Bubbles in History & Tulipmania
Bubbles in History & Tulipmania
This month we will look at some of the most infamous investment bubbles in history. In Niall Ferguson’s The Ascent of Money: A Financial History of the World, a financial bubble can be identified through five stages –
- Displacement – some change in economic circumstances creates new and profitable opportunities for certain companies.
- Euphoria or overtrading – a feedback process sets in whereby rising expected profits lead to rapid growth in share prices.
- Mania or bubble – the prospect of easy capital gains attracts first time investors and swindlers eager to mulct them of their money.
- Distress – the insiders discern that expected profits cannot possibly justify the now exorbitant price of the shares and begin to take profits by selling.
- Revulsion or discredit – as share prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether.
There are other features, including the role of insiders, cross border flows of capital and most importantly – without easy credit a true bubble cannot occur. Given the role of Central Banks in recent years, this is particularly prevalent.
Tulipmania (1634-1637) is recognised as the first major financial bubble. Investors began to madly purchase tulips, pushing their prices to unprecedented highs; the average price of a single flower exceeded the annual income of a skilled worker. Tulips sold for over 4000 florins, the currency of the Netherlands at the time. As prices drastically collapsed over the course of a week, many tulip holders instantly went bankrupt. Tulipmania, reflects the general cycle of a bubble; investors lose track of rational expectations, psychological biases lead to a massive upswing in the price of an asset or sector, a positive-feedback cycle continues to inflate prices, investors realise that they are merely holding a tulip that they sold their houses for, prices collapse due to a massive sell off and many go bankrupt.