Bubbles and wealth

Weekly Updates

The bursting of the bubble late last year seemingly had minimal economic consequences. Labubu dolls losing their allure does not have profound macroeconomic consequences.
A bubble occurs when asset prices divorce from fundamental value and emotion drives price (meaning the asset ceases to be an asset). Bursting a bubble locks in a wealth transfer from bubble buyers to bubble sellers.
Bubbles generate a positive wealth effect for the bubble sellers—incentivizing them to spend their profits in the real economy. Bubble buyers’ losses when a bubble bursts are a negative wealth effect. Loss aversion means negative wealth effects can powerfully change economic behavior. The net impact of the positive and negative wealth effects depends on the spending patterns of the two groups. The world economy does not appear traumatized by any loss of wealth of Labubu buyers; that demographic’s overall spending is not hugely economically significant.
Wealth effects matter when economically significant groups are affected, or when the bubble has occurred in something widely held—one reason why a housing bubble has the potential to be so economically devastating. Wealth effects also matter when the financial system is implicated in losses, because that changes credit creation. However, banks do not appear to have been big buyers of Labubus.