Financial bubbles have always exercised a fascination over academics and ﬁnancial journalists. Business economists can make their reputation by spotting them in time. But in truth relatively little is known about what generates bubbles, what causes the eventual bust, what damage bubbles can do, and how they can be prevented. Most importantly, are we in one now? In this book, John Calverley explores this subject in considerable depth, using an analytic approach but writing in a style accessible to the interested layman. Calverley is the Chief Economist of American Express bank, so he knows what he is talking about. He belongs to the school that believes bubbles are recognisable, dangerous and preventable. Moreover, he thinks the housing market in Britain and some other countries now displays the characteristics of a bubble. He has a number of policy recommendations, many of which will prove controversial. Not everyone will agree with all aspects of his diagnosis or prescription. But it is hard to dispute that this book addresses an important and so far poorly understood topic.

WHY BUBBLES MATTER:

When any bubble goes bust, some people lose. Experienced speculators can be caught out, though they sometimes recognize the end of a bubble and cut their positions in time. Most importantly, they usually know how to limit their risk to a bearable level. The investors who really suffer are those who are drawn in, often at the late stages of a bubble, with very little experience of how to manage risks. For a bubble to continue to inﬂate it needs more and more people to invest, risking more and more money. The end of the bubble occurs either because there is nobody left to be drawn in, or because some event makes people start to sell.

If bubbles affected only a few investors, with little impact on the overall economy, they would be of limited importance. Some bubbles are indeed like that. The bubble in classic car prices in the late 1980s, for example, had only minor repercussions. A few people made a lot of money on the way up and some lost when prices crashed at the end of the decade, but the numbers involved were small. Obviously classic cars cannot be newly manufactured so, although there were some new dealers who set up during the bubble and then closed after the bust, the wasted resources involved were small. The bubble in impressionist paintings at the same time had a similarly limited effect, as did bubbles in silver and gold prices in the 1970s.

However, bubbles can cause major problems when they occur in an asset that is widely held. Then, not only do a large number of people suffer directly when the bubble bursts, as the bubble inﬂates it also interacts with the economy, creating a self-reinforcing boom and bust. The dangerous bubbles, therefore, are usually the ones in stocks and property.