Why Are Financial Bubbles So Hard to Prevent?

Financial bubbles happen often enough for us to realize that they are economically harmful. And yet they continue to occur and pop.

Why can’t we seem to prevent financial bubbles from forming and bursting? When Bitcoin shed about 82% of its price in December 2018 after peaking at nearly $20,000 the year prior, it seems we had already forgotten the lessons learned from the Dutch tulip craze in the 17th century and the British railway madness in the 19th century.

By acknowledging that paying for something more than it’s worth will inflate its value, we should be able to identify financial bubbles at their infancy by now. But, doing so is not exactly straightforward.

For starters, the process of identifying a bubble is extremely complicated because we can only label it as such in hindsight. It is difficult to tell whether an asset is experiencing a bubble just because its price is rising steadily until its value crashes. In reality, many bubble predictions do not come true.

Even if some people catch the subtle red flags indicating financial bubble formation, their warnings usually fall on deaf ears. As long as more people believe that high prices are going to increase or stay the same, the few who think otherwise can’t do anything to stop a bubble from getting bigger.

Believers can find evidence to support their claim while skeptics can also find proof that a bubble does not exist.

Contrary to popular belief, not a single event compels people to sell. The only thing that can convince an investor to do so is a continuous drop in price. The more the price declines, the more it can trigger panic. A bubble usually bursts because enough people sold after seeing others were selling.

Logical investing is the only real way to prevent financial bubbles from happening, but it is extremely challenging to do.

To learn more about past financial bubbles, check out Fortunly’s infographic below!

https://fortunly.com/infographics/historical-financial-bubbles-infographic/

 

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