Robert Shiller, co-creator of the Case-Shiller index for US housing and author of Irrational Exuberance, has an interesting perspective on markets. Unlike the vast majority of economists, he recognizes both the role of speculative fervour in driving prices to over-reach themselves as a bubble develops and the fact that bubbles and their aftermath are swings of positive feedback inherently grounded in ponzi dynamics. As such, his position has considerable overlap with ours at The Automatic Earth:
Markets and the Lemming Factor (2008)
Some trends are persistent enough that they eventually attract a very wide pool of participants, as apparent gains amongst one's peers eventually overcome the caution even of many inherently skeptical people. When they last long enough to overcome the caution of bankers, the result is easy credit to fuel the fire, and a blatant disregard for systemic risk. This is how the largest speculative bandwagons are formed - the ones that become manias and eventually lead to ruin for a large percentage of the population.
Prices are continually pushed up, irrespective of any reasonable objective measure of value, by those who think that it does not matter how much they pay for something if there will always be a Greater Fool who will pay even more. The evidence of pyramid dynamics where insiders and early movers benefit at the expense of later generations destined to become empty-bag holders - should be abundantly clear. The pool of Greater Fools is not limitless.
In our view, major bubbles, of which there are many examples in history, represent a highly contagious collective taking leave of the senses. Over time, as they develop, the largest bubbles come to encompass and to drive much of the way in which a given society functions. The trend that takes hold, and which is destined to over-reach itself, becomes the defining the zeitgeist of an era, before reversing sharply with devastating effect.
The best known examples can be clearly seen in financial charts that allow the progression of the phenomenon to be quantified. This is possible when the infectious idea manifests as a parabolic increase, and subsequent implosion, in value of something that has become a focus of speculation.
However, speculative bubbles that manifest financially, and therefore lend themselves to quantification, represent only a subset of socioeconomic or sociopolitical swings that can spread exponentially within societies and come to define certain periods of their history. This broader category of transformative social movements that come to capture the collective imagination, and often later deliver the reigns of power into the hands of extremists, is also subject to over-reach and reversal.
The fundamental point is that Ponzi dynamics do not have to be quantifiable for their essential nature to drive cycles of expansion and retrenchment. Mr Shiller recognizes this point, and recently wrote a piece comparing what he calls "social epidemics" that occur within the context of market economies with those that do not.