Economics Paper Sample: A Bubble in Global Economies

There are times in the global economies that share prices rise steadily, and after some time, the prices come crashing down. The plump in prices is attributable to bubbles which occur in the different sectors of the world economies as a result of changes in investor behavior. The surge in asset prices which is not necessitated by the fundamentals of the asset creates the bubble which after sometimes becomes deflated or bursts. The contraction is as a result of increased investors with a high propensity to spend who purchase at the elevated prices triggering a massive selloff and hence, the bubble burst. The current growth witnessed in the London technology sector resembles a balloon in different aspects like the overpriced tech stocks and increased funding. With the current low-interest rates, the tech sectors stocks are at an all-time high and startups which have no revenue are being given billion dollar valuations.

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Besides, bubbles have occurred in the past which resulted in massive losses while on the other hand created wealth to those who had pulled out of the investments before the meltdown. The most notable ones include the South Sea Bubble of 1716-1720 where people were swindled into investing into the company. It had special trading privileges with South America, and its share prices rose steadily until a certain point when they collapsed due to overtrading resulting in high losses. The Dutch Tulip Mania of 1634-1637 whose speculation around the time involved tulip bulbs after the plant was introduced in Europe (Kennard & Hanne, 2015). The prices of the tulip bulbs implode after some time leaving the majority of the population in abject poverty and the country in economic turmoil.

Causes of Bubbles

Bubbles form disguised in some good economic reasons like experienced when bank interest rates are lowered thus encouraging people to borrow and when the economy is doing well. Some of the factors that lead to the formation of bubbles include but are not limited to:

The herd mentality

It is based on the assumption that the majority cannot be wrong. People observe the buying behavior of influential individuals and institutions thereby arriving at a conclusion that the investment is safe. An example is the massive venture capital investments in Londons technology companies some of which have achieved IPO like Powa Technologies, Funding Circle, Intelligent energy, and OrderDynamics.

Irrational Exuberance

Some people invest as a result of intense psychological pressures which compel them not to consider the value of an asset and harbor the belief that prices will keep going up. In this scenario, any news of price increases accelerates an investors momentum to invest thereby encouraging others to invest as the word goes around.

Similarly, bubbles present themselves as a rapid increase in the price of assets and financial instruments encouraged by speculative demand which becomes unsustainable (RAPP, 2014). The London technology sector could be compared to this scenario as witnessed in the massive funding and investment in the industry. Some London-based tech companies have experienced higher than average valuations after raising vast sums of money on various stock market platforms around the world. The current trends in the London tech sector resemble a bubble in the following aspects based on a bubbles stages:

The Displacement Phase

It is a result of investors being lured to invest in new technologies coupled with historically low-interest rates. About the London tech sector, a higher number of start-ups have achieved a valuation of $ 1 billion or greater. Funding of start-ups is at its peak level, and many have given IPOs and have received higher than anticipated valuations like king.com which got $500 million in its initial public offer. With the surplus capital, the tech firms have continued to hire more employees to run their operations. The massive investment in the tech sector is attributable to the fact that base interest rates are at their lowest standing at 0.25%. Majorities of the people have access to credit and hence can invest even in riskier portfolios.

Credit Creation

At this juncture, people have access to credit due to the low lending rates of lending institutions. New lending institutions like Funding Circle have also emerged as serious funders of the London tech sector. At this stage of the bubble, prices rise slowly and due to displacement but later on accelerate as more participants enter the market thus resulting in a boom. Currently, the publicity of the tech sector being the best investment frontier has created massive investments as people fear being left out of the opportunity to make significant gains.

Euphoria Phase

The phase is characterized by new valuation techniques that are meant to justify the unrealistic rise in the price of stocks and overtrading. Considering the London tech sector, many tech companies have received extraordinary valuations which are based on future gains. Companies like Skyscanner and TransferWise have huge valuations while others like Uber and Snapchat even with their high valuations continue to make losses. People are investing in these businesses with the thought that prices would go higher in future and that they will make higher profits.

The Critical and Revulsion Phases

The critical phase precedes the revulsion phase and is characterized by profit taking where smart investors start selling out their investments to realize benefits. The reason is that there is a surplus in the supply of a new invention as a result of excessive investments. Besides, the sale by smart investors creates a panic where investors rush to sell their stocks early to avert losses. This rush leads to the revulsion phase where asset prices head for a steep dive in the reverse direction just like they had ascended. The forces of demand and supply are in play as supply overwhelms demand as traders try to liquidate their holdings at any price.

However, the signs that the London tech sector is a bubble are in the first three stages as there are no serious warnings or panic to sell characterized by the critical and revulsion stages. The contrast could also be supported by the fact that no one can predict the exact time the bubble is due to burst since markets can stay irrational for longer periods of time (Schulte, 2015). Revulsion is characterized by low trading volume yet London markets are experiencing higher volumes of sale. Other justifications that the London tech sector is not operating in a bubble could be supported by the fact that the numbers of IPOs are not many and bubbles take some time to develop and burst. Also, there are formidable tech companies like Google and Facebook whose share price growth and valuation are justifiable.

References

BIBLIOGRAPHY \l 1033 Kennard, F., & Hanne, A. (2015). Boom & Bust: A Look at Economic Bubbles. Newyork: Lulu.com.

RAPP, D. (2014). Bubbles, Booms, and Busts: The Rise and Fall of Financial Assets. Chicago: Springer.

Schulte, P. (2015). The Next Revolution in Our Credit-Driven Economy: The Advent of Financial Technology. Newyork: John Wiley & Sons.