A speculative or economic bubble refers to the trading of high volumes of financial assets at certain prices considered a variation from the intrinsic value of these assets. The speculative bubble has numerous names such as a market bubble, a financial bubble, price bubble, or the speculative balloon or mania. In the speculative bubble, the price of the assets base on prediction of future prices, which are often subject to inconsistent or implausible perceptions of market analysts. Given that it is hard to evaluate the intrinsic values of financial assets within the market in real life situations, the identification of speculative bubbles happens conclusively in retrospect. It is regardless of a fall in the prices of assets (Shiller 1). Financial analysts refer to the fall prices as a bubble crash or burst. On the other hand, there are instances when there is a rise in the price of the assets, often referred to as a boom. The effects of a burst and a boom are that they are all mechanisms through which the financial market gives positive feedback to the participants. On the contrary, there is also negative feedback received from the market, which is the mechanism through which the market determines the equilibrium price of the financial assets. In a speculative bubble, the fluctuation of prices is erratic to an extent that it is almost impossible to foretell the prices based on the demand and supply forces alone.
Over the course of the history of capitalism, speculative bubbles have been the cause of the inflation of the prices of assets. In this light, it is important to examine the reasons speculative bubbles easily affect the capitalism. The whole point of a capitalist economy is that it is a private system where the allocation of resources depends on the price signals within the market. In capitalism, individuals, organizations, and institutions seek to maximize wealth and income. Therefore, if the allocation of resources bases on expected prices the speculative bubble affects the allocation of resources in a capitalist system of the economy. Mechanisms of private credit are elementary to financing of many economic systems in a way that the credit system allocates both real and financial resources in the economy. Here, the potential pitfalls within capitalism come into the light. First, the reliance on the flow of credit by capitalism is a weakness because credit may not be adequate to finance the required investments in the economy. In addition, credit cannot sustain the economic activity of the entire state. Secondly, too much credit may exist in the economy leading to credit inflation. It is a setback when it comes to capitalism. The excess of credit often results into a distortion of the cost of finance in the economic system. At the same time, inflation of asset prices triggers a distortion in terms of consumer investment and spending. Inflation of credit may happen through the prices of assets, which are subject to speculative bubbles.
Capitalism allows the inflation of asset prices. The inflation happens through speculative bubbles and bursts. The result is the creation and destruction of economic wealth. First, the speculative bubbles create wealth in the sense that they generate high amounts of monetary income in cases where the speculation is right. Given that the trade happens in high amounts, the revenue generated by organizations, institutions, and individuals is also high in cases where the speculation is accurate. Therefore, the create wealth by increasing the monetary income of participants in the economy. Monetary income relates to a high ability to spend, save, and invest. Increased spending implies that the cycle of income is repetitive in the economy (Read 2). When people spend more, it has an implication of income for other people, which creates wealth in the end. Similarly, increased monetary income also increases the marginal propensity to save because people have enough money to save after spending. With higher savings, the ability to invest also increases because of the surplus income at their disposal (Shiller 3). Therefore, accurate speculative bubbles increase both money and real income. Money income is the initial effect, while real income is the effect in the end because of the increased purchasing power that people have due to the wealth.
Another way that speculative bubble creates wealth is through the ability to intervene when there is a problem with credit ibn the economy. The capitalist system allows a free economy, one that is not subject to the intervention and regulation of the government. Speculative bubbles allow the prediction of the behavior of monetary instruments. It helps in the estimation of their value and helps to cushion times when the credit facilities are not adequate to facilitate the operations of the economy (Read 3). The value of the financial assets may be adequate to reimburse the shortcoming of the credit facilities meant to finance the economy. In fact, the prices of certain assets such as bonds are applicable as credit facilities by the time they will mature.
Speculative bubbles lead to the destruction of wealth through the risk element involved in the process of speculation and the trading of financial assets. The expansion of the scope of the speculative bubble also has a similar implication on the nature and scope of risk involved. As the years passed, the speculative bubble found ways of making the element of risk distorted, concealed, and camouflaged within the possibility of high returns in the future. Therefore, the deceptive nature acquired by risk makes it difficult to monitor, evaluate, and regulate the risk. As such, most traders and financial institutions are not in a position to foretell the possible losses thy will incur. On the same note, the process of intervening the effects of risk was rather self-reinforcing such that the nature of trading was risk averse. Speculation reduced the possibility of averting risks given that most of the focus lies on the expected revenues. Therefore, aversion of risk became a self-correcting and adjusting process where the expected revenues must mitigate the losses incurred by the participant. Therefore, speculative bubbles destroy wealth by creating an illusionary perception of the absence of risk in the process of pricing the assets. There is negligible intermediation in the element of risk making it rise to a highly dangerous level.
In addition, destruction of wealth also happens by increasing the emphasis to use debt instruments. For instance, if a government purports that a bond instrument will cost lesser at maturity, then it will prefer to finance the operations within its economy suing that debt instrument. It increases the use of credit facilities. At this point, it is important to note that the value of the bond may not be in line with the prediction as supposed by analysts. In the end, the government may end up paying higher for the financial instrument, unlike the expectations. Speculative bubbles destroying wealth by increasing the indebtedness of the participants in the economy through use of credit possibilities.
A CURRENT POSSIBLE ASSET BUBBLE
Today, a possible asset bubble lies in the pricing models of stocks. Stocks are financial assets often in the form of shares of a company or other incorporated corporations. The possibility of the bubble emanates from the unexpected levels of too much liquidity (Read 4). At the same time, stocks have diminishing liquidity such that the prices may be stagnant for a significant period in the economy. The fluctuation in the level of liquidity leads to the possibility of the formation of a stock bubble in the market. The unprecedented price fluctuations are the cause of the bubble. The likely causes of destruction of the bubble is the occurrence of economic phenomena that is universal and beyond the control of the company in question. For instance, in cases where there is a global recession, the prices of the stock will succumb to the prevailing economic conditions unlike the expected conditions anticipated by the bubble.
The likely aftereffects of the possible bubble in the prices of stock is the financial consequences that accrue to the participants. If the bubble asserts that there will be a boom in the prices, many people will buy the stocks todays in anticipation of high profits in the future. If there is a reversal in economic conditions, they will have to bear the financial losses because of the sudden, unanticipated burst in the stock prices. However, the outcome of the bubble could also be high returns for the participants if the market sustains or improves the prevailing conditions.
Works Cited
Shiller, R. J. Irrational exuberance. Princeton, NJ: Princeton University Press, 2000. Print.
