World history of economic «bubbles»

Economic “bubbles” in the markets have always existed. Some of them emerged long before the well-known “tulip mania”. Another interesting point is that almost always “bubbles” were inflated by the actions of central banks. Well, who likes to create on the Internet pictures with quotes of great people, you can take the expression of an ordinary speculator of the times of “bubbles”: “Two years ago I didn’t have a dime. Now I’m two million dollars in debt.”
1619-1623.

The crisis of these times was caused by the widespread deterioration of gold and silver coins of the Holy Roman Empire, which was arranged by the European monarchies to finance the Thirty Years’ War. New mints were created, where they tried to reduce the importance of secondary coins: they began to mint them not only from silver, but also added copper to the alloy, which was much more profitable. As a result, the nominal value of coins became much higher than the price of the metal from which they were made. This led to their instant devaluation. But even here were their own opportunities to profit: governments “leaked” cheap and damaged coins abroad and exchanged them there for full-fledged. The townspeople also became fond of playing with bad and good coins, and hyperinflation began.

1637

«Tulip mania»
The history of this craze, as well as the various legends surrounding it are well known to everyone. Tulips came to Europe from Turkey. These flowers perfectly tolerated the not too mild Dutch climate and began to rapidly gain popularity. They began to be traded on the stock exchanges of the largest cities.

Sales and resales were made many times, while the bulbs were never even taken out of the ground. Contracts for the sale of future bulbs were written all year round, and then the contracts themselves became the subject of speculation. This can be considered the beginning of derivatives trading (futures and options). Meanwhile, prices continued to rise. The most expensive flowers were sold for 15-20 times the annual salary of an experienced artisan. In 1625, one bulb of a rare variety of tulip could already cost 2000 florins. Ten years later the price reached 5500 florins. By the beginning of 1637, the price of tulips had risen an average of 25 times. One bulb was given as a bride’s dowry, three could buy a good house, and just one bulb of the Tulip Brasserie variety was given for a thriving brewery. But one day – as happens with “bubbles” – there was a crash, and prices fell by tens or even hundreds of times.

Tulip price index graph 1636-1637.

1720

The South Seas Company British Joint Stock Company has launched a campaign to reduce England’s national debt incurred after the war with Spain. Government obligations of holders of about £9 million were exchanged for shares in the South Seas Company, which has since become a creditor of the state. The shareholders were promised the exclusive right to trade with South America. In reality this was impossible as Spain controlled the entire continent at the time. The prices of the firm’s papers jumped from 100 to 1000 pounds, and then collapsed again, causing a series of bankruptcies. It is even written that it “burned” Sir Isaac Newton, who, having lost 20,000 pounds, said that he could calculate the movement of celestial bodies, but not the degree of madness of the crowd.

South Seas Company’s bubble graph

1720

The Mississippi company’s pyramid scheme
In 1717, the Mississippi Company, headed by the famous financier John Law, arose in France. He issued 200 thousand shares of 500 livres each. Shareholders were promised untold riches of Mississippi, where the natives are ready to literally give the arriving Frenchmen jewelry. Already in the spring of 1719, the shares were in great demand, grew in value. The more they were sold, the more popular they became, bringing huge dividends to the company. In the fall, papers with a face value of 500 livres were worth 10 times more. In January 1720, John Law for the “recovery” of the state treasury became the Comptroller General of France, but not six months later, as the company went bankrupt – could not artificially keep a high rate of shares.

1846

Railway mania
In 1836 a real railway mania swept England. The abundance of capital and the huge dividends of the already operating roads caused a general desire to build them. In 1836 alone, no less than 29 new lines, 994 miles long, were approved by Parliament. In 1845 Railway mania began with renewed vigor. At the same time as railroad mania, speculation in railroad stocks also flared. At one point, the stock of railroad companies became worth more than the companies themselves were actually worth. However, after 1847 came the years of crisis, the income of the companies began to decline (instead of 15% – 3% and even less), the price of shares began to fall, mass bankruptcies of railroad companies began.

1886-92

Bubble in Brazil
An economic bubble in Brazil caused by new banking laws that were intended to stimulate industrialization. But it ended up with uncontrolled speculation around IPOs and other transactions.

1920x.

Florida madness
Florida used to be an agricultural state with no developed infrastructure. However, at the end of the 19th century, American entrepreneurs began to actively build hotels, houses and develop infrastructure here. The state became a resort for the rich and successfully competed with the French Riviera. The construction boom began in 1923 in Miami, in 1924 spilled over to Tampa, and in 1925 reached Jacksonville. The peak of speculation came in 1924-1925, and its epicenter was Miami Beach – a resort for the middle class. Only in January 1926, the volume of real estate transactions here amounted to $ 2 billion. At the same time, most projects were sold at the stage of the plan, often the plots were not even shown to buyers, and sometimes even their location was indicated approximately. Then real estate firms began to trade lots, and you could buy them on credit. The buyer received a receipt for an advance payment, which gave the right to buy the lot, but was not an obligation to buy it. As a result, there were even speculators with advance receipts to buy a lot. Cases when the lot changed owners a dozen times before the deal was closed were not isolated. Those who could not come, offered to buy the property in absentia, just sending a check. The price peak of the Florida boom is considered to be May 1925, and the record transaction – the sale of plots at prices from $6.5 million to $30.6 million per acre. But one day everything changed dramatically: the rich again went on vacation to Europe, sales stood up. Those who bought plots worth $20 thousand and expected to resell them for $ 30 thousand, suddenly realized that they are offered $ 18 thousand, or even $ 15 thousand. By September 1926, prices in Miami fell by about a third of the peak level. And then a devastating hurricane hit the coast, and in 1929 the stock market crashed.

1969-70x.

Poseidon’s bubble
A stock market bubble in Australian mining stocks. It was triggered by speculation around Poseidon securities, which made a big nickel discovery at a time when the metal was in short supply.

1980-90x.

Japanese asset price bubble
That time was characterized by a lack of financial regulation, a wealth of liquidity and loose monetary policy. All this led to euphoria about future growth prospects and massive speculation in the equity and real estate markets.

The Nikkei index rose from 7500 to 38,900 points between 1983 and 1989, i.e. 500% growth in 7 years. This was followed by a collapse to 7,500 despite stimulus measures.

2000

The dot-com bubble
Between 1996 and 2000, the Nasdaq index jumped from 1,000 to 5,132 points. It was a speculative bubble in the stocks of companies whose business processes were related to functioning on the Internet. Many financial gurus had already prophesied the era of the “new economy,” but the new business concepts proved unsustainable. Hundreds of firms were forced to recognize their financial insolvency.

Chart of the dot-com bubble on the NASDAQ index

2006

The Yathukam amulet craze
Speculation about amulets, which are Buddhist jewelry worn around the neck, has been going on in Thailand – people believed that these things bring wealth.

2007

Uranium bubble
Uranium prices have skyrocketed. This was probably triggered by the flooding of the Cigar Lake deposit in Saskatchewan, a province of Canada. It was the largest unexplored source of uranium, but it had not yet been brought into production.

2000x

Real estate market bubbles
2005 — India
2006 — United Kingdom, Ireland, Spain
2007 — USA, China
2008 — Romania
2009 — Australia

How do «bubbles» arise in financial markets?

After 2008, the term «bubble» became topical, and the current tense situation in the world economy makes us think about such phenomena.

The term «bubble» in the financial world refers to a situation where the price of assets exceeds their fundamental value by a large amount. During bubbles, the prices of financial assets or certain asset classes are inflated, but this is not really justified by anything.

Characteristics of the bubble

The main feature of a «bubble» is market participants’ disbelief that assets are overbought. In fact, it is worth recognizing that it is usually hard for market participants to detect the presence of a «bubble», and everyone recognizes them after they burst. Economist Hyman Minsky identifies five stages in a typical credit cycle – the shift, the rise, the euphoria, the profit-taking and the panic. Although cycles can vary, the main points of bubble activity are fairly consistent.

The «shift» phase occurs when investors get excited about some new paradigm: for example, new technologies or changes in interest rates that are at historically low levels. A classic example: rates in the U.S. fell from 6.5% to 1% from 2000 to 2003. In that three-year period, interest rates on 30-year mortgage-backed securities fell 2.5% percentage points to a low of 5.21%. This sowed the seeds of a future bubble in the real estate market.

At first prices rise rather slowly, but then the push becomes stronger as more participants enter the market and the «upside» phase begins. At this time, the attractiveness of the assets is fueled by press coverage – the fear of missed opportunities spurs more buying and speculation.

At this stage, all thoughts of danger are dismissed as asset prices fly upward. Valuations reach extreme values. For example, at the peak of the real estate bubble in Japan in 1989, land in Tokyo sold for 139,000 per square foot – that’s 350 times the price of land in Manhattan. After the bubble deflated, real estate values collapsed by 80% and stock prices plummeted by 70%. It was exactly the same situation with the Internet bubble in March 2000, when the total value of technology stocks on the Nasdaq exchange was higher than the GDP of many countries.

At this time, those in possession of “smart money”, are heeding the warning signs and selling assets at a profit. However, estimating the exact time when a “bubble” may burst is a very difficult and dangerous endeavor. That is why John Maynard Case says that “markets can stay irrational longer than you can stay solvent”. The important thing is that when a bubble bursts, it happens very quickly, and it does not inflate back up “smart money” heed the warning signs and sell assets at a profit. However, estimating the exact time when a bubble may burst is a very difficult and dangerous endeavor. This is why John Maynard Case says that “markets can stay irrational longer than you can stay solvent.” The important thing is that when a bubble bursts, it does so very quickly, and it does not inflate back up again.

In the panic stage, asset prices roll down as fast as they rose. Investors and speculators face margin calls and a sharp decline in the value of their assets, so they dump them at any price. A good example is the global financial market panic in October 2008 when investment bank Lehman Brothers declared bankruptcy and insurance companies Fannie Mae, Freddie Mac and AIG collapsed. The S&P 500 index fell by 17% in one month, and global equity markets lost $9.3 trillion, or 22% of their total capitalization.