5.16 Financial Bubbles


The law of supply and demand is that the more there is demand for a product and the less there is of that product the higher the price will be.  Lets say a great new King Kong movie came out that all the kids are excited about.  Lets say someone invented a delicious new kind of bubble gum that they sell with King Kong cards like this one.. 

What if there aren't enough cards for all the kids who want them?  The stores that sell the bubble gum will be able to raise the price because the demand is so high and because people are willing to pay so much to get it.  If the price keeps going up people might realize that if they bought the bubble gum today they could sell it in a month for a lot more money and make a lot of money.  When they realize that, they will buy more, the demand for the bubble gum will go up even higher and so will the price.  More and more people will buy that bubble gum for higher and higher prices because they will believe that in the future they will be able to sell the gum for more than they paid for it. 

The day will come when the price of bubble gum starts to go down.  When that happens not only will people stop buying they'll start selling their bubble gum because they want to get as much of their money back as they can before the price of bubble gum goes even further down.  When every one sells the supply of bubble gum will go way up and the price will drop even further.  People who spent enormous amounts of money for bubble gum will lose most of that money.  If they borrowed money to buy the bubble gum they will be in debt. 

Bubbles like this one have happened many times in the United States.  One of the most recent bubbles was the housing bubble in which people borrowed money to buy houses because the price of houses kept going up.  The day came when the price of houses started to go down and a lot of people lost a lot of money and found themselves in debt for a lot of money that they couldn't pay back.

The video below explains more about bubbles.

Banks in which people put their money, often used to lose that money when financial bubbles popped.  People would run to the bank to get their money out and find that their money was already gone.  The Federal Reserve bank was created to stop this from happening.  The Federal Reserve bank can print money and it would loan that money to other banks so they would be able to give their customers their money back. 

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There is something very wrong with what Federal Reserve does.  It actually creates bubbles.  It also creates inflation.  The time may come when all the money it prints won't save people from bubbles anymore.  Why is that?

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