The "cute" factor in investment bubbles -- predicting others preferences can lead to bubbles

[Elmore Furth]

The stock market is something like a beauty contest. People invest in stocks they think others consider valuable. If they predict the future desirability incorrectly, you have a bubble.

Welcome to behavioral economics where irrationality and mania in the short term reign supreme.

On the surface, Planet Money's first-ever economics experiment was all about cute animals. (You can see the experiment here.) But we were really trying to get a better sense of how the stock market works.

In the market, Keynes argued, it doesn't make sense to invest in the company you think is best. It makes sense to invest in the company that you think other people will think is best. Because if everyone else invests in a company, the price of its stock will rise.

Of course, when everyone does this, it leads to a slippery investment world. "We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be," Keynes wrote.

It might look something like the housing bubble. People kept buying houses — not necessarily because they thought home prices made sense, but because they thought everyone else would keep buying houses at any price.


Ranking Cute Animals: A Stock Market Experiment

[Taitertots]

1. When the ignorant enter the market, it becomes more American Idol than Economic fundamentals

First the Tech stocks, then housing, now gold. Herd investors are destroying the economy.

[Art_from_Ark]

2. Gold investors are not destroying the economy

There is not a huge segment of the US population pouring their savings into gold. And the gold market extends well beyond the United States-- it is a world market that trades 24 hours a day. The main buyers aren't the Glenn Beck viewers, survivalists, or bandwagon players-- they're countries like India and China, and big institutions. Gold in its physical form represents a tangible asset that has been considered a monetary medium for millennia. It is viewed as a hedge against fiat money that is literally created out of thin air, fiat money which has been debased to the point where, for example, one US dollar today only has the buying power that 18 cents did 40 years ago.

If you want to know what is destroying the economy, take a look at the outsourcing of decent-paying jobs, the huge tax breaks given to people who already have far more money than they'll ever need, the increasing financial burdens on the non-wealthy, the war machine that is squandering untold billions, the wage scale that has not kept up with inflation, or at rising health care, tuition and utility costs, to name a few.