Nothing strikes fear in the hearts of investors more than the burst of a financial bubble. Just like soap bubbles that take a split second to pop, financial ones can cause trillions of dollars to evaporate before most stakeholders even realize what went wrong.
In its vividly illustrated infographic below, Fortunly explains the most notable financial bubbles that set the stage for localized recessions and, at times, turned the global economy upside down.
But why do these economic disasters happen in the first place, and are there lessons in history we can look back at for guidance?
All financial bubbles form the same way. A new asset enters the market, it creates noise with its potential to disrupt the status quo, inspires demand, and catches the attention of investors.
Although every company begins its journey to profitability this way, a bubble is formed when upstart ventures (or even an entire industry) are excessively evaluated without any solid objective basis. The unbridled influx of capital blows the bubble bigger, augmenting the invisible blanket of delusion started by early investors and hyped up by publicity.
Without any assurance of business-model feasibility, it is only a matter of time before the weak building blocks of an overvalued array of assets collapses. The first rational investors who notice the cracks in the foundation quietly anticipate the inevitable, for they are not ones to stop the party while everyone else is having fun.
When the speculative mania runs out of steam, a big-time selling event instigates panic. Soon, others follow suit to recover whatever money they can. The unjustified valuations crash, and many of the companies that benefited from irrational investing bite the dust.
This pattern continues to reappear in financial bubbles throughout history, and yet the new generation of investors continues to turn a blind eye at these past events.
A financial bubble has the potential to cripple a regional, territorial, or national economy. But then again, it would be wrong to say that nothing good could come out of it. Sometimes, a devastating economic event is a blessing in disguise.
If theRailway Mania did not happen, the United Kingdom would not have had a 6,000-mile-long rail system that eventually paved the way for the industrial revolution.
Moreover, the dotcom bubble burst was a turn-of-the-century affair akin to natural selection, which purged glorified paradigm-shifting internet companies, and gave generous funding to sustainable game-changers. Had it not occurred, we might not have Amazon and eBay today.
In some cases, though, economic disasters leave trauma without any consolation. The 2008 financial crisis, otherwise known as the Great Recession, swept away about $11 trillion worth of life savings and retirement funds in the United States. More than a decade later,many Americans are still trying to recover unsuccessfully.
When it comes to a national scale of struggling to recover economically, Japan is arguably the best modern-day example. The country is still striving to bounce back from the infamous Nikkei stock bubble burst—three decades after it happened. The nation’s GDP stagnated (and even saw periods of negative growth) for what felt like an eternity.
Despite underachieving for a long time, Japan has maintained its status as a global superpower, for it has remained one of the world’s largest and most important economies. Thanks toforecasts-defying GDP growth in recent quarters, the Land of the Rising Sun may have finally entered the dawn of a more promising economic era.
Nevertheless, the fact that it had to endure a decades-old depression is a frightening reminder that an overarching financial bubble can have a lasting destructive effect even to a widely influential developed nation.
Financial bubbles are bound to happen. More stringent regulation is perhaps the most effective tool to keep ourselves from investing without concrete rhyme or reason. In the end, policymakers have the utmost power to discourage speculative trading or at least make signs of a market crash more detectable sooner.