Bubble

In plain words

At the height of “tulip mania” in the Netherlands in 1637, the rarest tulip bulbs reportedly sold for the price of a house. People weren’t buying bulbs to plant: they bought them to sell to someone else at a higher price. When the new buyers ran out, prices collapsed. A price that runs far ahead of real value, kept up mainly by the hope of selling higher, is a bubble.

Bubbles usually start with something real: a new technology, a jump in demand, cheap borrowing. Rising prices attract new buyers, whose buying lifts prices further, and a story spreads that “this time is different”. In the end the buyers run out, prices fall, and the fall feeds on itself as everyone rushes to sell.

Famous bubbles include tulips (1630s), the South Sea Company (1720), US stocks in the late 1920s, Japanese stocks and land in the late 1980s, internet stocks around 2000 and US housing before 2007.

Example

One level deeper

There is no agreed way to spot a bubble while it is happening: a high price can also mean investors rightly expect fast growth. Economists look for several signs together: prices far above measures of value (like the P/E ratio or the CAPE ratio), lots of borrowing to buy, a flood of first-time buyers, and talk of a new era.

The economist Hyman Minsky and the historian Charles Kindleberger described the usual stages: a new opportunity, a boom, euphoria, then distress and panic. People join through herd behavior: watching others get rich is hard to resist.

Bubbles do the most damage when they are built on debt. The US housing bubble of the 2000s led to the 2008 financial crisis and a deep recession. The internet bubble, bought with less borrowed money, hurt investors badly but did less damage to the wider economy.

How expensive US stocks were: Shiller’s CAPE since 1881

CAPE divides the S&P 500’s price by ten years of profits, both adjusted for inflation. Its two great peaks of the 20th century came just before the crashes of 1929 and 2000. The latest reading is 40.7 (Oct 2026), far above its long-run average. A high CAPE says nothing about when, or whether, prices will fall: it can stay high for years.

Why it matters

When bubbles burst they can wipe out savings, sink banks and cause recessions, especially when the buying was done with borrowed money.

They misdirect money and talent: in a bubble too much goes into the hot thing, and the bust leaves empty buildings or idle equipment behind, though some of it, like the internet’s fiber cables, later proved useful.

Knowing how bubbles look helps you recognize the stories that drive them, such as “prices only go up”.

A common mistake