Economic Bubbles and History

Economic Bubble

 

Predictions are hard to make, especially about the future be it economic, social, or political phenomena. The economist Ravi Batra, for example, wrote popular books in 1989 and 1999 incorrectly predicting global depressions in 1990 and 2000 respectively, and in 1992 the economist Lester Thurow of MIT predicted that China ‘will not have a big impact on the world economy in the first half of the 21st century’.

And here we are in 2020 with China rising as a new global power.

History is filled with evidence of such cases over and again, where economist predictions have gone wrong. And similar is the case with economic bubbles. Many times economists failed to predict economic bubbles. Since the very early days of corporations and market capitalism, speculative bubbles have been around us. But long before the word ‘bubble’ came into existence in the financial world, there are instances when economies strained due to bubbles bursting up.

Here are some of the significant bubbles in the history of humankind:

 

The Tulip Mania

 

Tulip Field

 

The first-ever recorded transaction of an economic bubble is dated back to the year 1636-37 in the Netherlands. Tulips were first introduced in Western Europe around the 1550s and began to grow in popularity in the late 16th century. The Dutch learned that the Tulips can survive in harsher conditions of low-lying regions in the country. It takes seven to 12 years for a bulb to grow from seed before flowering, but a bulb itself could flower the very next year. Tulips bloom in April and May for about a week and lie in the dormant phase for the rest of the time.

Thus, a financial market was created where tulip traders can sign a contract to buy tulips at the end of the season. The saturated intense petal color and long blooming period contributed to its popularity. The spread of a Tulip breaking virus furthers the price rise and the price increases higher and higher in the year 1636. In February 1637, the highly inflated prices of the tulip were no longer supported and the Dutch contractors were unable to find new buyers for their bulbs. As this information spreads, the demand for the Tulips plummeted and prices crashed.

Tulip Price Index

Tulip Price Index

 

 The South Sea Economic Bubble

 

In the early 18th century, the British government was heavily debt-laden due to the pressure from the Spanish succession war and the Great Northern War. The government had borrowed heavily from the Bank of England – a private entity to meet its expenses and the future payroll for the British army was a huge concern. In order to meet its obligations, the South Sea Company was established by the British government in 1711. The South Sea Company was granted an exclusive charter by the UK government to trade in the south seas. The company also underwrote the government’s public debt, with a promise of 5% guaranteed interest.

Owing to the success of the East India Company, which was a success in the Indian subcontinent, investors went nuts for shares in the company. The share price increased multiple folds in the following period as the executives promised far-fetched exaggerations. In early August 1720, the price rose to a high of £1,000, and thereafter selling began. Soon the selling pressure was huge and the share price dropped back to £100 per share before the year was out.

Financial Crisis, Economic Crisis, Economic Bubble

South Sea Stock Prices

 

The First Gold Economic Bubble

 

All that glitters is not gold. Gold is usually considered as a preferred and a safer investment as compared to the others. However, in the 1970s gold prices led to an economic bubble. Gold demand is not driven largely by economic forces but of people’s sentiment of higher future value. In the later 1970s, owing to demand, price roses continuously only to fall later in the following years.

The Soviet invasion of Afghanistan, which began around Christmas 1979, was a terrible global shock. The “bilateral treaty of cooperation” signed between Afghanistan and Soviet did not last and soon the soviet attacked capturing the major governmental, military and media buildings in Kabul. This caused a major blow to the American economy due to the ongoing cold war between the U.S. and Soviets. The U.S. economy seems under pressure and the price plummeted immediately marking the beginning of a 22-year bear market in gold.

FInancial Bubble, Economic Bubble, Economic crisis

Gold price Index

 

DOT-COM Economic Bubble

 

The dot-com bubble also known as the NASDAQ bubble, the tech bubble, the internet economic bubble was fueled by the rapid rise in stock prices of internet technology-based companies in the late 1990s. World Wide Web (www) was invented by Tim Berners-Lee in 1989 and was later made available to the general public in late 1991. Following the commercialization of the internet, a race to become the biggest technology startup began and investors poured money into these internet startups in the hope that those companies would one day become profitable. The NASDAQ Composite Index rose more than 400% between 1994 and 2000.

However, the new companies are yet to generate revenue and profit to sustain the prices causing people to rethink their investment. The Japanese recession of 1990 and the ruling against the Microsoft of monopolization marked the beginning of a sell-off pressure from the investors worldwide. Within a few months, the stock market fell a staggering 78% from its peak value. Dot-com companies that had reached high market capitalization became penniless within a short period.

dot-com-bubble-large

The U.S. Housing Economic Bubble

 

Despite housing being a secure asset, the U.S. housing market created an economic bubble trapping the biggest of investors into bankruptcy and causing a global recession. In the period 2005-09 house prices in both the US and Europe saw a significant fall. The crisis occurred as a result of the subprime mortgages that were offered to the borrowers with less-than-perfect credit and less-than-adequate savings. The idea was to help everyone attain the American dream of homeownership. Since these borrowers were considered high-risk, their mortgages had unconventional terms that reflected that risk, such as higher interest rates and variable payments.

As more and more loans were issued, prosperity grew in the beginning. Financial investors, in the hope of high returns issued new securities in the market which were backed by the subprime mortgages. The credit rating agencies have wrongly graded the securities with higher ratings causing the prices to soar. The real estate prices were increasing at record speed. Later in the year 2007, most of the borrowers’ fault on their mortgage payment and as a result the housing prices and other securities attached to it came down crashing. The US housing growth and failure, and its ripple effects ended with a worldwide economic recession that was the biggest since the 1930s the “Great Recession.

Screenshot (3)

Identifying an economic bubble well before time is quite a difficult task. T he most important lesson that these above bubbles teach is every rise has a fall and higher the rise more painful will be the fall. Speculative bubbles are like open books in the sense that one can never be sure when a bubble will form. One can notice that each of the above economic bubble is significantly different from the other but one common element that can be recognized among all is the inclination of the investors to earn fast.  It is easy to jump on the bandwagon and difficult to resist the jump.

Needless to say, always make an informed decision as history tends to repeat itself!

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