The reason why bubbles are so important is that of their consequences when ignored. The dot-com crash (which lasted from March 11, 2000, to October 9, 2002) gutted most shopping and communication companies. Even big names such as Cisco, saw their stock decline by 86%.
Let's first look into why these bubbles form in the first place: economists cite that the rapid internet market expansion, as well as the increase of IPO at the time, drew in plenty of venture capital. Venture capital is effectively assets invested in a project in which there is a substantial element of risk. People viewed the internet, as a promising industry as well as one that would be sure to grow and make profits. As a result of this hasty investment, the economy began to inflate as demonstrated between 1995 and 2000 when the NASDAQ index rose 400%. During the time, an unprecedented amount of personal investing occurred, in extreme cases causing people quitting their jobs to engage in full-day trading. But if the market was doing so well, how did it crash from 400% up?
The issue is with the fact that much of the existing investment was hasty, overconfident, and driven by the upward trend of the market. The issue is that stocks cannot continue to go up: at some point, people will sell for profit. On March 10, 2000, the NASDAQ index peaked at 5048. At the market’s peak, many of the leading internet companies, such as Dell and Cisco placed huge sell orders on their stocks. The issue is that at this point, the market was not only full of experienced investors but also newer prospective ones who were riding the initial growth. Part of the problem is that a lot of these investors, rather than being predictive, follow the market lines. This meaning, as the stock rises they buy and when it falls they sell. This major tech company pull out, sparked panicked selling among investors. Within weeks the market lost 10% of its value sparking another wave of scared selling. Investment capital began to dry up and with it, a majority of publicly traded dot-com companies.
In the aftermath, some companies were forced to liquidate, others such as eBay and Amazon declined in value but recovered quickly. People who quit their jobs to invest were stuck outside of the market. Others who had jobs were laid off of their companies now bankrupt.
In summary, while increased investment may be good, when risky investing occurs, it slowly becomes dangerous and can turn costly.
Tamur, you did a great job highlighting the consequences of ignoring economics. Many of the economic disasters in U.S. history have been rooted in the same patterns. You highlighted the dot com bubble and the housing bubble, more recent bubbles, and there are many more throughout history. Another example would be the Panic of 1837, where one of many causes was the abundant land speculation that occurred, and the resulting crash when buyers were not able to produce the gold and silver required to buy the land, per the Specie Circular issued by Jackson. Of course, this wouldn't be discussion about bubbles without the Great Depression, where stocks once again were the culprit in terms of boosting consumer confidence without real returns. It's very interesting to observe how history tends to repeat itself, despite the obvious consequences. It seems like economic theory continues developing, but as long as there is greed, history will repeat itself.
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