report in February 2018  showed unemployment at 4.1%, its lowest for 17 years, and average hourly earnings rising at an annual rate of 2.9%, the highest in eight years. The dollar becoming weaker has makes international imports more important, while Trump’s tax cuts will start toward the end of a long upswing when there is a danger of the economy becoming overactive. In recent years low interest rates have lead to too much speculation especially since the market has yet to recover form the “bubble of all bubbles”, the 2008 housing market crash. After the recent crisis the US economy needs to continue working on debt dependency, rising inequality, under-investment to provide a more stable economy (Elliott).

Solutions:

a safety net to avoid the worst possible situation, another Great Depression. After the burst of an economic bubble, the government would use the power of the Federal Reserve to drop interest rates and increase lending to provide liquidity to markets. This would avoid the problem that happened when the government failed to do this between 1929 and 1933, where the US GDP fell by more than a quarter in the absence of such measures. However, when the US economy implemented this strategy between 2007 and 2009, the US GDP only fell by 5% (Gugerell).

Here is what you can do if you want to help prevent economic bubbles:

1) Encourage friends and family to avoid dramatically rising stocks and other assets.

2) Pay attention to your own investments, make sure that you know what you are investing in and not raising an asset’s value past its inherent value.

Optional video:

https://ed.ted.com/lessons/what-causes-economic-bubbles-prateek-singh

Form:

Works Cited:

Amadeo, Kimberly. “Protect Yourself from the Next U.S. Economic Crisis.” The Balance, The

Balence, 2018, www.thebalance.com/u-s-economic-crisis-3305668.

Aziz, John. “Would a Bubble Be Good for the American Economy?” The Week – All You Need to

Know about Everything That Matters, 15 Sept. 2014,

theweek.com/articles/443826/bubble-good-american-economy.

Bayoumi, Tamim, and Charles Collyns. “Post-Bubble Blues–How Japan Responded to Asset

Price Collapse.” International Monetary Fund, International Monetary Fund, 2000,

www.imf.org/external/pubs/nft/2000/bubble/.

Bertozzi, David. “34 Eye Opening Photos Of The Great Depression.” BuzzFeed, www.buzzfeed.com/davidbertozzi/the-great-depression?utm_term=.bvqqwlpmX#.bcwzK1q9o.

Bayoumi, Tamim, and Charles Collyns. “Post-Bubble Blues–How Japan Responded to Asset

Price Collapse.” International Monetary Fund, International Monetary Fund, 2000,

www.imf.org/external/pubs/nft/2000/bubble/.

“Dot-Com Bubble.” SF-Info.org, Sf-Info.org, 2017,

www.sf-info.org/history/d15/dot-com-bubble.

Elliott, Larry. “Deja Vu? It’s Looking like 1987 Again for the US Economy.” The Guardian, Guardian News and Media, 4 Feb. 2018, www.theguardian.com/business/2018/feb/04/is-this-the-1987-us-economy-or-just-deja-vu.

Faola, David. “The Causes And Aftermath Of The 2007-2008 Financial Crisis.” The Market Mogul, MarketMoguls, 8 Aug. 2016, themarketmogul.com/causes-aftermath-2007-2008-financial-crisis/.

Gugerell, Gertrude. “Asset Price Bubbles: How They Build up and How to Prevent Them?”

European Central Bank, 3 May 2011,

www.ecb.europa.eu/press/key/date/2011/html/sp110503.en.html.

Kanopiadmin. “The Truth About Tulipmania.” Mises Institute, Mises Institute, 26 Apr. 2007,

mises.org/library/truth-about-tulipmania.

Landler, Mark. “U.S. Housing Collapse Spreads Overseas.” The New York Times, The New York

Times, 13 Apr. 2008,

www.nytimes.com/2008/04/13/business/worldbusiness/13iht-housing.1.11931770.html.

“South Sea Bubble Short History.” Harvard Business School Library, President and Fellows of

Harvard College, www.library.hbs.edu/hc/ssb/history.html.

“The Dot-Com Bubble.” EconPort – The Dot-Com Bubble, Experimental Economics Center, 2006, www.econport.org/content/handbook/Internet-Economics/dotcom.html.

“The Impact of the September 2008 Economic Collapse.” The Pew Charitable Trusts, The Pew

Charitable Trusts., 10 Apr. 2010,

www.pewtrusts.org/en/research-and-analysis/reports/2010/04/28/the-impact-of-the-september-2008-economic-collapse.

Tsutsui, William, and Stefano Mazzotta. “The Bubble Economy and the Lost Decade.” Journal

of Gobal Initiatives, Digital Commons, 2014,

digitalcommons.kennesaw.edu/cgi/viewcontent.cgi?article=1164&context=jgi.

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COMMENTS: 1
  1. April 29, 2018 by Cassidy.Mott

    Overall I thought that your project was really interesting and I had no idea that this was a problem. I am not sure if you meant to do this but the font and sizing of the letters for the part where it says “Your Interest” is different from the rest of the paragraphs. I think that this is definitely something that we should pay attention to and I am surprised I haven’t heard of it before.

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