greater fool theory

DEFINITION: The expression “greater fool theory” is used to explain the market success of a good (often a corporate share or other form of investment) that ought not to be economically successful, given the underlying fundamentals.

In a nutshell, the greater fool theory hypothesizes the following:

Though it was foolish of X to buy a given good in the first place, the price is still going up because there are even greater fools than X present in the market who are prepared to buy it at an even higher price.

USAGE: The expression “greater fool theory” was made famous in 2022 by Bill Gates, when he appealed to it to explain what he considered to be the irrational market success of non-fungible tokens (NFTs).

To invoke the greater fool theory is, in effect, to predict that the good in question is undergoing a bubble, which must burst, sooner or later.

Unfortunately, it is not possible to distinguish between bubbles (bad investments) and price increases driven by ordinary market forces of supply and demand (good investments) before the fact.

Therefore, the greater fool theory is simply the expression of a commentator’s opinion until it becomes apparent that the price increase really did represent a bubble—which can only be determined in hindsight, after the bubble has burst.

In this ex post facto situation, the greater fool theory may have some limited utility in explaining how the bubble was possible. However, even in this situation the theory must be considered together with other theories, such as the “bandwagon effect.”

For further discussion, see the Glossary article on Ponzi schemes.