Virginia Postrel writes about the mass psychosis that leads to asset price bubbles. She observes that there’s an experiment that’s commonly conducted over the past couple of decades wherein you get a bunch of volunteers together and you give them some money and “shares” to trade. In one version of the experiment, the shares are given a fixed dividend value of 24 cents. In other versions, there’s an equal chance of getting 0, 8, 28, or 60 cents, which averages out to 24 cents. But either way, since “the fundamentals” in this artificial equity market are known, and known by all, and known by all to be known, the value of the shares ought to swiftly converge to a stable, fundamentals-based value. And then there’s the real world:
Again and again, in experiment after experiment, the trading price runs up way above fundamental value. Then, as the 15th round nears, it crashes. The problem doesn’t seem to be that participants are bored and fooling around. The difference between a good trading performance and a bad one is about $80 for a three-hour session, enough to motivate cash-strapped students to do their best. Besides, Noussair emphasizes, “you don’t just get random noise. You get bubbles and crashes.” Ninety percent of the time.
All a reminder that we’re probably never going to develop policies that totally prevent asset bubbles. We need to focus on better ways to unwind the bubbles. And we also need to focus more on social justice issues and less on the farcical notion that unduly high taxes on the wealthy financiers who make up an incredibly large share of the rise if hyper-inequality will somehow impede the “efficiency” of the economy.