The Anatomy of a Bubble

Abstract:

The term bubble is recent in history. This is probably because of modern complexity and the frequency of such micro-crises in modern times. Though the tendency is to hold someone accountable for these instances, there are clear, systemic incentives that promote bubbles. Finance itself is a bubble of sorts; as it is rooted in borrowing from the future. Securities add the effect of being able to bet on futures; and dividends are the engine of aggregation of wealth. Bubbles are the subject of a great deal of top down influence; that has existed since the advent of currency, and the asking of the question “how will I pay for this?”.

Unsustainability:

Competition between nation states is centered around not only military superiority, but also economic superiority; and the latter heavily influences the former. Over the past few thousand years, crises have become increasingly more frequent over time. This is probably the result of technological advances, that lend increasing liquidity to the economic systems themselves. Now that crises are much more frequent, several are being experienced in a single lifetime. This increasingly rapid succession of technological advancements is having an adverse effect on finance itself. The future that is being borrowed from in modern times is demanding payment, not only from the generation that borrowed it, but even from some of the same individuals. This is occurring due to the bubbles that are created in the financial sector. Sustainability in this context, is a gradient of sorts; and the windows in which the system appears to be sustainable are narrowing over time. Finance has always had a degree of unsustainability; but in modernity, it has become much more humanly tractable.

Growth Incentives:

Any expectation of a profitable return on lending is a financial incentive for growth. In order to repay the debt above the principle, the endeavor has to be profitable itself. Where the incentive is to produce a compounded dividend indefinitely, a bubble blowing machine is created. This is because there is no incentive to yield to growth maximum. When growth maximum occurs, the dividends are still expected; even though it’s a great expectation. Markets now quickly grow beyond the ability of a population to support them. The markets themselves have similar viscera to that of bubbles.

Public Funding and Trading:

Though in the larger scope wealth is aggregated into the hands of a small percentage of the population by financial models, opportunities exist for new endeavors to compliment economic complexity. Going public however creates advantages over the small business owner. Going public often means large amounts of initial public funding. It also means that shares are directly tied to funding. This social contract is not only legally binding, it’s also subject to financial incentives. The incentives for the investors who buy shares of a company is quarterly dividends. Their investment in the company grows as the company grows; because shares are a percentage of the companies value. As the company’s profits accumulate, the company becomes more valuable; and thus the value of stocks increases. This is a method for publicly funded companies to share their profits with their investors; that is built into the system itself.

The financial incentives for a company to increase profit margins and grow is the fact that investors have no obligation to continue funding the company. This is part of the model for trading securities like stocks. The investors incentives to continue funding is based solely on the companies ability to increase profits. This means growing. Where growth is stunted or maximized relative to the number of patrons that a company can provide products and services for, there is a risk that investors will discontinue their funding of the company. This means that shares will be traded. In instances where there is little to no speculation for growth in a company, there is little to no expectation for their stocks to provide quarterly dividends. The incentives to buy such stocks are thus no longer present; and the company is obligated to buy them themselves. This doesn’t however decrease the value of the companies; it only decreases the amount of funding that they have access to. This is of course not an ideal situation; so they often begin looking for creative ways to increase profit margins. Too often this results in anti-competitive behaviors or mergers that reduce the diversity of the markets; thus making them less stable.

In instances where businesses themselves have grown to what a population can support with respect to patronage, the businesses themselves are at a state of growth maximum; and that particular market is considered saturated. The state of such a system as it goes forward with unsustainable practices shares many commonalities with bubbles.

Predatory Lending:

Derivatives make up the vast majority of the transactions that occur in modern economics. Much more profit is accrued from investments than from selling products and services. This is how wealth is aggregated.

Predatory lending can only be advantageous for the lender if the risk doesn’t weigh heavily against the returns. In the state of growth maximum of the economy itself, there tends to be certain institutions that have extraordinarily unbalanced influence in the economy. Economies are very complex, integrated systems where one economic entity can have far reaching effects throughout the entire economy. This makes such entities the object of attention and nurturing as they are financially and / or economically critical. The risk of not nurturing such institutions is the risk of financial crisis. This defers risk from such entities to the whole of the economic system itself. This is the sort of situation that accommodates predatory lending.

It’s the lack of risk for the lenders themselves that catalyzes predatory lending. This allows lenders to invest in more risky endeavors without the concern of taking that risk themselves. This of course often has far reaching effects on the economy; so there is a bit of a paradox to consider. Initially the effect is overall growth of the economy. This is however probably a bubble; as it’s clearly unsustainable. This is a scenario where risk accrues over time until the endeavor collapses under it’s own weight; as there is no feasible, financial foundation to support it. This of course results in far reaching, negative effects on the economy as a whole. When this occurs, it’s often more concerning that the financial crisis could worsen if not handled carefully. This often means being very selective in who is punished for it; but even more concerning is the fact that there is not more effort being leveraged toward solutions to the issue.

Human Predisposition and Securities:

Dopamine appears to have a particularly interesting effect on human motivational systems. When outcomes are difficult to predict, dopamine levels tend to be significantly higher than when there is confidence in predictions. The effect is that complex life is still motivated to try to function where fear of the unknown is present. This of course raises interest concerning issues like gambling addiction. It’s not entirely unlike the biological drivers that facilitate substance and sexual addiction. These are all relevant considering investment culture.

Substance abuse and sex addiction in investment culture are reported to be well above the national average; which is currently considered epidemic. Investment culture is known for the stress and anxiety that accompanies it. Much of the addiction that exists in the culture is attributed to the effect that substances and sex have on stress. They both mitigate stress to some degree; so it’s not surprising that there is a high number of instances of drug, alcohol and prostitution usage in the culture.

The endeavor itself being speculative, it produces a sort of dopamine addiction; not unlike that of gambling addiction. The stress associated with an inability to make confident predictions about outcomes is rewarded with spikes of dopamine.

Being involved in investing under the current state of growth maximum includes the risk of being the one that is held accountable when the bubble bursts; or the corporation is sued, or the bank is investigated. Though the system itself is essentially designed to fail in spectacular fashion, those who suffer the losses want a head for their pike. This is contrary to a systems view because the systems view defers responsibility to those who created the initial model. This would mean that the search for that head includes digging up long dried bone. Of course the ones that endeavored to take the most risk are normally the candidates for responsibility; but this doesn’t include the pressures being leveraged on them to do so.

Shorting:

Betting against the speculation of bubbles is of course quite common as of late. A lot of money is being made off of the desperate measures that are facilitated by the growth imperative. Though it’s morally punitive and can result in degrees of correction, it’s not necessarily wise to follow through in more serious bubbles. This is in reference to the economic entities that have unbalanced influence in the overall economy. Their risks are even deferred to shorts as well. Shorts themselves have varying degrees of risk that include more than just being wrong.

Conclusion:

The development of Socioeconomics over the past several thousand years is likely to result in a system that no longer allows borrowing from the future. The increasing liquidity of the markets themselves is approaching that of currency systems and finance. This is already resulting in lack of economy in markets that increasingly quickly become bubbles; or at least quasi-bubbles.