The Psychology of Bubbles and Dramatic Price Increases

Let’s quickly discuss asset bubbles, rapid price increases for commodities and how people perceive the root causes. Namely: it seems to me that a lot of people’s perception of the root cause behind a price increase has more to do with how the increase affects them, as opposed to the actual fundamentals. Here are a couple of examples:

The housing boom was making people rich so they were more than willing to pretend that actual fundamentals were causing the rapid rise in prices, instead of accepting the role of speculators and weak lending standards.

The commodities boom is causing a lot of pain so people want a culprit to blame for the situation, after all who wants to live in a world of expensive oil and food? So we blame the oil companies, speculators, bio-fuels, etc, as opposed to confronting the supply and demand issues driving the increase in prices.

In both cases it appears that many investors, analysts, et al, looked to reasons that support a more appealing reality, as opposed to truly looking at and confronting the true root causes. Granted there is an element in logic in their viewpoints and they’re not completely wrong, it’s just that their ignoring other large factors that are probably more important in terms of determining future price levels. It’s an interesting study in how psychology not only creates bubbles, but extends them and perhaps even impedes the development of solutions to economic problems.

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