Bubbles, Booms and Crashes part 5. Their exponential growth and long-term effects

The growth of social epidemics like bubbles is exponential and nothing happens overnight. They can last from days to decades. Unlimited growth has a certain profile to which four parts can be attached: the slow onset of low exponents, the rapid rise of high exponents, the peaking of rising exponents, and the decline. The first profile is clearest when not restricted or regulated. The profile changes with restrictions and regulations. Exponential growth in stock or house prices are difficult to monitor because each has a different impact on epidemics. Therefore, it makes more sense to follow the exponential changes in other figures such as money supply.

Social epidemics rarely grow steadily. They do not follow a normal distribution and their growth cannot be predicted, although claims to the contrary are normal. The exponents vary at different time intervals. They can take a backseat even if the general direction is upwards. There may be variations in the exponents due to the time of measurement. For example, the weekly variations in the current Covid-19 pandemic are so great that it is not worth looking at daily exponents but at weekly readings.

One of the most important things to monitor is the change in exponential growth. In other words, the progression of epidemics can be monitored by observing exponential changes at regular intervals. A significant slowdown in growth is a sign that the epidemic is fading. This cannot be seen from the individual figures. Sometimes epidemics end in single exponential peaks. The following fictional exponents tell of acceleration first and then decline:

1.0, .1.1, 1.3, 1.6, 2.2, 3.2, 3.8, 4.2, 4.3, 4.0, 3.2, 2.4, 1.3, 1.1, 0.9, 0.7...

In the first phase of an epidemic, the exponent is often a little over one for a long time and does not change much before collapsing or moving on to the next phase. Most of the epidemics are not progressing further. The second phase distinguishes the most contagious epidemics from others. Initially, exponential growth accelerates. It is significant and ongoing. At the same time, the critical mass of the epidemic is reached, that is, it becomes unstoppable for a moment. The exponent is often the largest after that moment and may decrease momentarily before turning back up. The trend continues until there is a gradual decrease or a short steep peak with a potentially record exponent. The former is the most likely option when the epidemic is contained and the latter when it is not affected. The peak is followed by a decline, which in most cases is on average steeper than an increase in economic epidemics.

Long-term effects

Bubbles, booms and crashes have long-term effects. The true nature and duration of the resulting collapse is impossible to assess in advance. One significant factor is how banks operate during a bubble and/or a boom. The second is the source of the money. In addition, the actions of central banks and other regulators are significant factors. In the best case, the collapse will be cleared quickly and in the worst, the consequences will be visible for decades. The more bubbles in different asset classes, the longer the footprint. Declines can be short if not all investments instruments are expensive. Therefore, the dot-com boom of the 21st century did not leave large traces in the U.S. economy as bonds and real estate were affordable.

The devastation of the banking crises caused by the big bubbles and/or booms is awful. House prices will fall by an average of 35%, stock prices by an average of 55%, GDP by an average of 9% over the next two years and unemployment will rise by an average of 7% over the next four years. Without banking crises, the devastation will be smaller on a larger scale, although stock markets, for example, may fall more. The problems without the banking crises can be repaired in a few years. The flight of foreign capital exacerbates problems if it has played a significant role. Roughly speaking, the smaller the local market, the greater the devastation that may result from the outflow of foreign capital.

The aftermath of the Japanese boom tells the harsh language of the consequences. Individual investors may never overcome their losses. The Nikkei index has not reached its previous peak of more than 30 years ago. Property prices also peaked decades ago. Even long-term index investing is not worth it when the boom overheats. The aftermath of the Japanese boom is an example of the crash of simultaneous stock and real estate booms. Not all countries will recover even in several decades. The consequences can be complete changes in societal structures such as the transition from market economies to planned ones.