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The greatest book that I have read so far is Economics in One Lesson by Henry Hazlitt (published 1946). It was written to expose the popular fallacies in economics and the lessons are as applicable today as they were over 60 years ago.

I received a direct message on Twitter asking if I could explain what causes bubbles. Taking cue from Hazlitt, I said that I could do that in less than a dozen Tweets. 

In this post I have reproduced the same (with a few edits to increase readability).

  1. Bubble Tip: There is no boom-bust theory in Micro Economics - ergo free markets are stable. The destabilization factor must come from... outside.
  2. Bubble Tip: Look for the fuel for speculation... check if real inflation adjusted interest rates are negative!
  3. Bubble Tip: The fuel for speculation comes when the Central Bank prints "mickey mouse" money out of thin air. [Hint: Printing = Quantitative Easing].
  4. Bubble Tip: "Mickey mouse" money has to go somewhere... and it fuels a speculative bubble where it does. First movers have an advantage.
  5. Bubble Tip: With the aid of leverages asset prices can be inflated beyond the wildest imagination. [Hint: Japan in the 80's].
  6. Bubble Tip: Monetary injections are like a steroid. It turbo-charges activity in interest rate sensitive sectors. [Hint: Nasdaq & Housing].
  7. Bubble Tip: Look if externally created incentives provide support for the bubble i.e. government policy. [Hint: Freddie & Fannie, The Community Reinvestment Act, Tax beaks on Capital Gains].
  8. Bubble Tip: Finally look for other tell tale signs - poor economic data, inflation, health of banks, inflation, mania, valuations...
  9. Bubble Tip: The music has to stop. It will when interest rates start to rise to pre-boom levels. Once it does the bubbles pop.
Believe I managed to explain the anatomy of bubbles in less than a dozen tweets. Credits go to Austrian School Economics – notably the work of Ludwig von Mises, Friedrich Hayek, and Murray Rothbard.



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