Reality Bubbles

October 12, 2009

We’ve been hearing the word “bubble” a lot in the past year, thanks to the global economic crisis.  The stock market has been prone to bubbles as long as it’s existed; the principle extends to other markets like real estate.  Bubbles happen when buyers overestimate the intrinsic value of whatever they’re buying.  Continuing the metaphor, the excess valuation is sometimes called froth.

Market bubbles are a classic (if not the classic) example of a disconnect between objective and subjective reality.  A commodity’s intrinsic value is its objective value.  Market prices are subjective – they represent the value people believe the commodity has.  The perceived value typically fluctuates around the intrinsic value, pulled either higher or lower by rumors, market buzz, and other belief trends that misrepresent objective facts.

Within a bubble, beliefs are king, and overrule the objective facts they (mis)represent. Suppose the intrinsic value of an ounce of silver is US$15 but a rumor drives the market price up to $30.  It seems trivial to observe that buyers of a fixed amount of silver will see their brokerage accounts drop by twice as much as if they had paid a price based on its intrinsic value, but this fact underscores the power that beliefs have to impose objectively real effects within an information community, even if the beliefs themselves are not objectively true.

But bubbles can, and often do, burst.  False beliefs about the value of a commodity, whether it’s silver, mortgage-backed securities, or something else, are eventually (though not inevitably) “outed,” resulting in a correction of the price to one closer to its intrinsic value.  Through this continuous and iterative process, objective reality keeps our beliefs from straying too far afield and reins them in when they do.

The term “reality bubble” has generalized beyond its original market-based meaning.  The principle really applies to any situation where a person or group of people succeed in sustaining (for a time) a belief inconsistent with objective facts.  The reality inside the bubble is what I call beta reality – beliefs are the “facts” of this reality, and their effects (the actions taken by people based upon them) are the equivalent of the effects of objective facts as enforced by the laws of physics in objective (alpha) reality, which is outside the bubble.

One popular example of a reality bubble is Apple’s Reality Distortion Field (RDF).  The term (borrowed from Star Trek) refers to Apple founder Steve Jobs’ rare ability to create, through charisma and persuasion, the belief that Apple product breakthroughs are more substantial than an objective comparison with competing products would support.  Apple has skillfully leveraged this perception into what numerous polls have proclaimed the world’s top brand.  Multiplied across a market, it’s a belief inflection that translates into billions of dollars of extra revenue.  That’s a hefty beta effect.  And this bubble is not likely to burst anytime soon.

Groupthink is another phenomenon that creates reality bubbles that can burst with disastrous results.  Small belief communities are vulnerable to social pressure to sacrifice cognitive diversity for the sake of group cohesiveness.  This impairment of the ability of the group to construct accurate representations of objective reality is widely acknowledged as largely to blame for the failed Bay of Pigs invasion, the explosion of the Challenger space shuttle, and the failure of General Motors executives to recognize shifts in car buyer preferences.

The Rule Not the Exception

Reality bubbles are talked about like they’re anomalies or exceptions.  On the contrary; the manifold nature of objective reality and the limitations of human cognition mean our mental representations of that world are rarely spot on.  They usually miss the mark in one direction or another, to one degree or another.  Their distance from their objective referents traces the outline of a reality bubble.  Our individual and shared beliefs anchor our beta realities until and unless the bubble bursts and the belief is corrected (see The Correction).

Reality bubbles are thus the rule, not the exception; they characterize the fuzzy accuracy of human information processing.  Each of the following is a snapshot of a reality bubble bursting.  In each case, a false belief and its effects reign for a period before being overruled by the objective world.

  • I learn from a local appraiser that the Ming vase that’s been collecting dust in my attic is a knock-off worth only $50, not $5,000 like the one I saw on Antiques Roadshow.  Too bad I already spend the money in anticipation of my windfall.
  • A group of music fans stoke each other’s anticipation as they drive to a concert, only to discover upon arriving that the headliner came down with strep throat and had to cancel the gig at the last minute.
  • Officials at the Dutch national museum learn that the moon rock that has thrilled many visitors over the decades it’s been on display is actually a piece of ordinary petrified wood.

We typically don’t know we’re in a reality bubble until it bursts.  That means that as long as we’re in one, our beliefs that are false in alpha (objective) reality are true in beta reality, and have all the (belief-based) effects of beliefs that are objectively true.

But some reality bubbles never burst.  You may never know if that autographed Babe Ruth baseball your dad left you was really signed by the Babe.

And you may not want to know.

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