One of the earliest documented economic bubbles was the tulip bubble in Holland, which burst in autumn of 1635.
From 'The Tulip' section of Michael Pollen's "Botany of Desire":
As with society, so with capitalism in the throes of a speculative mania: all of its values are turned on their head - thrift, patience, value for money, reward for effort. For as long as the carnival of capitalism lasts, the rules of logic are reapealed, or rather recast along new lines, ones that will appear absurd in the cold light of the morning after but that make impeccable sense within the fevered space of the speculative bubble.
But if we know bubbles exist, and have occurred over and over again, why is it so hard to recognize or respond appropriately tothem?
Again, from Pollen:
The bubble logic driving tulipomania has since acquired a name: "the greater fool theory." Although by any conventional measure it is folly to pay thousands for a tulip bulb (or for that matter an Internet stock), as long as there is an even greater fool out there willing to pay even more, doing so is the most logical thing in the world. By 1636 the taverns were crowded with such peopele, and as long as Holland remained home to an expanding population of greater fools - people blinded by their desire for instant wealth - the truly foolish act would have been to abstain from the tulip trade.
Ok, so don't let's be the greatest fool? That would only work if we can recognize the bubble. Before our current housing bubble burst, I told my husband we were in a housing bubble. Did I recognize this because the one required semester of economics in college 30 years ago made me brilliant? Not so much. We had a mini-bubble here which burst around 1990. We bought a townhouse just as the market was turning down, and 'lost' maybe $75,000 of value as housing prices plummeted. But the loans were based on reality then - we could afford our loan and we just readjusted our property tax value and eventually we regained our value and then some. Since we didn't have to sell during the downturn, we didn't lose a thing. But the weird thing to me is that my hubby, who went through this whole experience with me DENIED THAT THE CURRENT HOUSING BUBBLE EXISTED, UNTIL IT BURST.
I had a co-worker who made the excellent observation that many, many of the new dot coms were not based on reality-based business plans. He was right. But lots and lots of people were willing to put up money on pretty silly ideas, and they were the greatest fools.
I had a similar experience working for a electronics manufacturing company. We used memory chips which were commondities - meaning that several companies made interchangeable products so there was lots of competition. Early on, we went through a sellers market. Demand was greater than supply so it was hard to get enough chips to make our product. We worked with our suppliers and one of them especially (let's call them Supplier A) came through for us and helped us meet demand. Later, the tides turnedd and we had a buyers market. More manufacturing had come on line and there were more chips than demand, so we could pick and choose among suppliers, choosing the ones with the lowest cost or best quality or most supple supply chains. And maybe we'd drop the supplier who hadn't wined and dined us with sufficient opulence (they were ugly times, no debate). I stumbled upon a discussion about dropping Supplier A and wondered why we would drop them when they had been helpful in the last downturn and might be helpful again in the future if we didn't behave injuriously to them during a buyers market. I was met with surprise - the buyers market would endure - what was I talking about? But at least some of these people had been through the cycle before! And they were bright people. (Aside, they did keep Supplier A on the list, and my comment was certainly not cited as a reason).
So the bigger question is: Why do otherwise reasonable people throw away reason and speculate in bubbles? A few of them are certainly 'greater fools' (no knowledge of history and just a desire to get rich quick) and a few of them are ruthlessly exploiting the greater fools, carefully watching the signs to get out in time. But I can't help thinking many participants CANNOT help themselves, even if they ought to know better. Why?
Last speculation: the same brain chemistry that leads to gambling problems leads to the bulk of the sheep in bubbles. Ok, have at it!