Wednesday, May 22, 2019

Bubbles - The shining new thing

One of the popular statements heard when there is a bubble is "This time it is different".

It is fashionable to look back at these statements and think how foolish these statements were. But what if it is true?

During the Bitcoin boom, I actually said it afew times, when talking about Bitcoin. "This is a different asset".

A bitcoin is not a stock. It had not been seen before. How would I value something that has only existed for a few years, that was made up of complex software and that kept coming up in the news everyday?

I think back to previous bubbles that I have lived through and remember vividly - the housing bubble in the US, the dotcom boom, and a real estate bubble in India, etc. I realize it is true that every bubble has a novelty effect. During the start of every bubble, there is something new and shiny.

A shiny new thing is hard to quantify and evaluate in terms of risk. If there is an entirely new phenomenon, there is limited data to predict its risk. Our in-built optimism will make us focus on the upside and not focus too much on (as yet) invisible downside.

Here are some bubbles and the shiny new things that were so new that most people had no idea of how to value them.

(Note: There are many factors at play during a bubble. I am only thinking about the "new and shiny" aspect of bubbles).

  1. The internet - While it seems normal and ubiquitous today, the internet was terrifying and awe inspiring during the 1990s. There were daily articles of what the internet could do, and how it will change the world. In my opinion the Internet in 1998 was equally as complex as Bitcoin was in 2017.
  2. US housing boom around 2004 - There was financial "innovation" that bewildered people. Buying homes "easily" was the new thing. The speed of loan processing and the packaging of loans into mortgage backed securities.
  3. Bitcoins - it is the shiniest thing I have ever heard of so far.
  4. Historically, the South Sea bubble is also similar. In 12th century England, the new unexplored colonies would have been a shiny new thing, that cannot be reasonably valued and risk profiled.

Another aspect on a shiny new thing causing a bubble is that people focus excessively on the "shiny new thing" from the past. The reasoning is - "Didn't tech stocks cause the collapse in 2000? So maybe the tech stocks of today - FAANG - may cause the next bubble burst?". Or something like, "The Great Financial Crisis of 2008 was because of the collapse in housing prices. So housing prices going up now is a sign of a bubble".

I believe the next bubble will be something we haven't seen before and something that makes us say "We know the past risks....But this this is different".

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Book reading - Factfulness

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