Monday, August 16, 2010

Economic bubbles

I recently read this fascinating comment from Paul Graham:

By 1998, Yahoo was the beneficiary of a de facto pyramid scheme. Investors were excited about the Internet. One reason they were excited was Yahoo's revenue growth. So they invested in new Internet startups. The startups then used the money to buy ads on Yahoo to get traffic. Which caused yet more revenue growth for Yahoo, and further convinced investors the Internet was worth investing in.

[Paul Graham, "What Happened to Yahoo?" August 2010]

This is a key piece of the puzzle, it seems to me, for the precipitation of the "
dot-com bubble" that burst in 2000.

What is interesting is that, with the more recent housing/real estate bubble that burst, a not-dissimilar (though slightly more complex) cyclical pattern emerges, involving negative equity, credit-default swaps, and subprime mortgages.

Is there a cyclical pattern that precedes such "bubbles" and their subsequent bursting? If so, shouldn't we look for some economic theory that would allow us to identify the pattern before it reaches epidemic scale?

What do you think? (I'm talking to you, Scott Cunningham!)

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