Saturday, January 2, 2010

Why We’ll Always Have More Money Than Sense - By Robert Shiller

When it comes to market bubbles and how they are created, very little, if anything, has changed. This is because human psychology has not changed. Massive bubbles are created when large numbers of people buy into "new era" stories that exaggerate how much the world has improved. For example, in the past few years the global equities and housing bubbles were driven by a giddy faith that world markets were on a tear and prices would go up indefinitely. Our animal spirits are sparked by these tales; we find them irresistible. And since as animals we're also given to a herd mentality, in a bubble we tend to invest too much in the most popular stories—and continue to do so even after the bubble bursts.

Bubbles are also encouraged by the Internet and by high-speed data transmission. People pick up ideas in newspapers, via TV, or online, then spread them via word of mouth. Anyone who's ever played the children's game of telephone knows that, once started, a story or idea takes on a life of its own. It's probably no accident that the tulip mania of the early 1600s occurred around the time the first newspapers and pamphlets began circulating, and that the crash of 1921 coincided with the first mass radio broadcasts. The Internet helped fuel the tech bubble and the financial crisis. I have no doubt that new social media like Twitter or Facebook will contribute to the next craze, or that the Internet will have other, unexpected effects on markets as well.