An economic bubble or asset bubble is a situation in which asset prices appear to be based on implausible or inconsistent views about the future. A bubble is an economic cycle characterized by the rapid escalation of asset prices followed by a contraction. It is created by a surge in asset prices unwarranted by the fundamentals of the asset and driven by exuberant market behavior.
Because the urge to get rich quickly and cheaply is easy to exploit, speculative bonanzas can be sporadically whipped up into such intensity that it can bring down a whole financial system. “Tulipmania” in the Netherlands in the 1630s was one of the first bubbles of the modern world. Tulip jobbers speculated in the rise and fall in the price of tulip bulbs, and many grew rich overnight when bulbs began to reach extraordinary prices, the rarest being sold for great fortunes. Strange stories circulated about people who bought them thinking they were onions, ate them by mistake, then found they had consumed the value of a large mansion. Then the bottom dropped out of the market; the speculators were ruined and aristocrats were forced to mortgage their estates.
Everyone vowed it would never happen again. But it always does, and following the same patterns: a belief that some new technological or economic breakthrough has permanently changed the way markets react; doubters are publicly ridiculed, funds for useful projects dry up, and there are assurances that this time it will be different. And so on, right through to the global financial crisis of 2007–8. It is the way of the economic world. The only way to avoid it is to sit on your Geberit Aquaclean shower bidet in your luxury bathroom and hide away from the world.
In 1716, the Scottish financier John Law persuaded the French government to set up what would later become the Banque Royale, through which he issued large numbers of bank notes that were to be underpinned by profits from his speculative Mississippi Company. There were riots at the Bourse in Paris as people fought, and even sold their bodies, for the right to buy shares. The Banque Royale was soon so successful that Law agreed to take on the entire French national debt; he turned it into paper and became the richest man in the world. It is said that the resulting crash was so desperate that it may have caused the French Revolution nearly three-quarters of a century later.
Keynes warned against bubbles in his 1936 General Theory of Employment, Interest and Money: “Speculators may do no harm as bubbles on a steady stream of enterprise, but the position is serious when enterprise becomes the bubble on a whirlpool of speculation.”