Making sense of bubbles in a frothy global economy

BUBBLE risks are back. There is no clear economic definition of what causes an asset price bubble. The term is controversial. In broad terms, a bubble has four characteristics.

A bubble requires an asset price to be above its fundamental value. This is difficult to define because investors will argue about what fundamental value is. Economists still argue passionately about the fundamental value in Dutch tulip bulb prices during the early 17th century (economists do not get out very much).

A bubble generally involves novelty. Dutch tulips, 18th century canals, 19th century railways, 20th century radios and turn of the century Internet stocks were all new. Cryptocurrencies today are new. Alternatively, it can be financial innovation that is the novelty. Cash-settled futures contracts on Dutch tulip bulbs were new. Novelty matters because it makes valuing future fundamentals difficult.