Why we need inertial dampeners

[andrewducker]

Assume you own a tulip bulb. There seems to be a bit of a craze for them - owning your own tulip bulb collection has become a trend, after David Beckham revealed that he loved them.

You don't actually want this tulip bulb - it was a present from a friend - but you do want to get a decent price for it. You could sell your tulip bulb for a fiver - that's the going price at the moment. Except...

They used to cost a pound or so, and only gardeners wanted them, but since this took off you've noticed that prices are slowly going up - there aren't enough tulip bulbs around for everyone to have one, so people are offering more for them. In fact, it looks like prices will be £10 a bulb in a few weeks, if things carry on like this. So you won't sell now - you'll only sell when the price hits £10.

Of course, you're not alone in feeling this - lots of other people have spotted that prices are going up, so they also aren't selling for £5. And the few bulbs that _are_ going for £5 are being snapped up by people who think that they can make a quick profit by buying up £5 bulbs and selling them on in two weeks time.

Heck, some people are taking out loans so that they can buy up bulbs en masse and make a fortune on them. And as prices are definitely going to hit £10 they're willing to pay £7.50, £8 or even £9 to buy a bulb. If you're buying a load of them then it's _so_ worth it.

Of course, with the prices rising _that_ fast they're going to hit £20 in a couple of more weeks - so there's no point selling at £10 any more - there are better profits to be made, if you just hang on a little longer. Heck, if prices keep this up for a few years then you'll be able to retired, based on just this tulip! Everyone knows that tulip prices are a good investment, and so they are.

Except that after a while, the people who are buying up bulbs are _just_ the speculators. The gardeners can't afford them any more. And some of the larger speculators have stretched themselves an awful lot - they've bought _thousands_ of bulbs, taken out expensive loans that they have to pay back soon, and the prices aren't being pushed up as much as they were. If the prices don't keep going up then they're stuffed. And the prices aren't going up as fast as some of the more excitable people thought they were.

And then the first speculator fails - they need some cash in a hurry, so they sell their tulips for as much as they can get - just about scraping a profit, and get out of the market. The people buying the tulips from them weren't paying as much attention to the market as they should have been, and they just bought a bunch of tulips for more than you can get for them, any more. Other speculators, sensing an imminent collapse, try to dump all of their stock at once.

The market plunges into freefall, prices plunge, and the marketplace is flooded with bulbs. Suddenly, because everyone knows that tulips are a terrible investment, they are. Eventually, things calm down. Everyone who doesn't actually need tulips has sold up, and moved onto the next big thing (I hear that rare comics are worth investing in). You're left with your tulip. If you pop down the gardeners market you can get a pound for it, if you're lucky.

===


I saw this happen with comics in the early nineties (see Neil Gaiman's essay Gods and Tulips, which is at least partially inspirational for this) . I saw it happen in the DotCom bubble (which I was predicting the end of about 18 months before it plunged). It happened in the housing market recently, and it's happening right now with oil (still on the way up - massive profits to be made if you're the last person to sell up before the market crashes).

When prices are going up, the investors pile in and push the prices up further. When the prices are going down, the investors pile out and push the prices down further. Eventually the prices end up back where they started. But all it needs is for there to be some kind of internal event that makes the prices vary by more than the rate of inflation, the subject becomes an investment target, and boom, you're onto the boom/bust rollercoaster.

If you know what you're doing, you can ride this rollercoaster, and make money both ways - buy cheap on the way up, sell expensive on the way down. Chance are, if you're reading this journal you _don't_ know what you're doing. In which case the best you can do is watch the overall pattern repeating itself every few years with a new commodity and look forward to laughing at the idiots when it collapses around them.

Comments

[andrewducker]

Oh, what actually caused this post was an email from octopoid_horror (who also works in a lage financial organisation) saying:
The weird thing about share prices is that when they're going up, you can't convince the public that they'll go down. And when they're going down, you can't convince the public that they're going to go up.

[chuma.livejournal.com]

There's one problem with this analogy... people NEED oil at the moment. Until there is an alternative fuel or power source for the nation's cars that works over long distances with decent performance, people will STILL buy it. I personally see oil prices starting to decline again soon, but I doubt very much if they will dip much below $100 a barrel (partly down to the very weak dollar).

[andrewducker]

And people don't need houses?

There's a "natural" price for things, based on supply, demand, etc. And then there's what happens when investors get involved, because they see something going up in price by more than the rate of inflation and jump aboard.

Oil went up for perfectly natural reasons (supply worries due to North African fun and games, increased demand from China), and then because of that investors got involved. And you're right - once the investors get out, it'll drop again, back to the "natural" price. Which is probably a bit over $100, but not as high as it is now.

[chuma.livejournal.com]

People don't need to BUY houses. Renting is standard in Germany and other european countries.

I agree there is a natural price for something, and I agree that oil is inflated at the moment, but I see this being a gradual decline rather than a sudden fall.

[octopoid-horror.livejournal.com]

Andy loves mortgages.

[andrewducker]

Andy has never seen an alternative to them, if you want to own your own home.

[themongkey.livejournal.com]

You can't rent petrol to fill up your car, though.

[red-phil.livejournal.com]

Another problem is that your tulip bulb may rot before you sell it.
True of Oil too, especially in its more refined forms.

I can't stockpile petrol when the prices are low to save me money when the prices are high as current formulation unleaded fuel breaks down within a surprisingly short period of time.
3 - 4 weeks sees it loose a lot of the more volatile elements.
Only really noticable if you have an engine that has been sitting unused for a while.
Restarting Tina's bike that has been off road for 6 months required a complete fuel flush.

[octopoid-horror.livejournal.com]

I'm generally of the opinion that some of the companies paying double what they used to in order to buy oil are wishing they were the ones spending money on finding alternatives, rather than the companies making money from expensive oil being the ones using their profits to a] get oil that's more expensive to get and b] oh yeah, best think of an alternative.

Someone making money from oil being scarce is not necessarily best placed to invest in an alternative until oil gets -very- scarce and even then, not until the last minute.

[drdoug.livejournal.com]

True, and in a more normal situation you'd simply expect someone who *was* better placed to develop alternatives to do so by borrowing money from other less compromised investors who see the opportunity for a small upstart company to grow vast by undercutting the dinosaurs. Alas, one of the many 'interesting' facets of our current situation is that the availability of such credit is ... er ... somewhat restricted compared to a normal situation.

[zz]

i hope there is a housing Crash, cos then i have a remote chance of being able to buy something before i'm 50.

[sbisson.livejournal.com]

There was an interesting session at this year's FiRe on just this - and how treating economics as a *physical* science is the root of many of our current problems. People do not behave like particles, and they are not rational actors.

Which means, of course, that pretty much all of our current financial models are seriously broken.

[andrewducker]

Well, they are rational, in some senses. They just want different things. Some of them want a home to live in, some of them want a profit. It's when you have two groups with different motives both buying the same commodity that things go horribly wrong.

I'm constantly amazed at the awfulness of overly-simplistic economic models. Not that it's an area I know much about, but every time I read that someone has been given an award for the "discovery" that people sometimes act imperfectly I want to bash my head against my desk.

[guyinahat.livejournal.com]

Coincidentally, I was reading a little-seen artical (http://news.bbc.co.uk/1/hi/business/7456141.stm) today about Honda launching it's first commercially produced hydrogen car. It's only a tiny production at the moment, but as the technology gets better, it may well be the direction we go in.

Which would do a lot to kill the price of oil over the next ten to twenty years.

Of course one of the problems with hydrogen cell cars is the expensive components, particularly platinum.

Hmmmm. Platinum. That gives me an investment idea...

[andrewducker]

Sadly, the problem is how to produce the hydrogen, which take a lot of electricity, most of which is produced by burning things.

So, yes, possibly better for oil prices, but no better for the environment.

[heyokish.livejournal.com]

a good example of is this what happened to us with our old flat. As you know, we were kicked out because the investment company that owned our place decided to sell off about 60 of their properties to cash in on the insane market here...so, we moved out, and the flat went up for sale for offers above £375k. Nothing happened. Then it went to fixed price at, I think, £395k, and didn't sell. Now it's back on the rental market, for £1100 a month (up from £700pcm). There's a rash of for sale signs round here that are switching over to for let signs, as they can't sell at the high end...and they lost 6 months rent on just the one to go through this. Multiply by lots, as very few have sold, as they are just too expensive, and everyone is waiting for the prices to plummet.