Structure of Speculative Bubble (For SD Fall Conference in Chung-Buk National University)

1. Structure of Speculative Bubble (For SD Fall Conference in Chung-Buk National University) October 31, 2008 KEPCO Management Research Institute Namsung Ahn

2. The Feedback Structure of Market : Adam Smith’s Invisible Hand Each individual endeavors to employ his capital so that its produce may be of great value. He generally neither intends to promote the public interest, nor knows how much he is promoting it. He intended his own security, only his own gain. And this is led by invisible hand to promote which of no part of his intension. By pursuing of his own interest, he promotes that of society more efficiently than when he really intended to promote it. (The Wealth of Nations, Adam Smith)

3. The Speculative Bubbles When there is a general impression that the price of some commodity is likely to rise, from an extra demand, a short crop, obstruction to importation, or any other cause, there is disposition among dealers to increase their stocks, in order to profit by the expected rise. This disposition tends in itself to produce the effect in which it looks forward to, a rise of price: and if the rise is considerable and progressive, other speculators are attracted, who, so long as the price has not begun to fall, are willing to believe that it will continue rising. These, by the further purchase, produce a further advance: and thus a rise of price for which they were originally some rational grounds, is often heightened by speculative purchase, until it exceeds what the original ground will justify. After a time, this begins to be perceived; the price cease to rise, and the holders rush into the market to avoid a still greater loss, and, few be willing to buy in a falling market, the price fall much more suddenly than it rise. (Principles of Political Economy, John Stuart Mill)

4. Examples • Oil Price • Real Estate Price • Financial Crisis

5. Oil Prices Slip Below $70 a Barrel Oil prices dropped below $70 a barrel for the first time in 14 months Thursday, prompting the OPEC cartel to call for an emergency meeting next week to establish some stability in prices Oil prices have tumbled by nearly $40 a barrel in just three weeks as indications grow that demand for energy will slow along with weakening economies around the world. As recently as July, oil was trading at a record of $145 a barrel.

6. Speculative Bubble on oil From its inception, the oil industry has gone through countless cycles, with oil companies cutting investments when prices fell. The price collapse of the 1980s forced companies to slash investments and prompted a wave of large mergers through the industry. But this retrenchment left the world scrambling for oil when demand from Asian and Latin American economies soared. (NY Times, 2008.10.17)

7. Oil Price

8. Speculative Bubble on Housing Price But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions - hence "zoned" - makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles. (NY Times, PAUL KRUGMAN, Nobel Prize, 2008) Mortgage lending excesses in the early years of this decade ultimately took a toll on the financial sector, bringing down lenders like Countrywide Financial and Wall Street icons like Bear Stearns. As confidence ebbed, credit tightened, and central banks took steps to limit the damage to the economy and the financial system.

9. 대세는 하락기…‘반등 미련 접어라’- ‘폭락론’ 갑론을박 - 거품 붕괴 시작됐다

10. Real Estate Price

11. Capital Availability Speculative Market

13. The Power of Vicious Cycle in Financial Crisis (Fortune, October, 2008) Confidence, Deleveraging, and Housing Mortgage lending excesses in the early years of this decade ultimately took a toll on the financial sector, bringing down lenders like Countrywide Financial and Wall Street icons like Bear Stearns. As confidence ebbed, credit tightened, and central banks took steps to limit the damage to the economy and the financial system.

14. Conclusions • Not all market consist of negative feedbacks alone. In many markets, the locally rational behavior of individual entrepreneurs creates positive feedbacks as they interact with one another and with the physical structure of system • In addition to the invisible hand, structure of speculative bubble, as a part of side effect, always exist in the market, specifically in the hot market such as oil, real estate, paintings, and internet stocks • Any action taken to cure the speculative bubble should be careful because of its vicious cycle