Economic Bubbles

They brought down our house of cards.  So as future leaders of the Financial Industry, how about we learn what they really are?

By David Fung and Jeff Fritz

Economic bubble is a popular, though informal, term that is used by many. It describes how a significant portion of a trading market is dominated with securities that have inflated values.

This phenomenon often occurs when too much money is chasing too few assets, causing both good and bad assets to be inflated in value excessively beyond their fundamentals to an unsustainable level.

Economic bubbles are often identified in retrospect, when there is a sudden drop in prices of many securities. The bursting and the expansion of economic bubbles, mirror the peak and the trough of a typical business cycle; and in some cases,  they occur in a more dramatic way.

A classic example of this phenomena, that one may see as eerily similar to the events of today, occurred in the 17th century.   Tulips were very popular flowers in the Ottoman Empire during the 13th and 14th centuries.   In the 15h century, European diplomats sent tulips back to Germany and the Netherlands.   Soon after, many Dutch farmers started to grow special types of tulips for trade, which helped lead to its increased popularity and demand and then,  ultimately,  to its being traded as a commodity at exchanges in the 1600s.

Yet unexpectedly, in the 1640s, tulip prices fell incredibly, leading to an unprecedented situation in the European flower business.

Many farmers and businessmen couldn’t sell any of their tulips and suffered huge losses.  This economic bubble was later termed as Tulipmania.

One can see now how long and storied the history of economic bubbles has become.  But as we enter this new age of globalism,  where the world’s markets are now more interconnected than ever before and,  accordingly,  domestic markets become ever more vulnerable to economic seizures that occur from external markets,  there’s now a new impetus to get a sense of what these bubbles really are in order to insulate ourselves against it.

How do they work?  Why are they allowed to happen?  What can be done about them?  Hopefully the following pages will help shed some light on those questions…

Biography of interviewees:

Lois King is a finance lecturer with the School of Administrative Studies, a part of the new Faculty of Liberal Arts & Professional Studies (LA&PS). She worked in the finance industry for many years as a derivative securities analyst and as a hedge fund manager.

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Xiaofei Li, PhD, MA (McGill University) Assistant Professor.  Xiaofei Li joined York in 2003.  He received his M.A. (economics) and Ph.D. (finance) from McGill University after his undergraduate studies in economics at  Nankai  University  in  China.  Dr.  Li’s  research  interests  include corporate finance and fixed-income securities and markets.  Xiaofei has taught courses in corporate finance and derivatives and risk management.

Jury Kopach, B.Sc., M.H.R., P.R.P. Prof. Kopach has more than 30 years experience working with employees of Canadian industry, government and post secondary teaching institutions to prepare them financially for their retirement.  He has held the positions of senior vice-president at T.E. Financial Consultants Ltd., as well as President of NBRS Ltd.  Currently, Prof. Kopach teaches a third year course “Personal Financial Planning” at York University.