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Comment by AnimalMuppet | Hacker News Reader

Here's my theory of bubbles:

You have an asset (doesn't matter what it is). It's going up because the fundamentals improved, or because favorable press, or whatever. That's not a bubble. Stuff goes up all the time.

So people start buying it, because it's going up, and they want in on the action. That's still not a bubble. People buy stuff that's going up all the time.

Now there's new money flowing into that asset. So now the price goes up because of the new money flowing in, and the new money was flowing in because the price was going up. Now it's a bubble. But it's not dangerous yet. People can lose their shirts, but it won't hurt the overall economy.

It becomes a dangerous bubble when (lots of) people invest in the asset with borrowed money. Now if it crashes, it can take banks with it. If that happens at a large enough scale, you damage the economy as a whole.

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You may enjoy this essay, which calls this mechanism "liqudity flywheels": https://lt3000.blogspot.com/2020/07/market-inefficiency-liqu...

    A liquidity flywheel is a situation where inflows into an asset class lead to buying pressure that pushes up prices, leading to favourable apparent return and volatility characteristics in the said asset class. This favourable outcome then attracts yet more inflows, leading to yet more buying, etc. Conversely, poorly performing asset classes with significant downside volatility can lead to investor redemptions, leading to forced selling that contributes to yet further price declines, yielding even worse returns and even greater redemptions, and so on. This process can go on for years, and sometimes even for decades, and is a fundamental contributor - perhaps the most important contributor - to both major asset-class bubbles, as well as asset price busts and secular lows that lead to fire sales prices (which are 'anti-bubbles' driven by the same drivers of bubbles in reverse)

IMO the trouble starts all the way back with "So people start buying it, because it's going up". That's speculation. And it uses up some of the wisdom of the crowd rather than contributing to it.

> "So people start buying it, because it's going up". That's speculation.

Mostly but not entirely. It's also previous shorters who buy to manage risk. These people are qualitatively different from the speculators.

there's nothing wrong with speculation.

But there's something wrong with speculating using other people's money.

There's nothing wrong with speculating using other people's money as long as you're honest about it. Most mutual funds operate that way.

Do mutual fund investors accept that their money is on the line? As the saying goes, a financial crisis is when someone loses money and it's socially unacceptable for them to not be paid back. So perhaps a bubble is when you speculate with money that it would not be socially acceptable to lose.

Yes mutual fund investors accept that their money is on the line. Many mutual funds have negative returns. Your definition of a bubble makes no sense.

I agree with you. I'll put it another way. Usually if the price of something goes up and becomes too high, fewer people buy and the price drops. That is a stable system. An unstable system is when the price of something goes up, so that causes more people to buy causing the price to go up more. That is an unstable system causing exponential growth, which I'd call a bubble.

Is the lesson learned that people are irrational gamblers?

I think the lesson learned is that the system is setup to encourage this kind of bandwagon investment. For example, all the people who are buying houses as a vehicle towards financial security: completely rational within the confines of the system we have. But causing huge problems, and therefore something that shouldn't be incentivised.

I'm seeing it in the sense of gambling: I buy when I think it's going to go up, you sell because you think it's going to go down (stocks), but people don't think, they just get excited, bubble happens, then we get a small minority winning big and the majority losing.

That's just human psychology. Can't fix that one. It's one of the fundamental anomalies of markets. People also tend to sell more when the price is trending downwards, all other things being equal.

That does not mean it's not the problem

But where I disagree maybe is that it's a market anomaly. It sounds like a human anomaly but the market is here to allow it to be expressed fairly and in the open so that it corrects itself naturally over time.

The alternative is a small group of well educated or armed people planning the economy by 5-year increment for the good of the people. They can be right for very long, but is it fair to prevent us to make mistakes and only allow them ?

The market maybe isnt here to maximize efficiency of outcome, but maximize fairness of access ?

free market does not maximize anything. it just is. fairness is not in the equation. free market (or something similar) is just good enough way to organize economy with good enough outcomes.

> free market does not maximize anything.

That's a little too strong. It doesn't maximise efficiency of outcomes. But it does (more or less) maximise profit under free-market rules.

There's this branch of medicine called "therapy" that is specifically about fixing human psychology, and this other thing called "education" that aims to prevent issues identified in human psychology early in people's lives.

Also, “religion” and “culture”.

Reminds me of a meme about the current state of real estate prices. Which is that because banks became stricter about lending, it's not a bubble this time. The reason it can still be a bubble is that 1) ZIRP and 2) while governments somewhat achieved their mandate of low unemployment, employment stability (not having to constantly job hop to survive) is through the floor. That's why this is a structural megabubble IMO and isn't tracked very well with the proxy of 'how much debt is on individual balance sheets'.

> ZIRP

The naive valuation of a stock that gives it an infinite value at a real 0% interest rate relies on an infinite horizon. Thankfully at least for residential loans it's difficult to get an interest-only mortgage -- in practice deposits and principal payments are binding constraints on valuations. Maybe that changes with corporate landlords becoming more prevalent, though.

> employment stability

This is interesting: high job turnover is usually seen as a sign of a healthy labour market because it can represent people sorting into jobs they're better suited for. I guess it's a question of what you hold constant: maybe people are changing jobs because jobs are plentiful. If people keep changing when jobs are hard to find things could get dicey.

The reason I and my colleagues are seemingly changing jobs often is because:

1) newJob pays more than oldJob

2) oldJob is becoming unstable, toxic, and will likely be firing us all in 6 months, so better to leave early and start the clock over

In a world where we remain at oldJob til the end, we risk 6 months of that extra pay differential, plus we now have to job hunt while technically not being employed

I think both points fit the "job market is healthy" description -- (1) explicitly has `newJob`, (2) implicitly assumes `newJob` in its faith in starting over. Conversely, if jobs were scarce it's plausible many of those changes wouldn't happen. Arguable in the case of "toxic" workplaces, though.

Bringing this back to shaker8's point about financial risks, I think these kinds of job changes mostly point to systemic resiliency, not fragility.

Interesting ideas. I suppose we can say the US job market is healthier than Spain's, because unemployment in the US is low, and the pay/expense ratio is good enough. In Spain, unemployment is very high, and the pay/expense ratio is not very good.

But imagine if the US job market changed to this scenario: still the pay is high, still the expenses are low, still the jobs are available, but you have to change jobs every week. That would signal two things:

1) Employers are suddenly finding it advantageous to rid themselves of workers on short notice

2) Time and money are being wasted interviewing people and onboarding them rather than letting them work for sustained periods

I think such a system, while still "healthy" because workers are still employed and paid similarly, is "less healthy" than a system where the workers can expect the duration of their work at one employer to be longer than 1 year

No, the pay/expense ratio is not good at a global level. The odds of making it to an 'early' retirement at age 60 at 50k per year and saving 20k are very low. The odds at 150k saving 50k are equally low. This is because the net worth required to move to passive income, due to ZIRP, has gone way up.

Based on these comments I believe everyone here is talking about the resiliency of the tech job market. I'm talking about the resiliency of the job market in the US, and the job market globally, what are sometimes called 'semi-skilled' jobs (a truly brutal term but hopefully that helps people get it). Even this doublespeak about talking about resiliency of markets implies a certain amount of dogma about how markets, not people, need to be resilient. If the market is resilient, it will somehow trickle down to ordinary folk.

agree but it’s not even just that.

it can just be a plain bubble even if everyone buying it has enough money to afford it. there’s been plenty of bubbles that didn’t involve leverage or loans at all. people simply got crazy and paid ridiculous amounts for assets far above intrinsic value. and when at some point something happens to the asset, it has a far way to fall.

Can even get worse if the borrowed money only exists based on promises in the first place.

The tragedy is that that these crashes often increase inequality and concetrate power. The victims are innocent and the perpetrators are not held accountable.

> Can even get worse if the borrowed money only exists based on promises in the first place.

but isn't this all modern fiat money?

I dont know if innocent describes people signing a contract. They can be victims of manipulation but maybe people are less stupid than you give them credit for.

Maybe they understood that it was an opportunity to seize, a cheap loan in a bubbling up market, and they decided against carefulness.

I face this with bitcoin for instance, trying to stay careful in an exciting rising market. If I stick to fundamentals and what I think I know of past experiments, this makes no sense. If I look at making money in my lifetime, I feel stupid resisting.

Every single working class/ non-asset wealthy person loses out as their relative net worth decreases with every rescue package.

I mean people who don’t participate, even cannot, or are convinced to participate by experts. This is the vast majority of affected after a crash.

The financial market and its powerful actors have a massive collective responsibility, that they often don’t seem to be aware of.

The few that are responsible have been ignored for reasons I cannot otherwise understand but as greed.

I speak as an outsider and layman here. I understand that mistakes can be made and that things are very complex and unpredictable. What I have a problem with is that they don’t seem to get accounted for, and certainly not fixed.

The criticism of the banking system and financial markets goes way back. It has been discussed and brought to attention by the likes of Adam Smith. But somehow we just keep patching over the symptoms, if at all, rather than question the severed connection between power and responsibility.

I think a naturally occurring Ponzi scheme is the simplest and best definition of a bubble.

I like the idea of calling market bubbles "wild Ponzis".

This definition is not the best since at the very least it missed that a Ponzi scheme lacks transparency and is fraudulent.

PG had one of the best definitions: "a rapid increase in buying based on the expectation of soon selling to a sucker willing to pay more". It's in an old Startup School video and I doubt I am getting his wording correct.

https://en.wikipedia.org/wiki/Greater_fool

Hyman Minsky had a concept he called Ponzi financing:

"Minsky distinguished between three kinds of financing. The first, which he called “hedge financing”, is the safest: firms rely on their future cashflow to repay all their borrowings. For this to work, they need to have very limited borrowings and healthy profits. The second, speculative financing, is a bit riskier: firms rely on their cashflow to repay the interest on their borrowings but must roll over their debt to repay the principal. This should be manageable as long as the economy functions smoothly, but a downturn could cause distress. The third, Ponzi financing, is the most dangerous. Cashflow covers neither principal nor interest; firms are betting only that the underlying asset will appreciate by enough to cover their liabilities. If that fails to happen, they will be left exposed."

-- https://www.economist.com/schools-brief/2016/07/30/minskys-m...

The crash that occurs when people realize that an asset class is not going to keep going up is a "Minsky Moment". His conclusion was that stable growth led people to take on more debt - that stability itself was destabilizing and financial crises are inevitable.

seems like they should restrict the use of debt-based (government emitted credit money) for the purpose stock market speculation.

or if they wanna keep the ability to take huge risks, there should be some way to force large financial entities to face the loses when they do risky things and fail as opposed to letting the "market" (i.e. the future taxpayer) pay the bills.

at the very least they should cut them off from "new money" (which is government emitted credit=debt-money) until they pay back in whole as opposed to just making even more "money" to dig a deeper hole for the future taxpayer to fill back up.

I'm reminded of filling up a hole by digging in other places to fill the original hole without ever realizing that you're actually in the ocean and thus you are just lowering the overall water level.

There is no separate category of debt-based government emitted credit money. Since we left the gold standard all US dollars have been debt based. That's not a bad thing, it's just how our banking system works.

Stock investors are already generally limited to 2× leverage in brokerage accounts.

> There is no separate category of debt-based government emitted credit money.

maybe there should be

Good analysis.

It isn’t looking great.

https://www.currentmarketvaluation.com/models/buffett-indica...

what's the difference between "People buying stuff that's going up" and "New money flowing in?"

None. "People buying stuff that's going up" is exactly "new money flowing in" to that asset.

But I may have left some confusion in my fourth paragraph. It's a bubble when it becomes a self-reinforcing feedback loop. People bought because it's going up, which makes it go up more, so more people buy, so it goes up even more, and so on. I didn't state that clearly enough.

I see, thank you.

It sounds like you're saying the provenance of the funds is a key indicator. People buying stuff that's going up because those people closely follow industry or sector news. The people who buy because THOSE people bought are what drive the bubble growth.

The difference is whether people are buying the stuff that's going up because it's going up or they're buying it because it's good and has intrinsic value beyond what they think the market will pay for it tomorrow.

Why not both?

If the government deems all banks “too big to fail”, does that remove the risk?

no. because bank going bankrupt doesn't wipe away YOUR debt. it wipes away banks obligation to the governing body.

also micro-lending will be as big in west as it's in China in the next decade. borrowing 10k to margin trade the stock market is inherently more risky than borrowing 10M for a mortgage.

Hardly, it may (or may not) help to mitigate the fallout though.

If only. The debt becomes worn as inflation and higher taxes.

It makes things worse because the banks now have an incentive to engage in riskier behavior. Their downside is covered by the government and their upside is payoff. So reckless behavior becomes a nobrainer.

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