Bubbles will exist as long as humans do.
But if this were true then bubbles would have always existed. Any serious study of history would reveil this to be untrue. In fact, bubbles are a modern phenomenon only occuring in the last 100 years or so. Bubbles can only occur when the price of credit (interest rates) become cheaper than the market would otherwise set them. This can only happen when the supply of money can be inflated or deflated. If the money supply is real high interest rates have to be extremely low or money will just sit around not being used. When they are real low there is a tendency for malinvestment because previously unattractive investment become higher priced in the market due to prices being bidded up – e.g, the stock marke in 1999 and the current housing bubble.
Most of the time, people do not act rationally, but rather make choices based on emotion.
All choices are rational choices in that they require reason. The fact that one person may be “emotional” while making the choice does not change that fact. What you are really saying is that you would behave differently under the same circumstances.
Basically, it all comes down to the fact that ALL individuals value things differently and will behave in different ways to bring the reality of their values about. It is very chaotic but when the market is stable (not being interfered with) it has a way of organizing the actions of individuals to coincide with the greater wishes of society. In a healthy environment it becomes increasingly difficult to profit off of taking advantage of people. The market will punish immorality while the government tends to (unintentionally) protect it via dimwitted regulation.
Actually, any serious study of history would reveal the tulip bubble of the 1600s. Many refer to this as the first recorded speculative bubble where the price of tulip contracts was significantly inflated. Now due to the lack of data from that time period, it is difficult to gauge the specifics of that phenomenon…but nevertheless many economists agree that this was the first bubble.
Prior to this time, my history is shaky at best, but I would surmise that this was the beginning of traded securities…or financial markets as we know them today. Perhaps there is evidence before this, but 400 years of bubbles is enough for me.
Interest rates due play a critical role in asset pricing. Your analysis that an increased MS causes lower interest rates is absolutely right. This may cause a tendency for buyers to bid prices up as they have excess funds from their ability to borrow at much lower rates and thus invest more. At the same time, the economy is very cyclical and as long as the Federal Reserve runs a dual mandate between price stability and employment there will always be an ebb and flow. Thus, periods of expansion/contraction. A direct result of this will be periods where interest rates are high and conversely periods where they are very low (right now). Therefore, the opportunity for bubbles to form will always be there at one time or another.
I agree that market participants have heterogeneous expectations, which would cause different perceptions of the same circumstance. However, behavioral finance cannot be discounted even though most asset pricing models do not consider it. People make knee-jerk reactions, which may or may not be in their best interest. Perhaps they do always have a ‘reason’ for their choices…but if that reason is simply to “keep up with the jones’” buy investing in the next hot stock then I would never classify that as rational behavior. It may be rational in their own minds, but that’s because humans can, and will, justify their behavior through rationalization. You get enough people making poor decisions like this one by purchasing stock in internet companies (without researching their financials), or getting into homes via subprime mortgages when they do not have the credit/income to be a homeowner, simply to boost their status then prices become inflated. Enough buyers in the market causes the underlying price to move beyond its intrinsic value and bam…before you know it you’re fucking knee-deep in the next bubble.
And then all of a sudden…it bursts.
I kind of look at it as a chicken and egg situation. There is only one sure fire way to end the cycle…but that is best left at the PWI threads.
I still think 400 years is modern is terms of monetary exchange. Though, I also know that we can expect that government fucked with the money back then, too – shit, their faces were depicted on it…