Concerns can still bubble up at times

Once thought of as consigned to history, over the past decade the financial bubble has once again popped up to dominate modern economics.

Once thought of as consigned to history, over the past decade the financial bubble has popped up again to dominate modern economics.

The term, which describes a period when asset prices spiral out of correlation with their intrinsic value, was originally coined during the famous "South Sea bubble" crisis of 1720.

This centred around the British joint stock firm the South Sea Company, which was founded in 1711 to trade with South America and to consolidate and reduce the cost of national debt.

Very little actual trade took place during the company's existence as Britain was at war with Spain at the time but, nonetheless, shares in the South Sea Company rocketed as the expectation of wealth from the lucrative South American trade was used to encourage the public to buy shares.

Driven by extravagant rumours, insider trading and bribing public officials, the company's share price rose tenfold in a single year from about £100, equivalent to about Dh950,000 in today's money, to £1,000 before collapsing back to little above its flotation price in 1720.

Other bubbles included the Dutch tulip mania of the 1630s when contract prices for recently introduced tulip bulbs rose 300 per cent as French speculators entered the market before prices suddenly collapsed.

And speculators in the 18th and 19th centuries were burned by a succession of bubbles covering railways, paper bank notes and the US stock market.

Yet from the 1940s until the mid-1990s financial bubbles in the West virtually disappeared and the study of them was left to economic historians searching through dusty papers.

Then, in the mid 1990s came the infamous dot.com bubble followed by bubbles around the world in housing and credit. All of a sudden, bubbles were back on the political agenda.

So why did bubbles disappear - and more importantly - why do they seem to be coming back?

"A bubble arises as price overweighs optimists' beliefs and investors anticipate the option to resell to those with even higher valuations," says the bubble specialist and Princeton professor Harrison Hong, one of a group of young economists hired by the former academic and now chairman of the US Federal Reserve Ben Bernanke to investigate the phenomenon.

Mr Hong and his colleagues argue bubbles emerged at points in time when investors disagreed about a new development. This could be the invention of the internet, the emergence of a new economies or the mis-pricing of new packages of debt. At the start, the surge in values is often justified but things quickly fly out of hand.

How can we tell if we're in a bubble? That, says Mr Hong, is something most people only find out too late. At some point, enthusiasm for investing in the bubble wanes. Prices start to fall and there is an expectation that sceptics will then start to invest back in the market driven by the lower asset prices. If they do not, then that is often seen as a signal that prices have risen too high.

So, is the Dubai housing market experiencing a new bubble this time? Most analysts do not seem to think so yet.

"This time it is different from 2005 to 2007," says Richard Paul, the director of residential valuations in Cluttons' Dubai office.

"Back then there was very little infrastructure. Dubai has come on leaps and bounds since then.

"Now Dubai is much more of a financial hub for the region and is attracting far more people to come and live here as well as tourists," he says.

"The city really has become more of a destination and we are selling far more to end users than we ever did before."