Asset bubbles are as old as the market. They can have different origins and historical specifics, but the core dynamic is relatively simple: People buy something because its price is going up and they believe it will rise more. This pushes the price up further, and convinces more people to buy for the same reason -- until reality intrudes, and the bubble collapses.
The United States experienced two of the biggest asset bubbles in world history during the past two decades: the stock market bubble, which burst in 2000-2002, and the real estate bubble, which burst in 2006. They both had serious consequences: they both caused recessions when they burst, with the housing bubble causing the Great Recession, our worst recession since the Great Depression.
These bubbles were also particularly painful for the people who bought these assets at or near their peak, with millions losing their homes when the housing bubble burst.
Now let's look at a contemporary asset bubble: in Venezuela, there is a bubble in the black market for dollars, which according to available information has now reached as much as 59 Bolívares Fuertes (Bfs) per dollar, up from 18 in January. The official exchange rate is 6.3 (Bfs), and there is another exchange rate determined at government auctions which is reportedly around 12 (Bfs).
Why has the black market rate price of the dollar recently risen so fast? The main reason is that people expect it to continue rising, just as Americans expected house prices to keep going up in the U.S. in 2006. But there is no credible reason for this to happen. It is true that inflation has risen over the past year, but the increase has not been accelerating or even consistent. It peaked in May at 6.1 percent for the month, then fell to 3 percent by August; it has since rebounded to 4.4 percent for September and 5.1 percent for October, but clearly this is not a hyperinflation scenario.
The government says it has no plans to devalue, but even if it were to let the currency float completely freely against the dollar, it would never settle at anything approaching the black market rate. So a Venezuelan who is buying dollars on the black market now because they think it is a store of value, or a hedge against inflation, is buying into a bubble. It is like buying into the NASDAQ in the U.S. when it was at 5050 in March 2000. (It later fell to 1140 in October 2002 and is currently at 3860 more than 10 years later.)
Of course, all bubbles produce popular rationales for buying. Remember the "new economy" in the U.S. that was used to justify prices that had no relation to reality in the stock market? In Venezuela, many people think they are making a one-way bet that they cannot lose when they buy dollars. They will be surprised when the bubble bursts.
This article was published in Folha de São Paulo, Brazil's largest circulation newspaper, on November 13, 2013.