Economic Bubbles: Money, Madness, and Meltdown
Tulip Mania (1637): The first crash
Tulip Mania is referred to the economic phenomenon that happened in the Netherlands, in the 1630s. It is generally considered to have been the first recorded speculative bubble or asset bubble in history.
Unlike the current times, this particular crash didn’t involve real-estate, shares, gold or banks. But a flower. Let’s understand how this bubble formed in layman’s terms.
I am a gardener who grows flowers and one fine day I notice some beautiful exotic-looking Tulip flowers have blossomed. I pluck them and bring 20 of them to market for sale. Within one hour I am able to sell each of them to 20 customers at $10, whereas the usual flowers are being sold at $1 or $2.
The next day, due to the 20 customers, word has spread, and I see 100 customers standing in a queue waiting for me and my exotic Tulips. Seeing the high demand, I double the price to $20. My entire stock gets sold faster than the previous day.
Now the problem arises that I don’t have any more flowers left. The flowers in the entire region are available only with those 120 customers. And they now start trading and selling to new customers!
New customer 1: I need the tulips. I am ready to pay $40 for one.
Old customer 1: Fine, I bought this at $20. So, $40 seems fine to me.
This pattern repeats and a chain of new customer-old customer-new customer forms and the price of the Tulip in the market reaches $500!
Realize that the early customers have purchased the flowers for their intrinsic value (beauty, smell, uniqueness, etc.) but the new customers are purchasing the flowers in the?hope?of selling it at higher prices — on the?hope?that there will be another person who will be willing to purchase at a higher price.
This hope is the killer of all.
What happens next is, people realize that it is easy to make money using Tulips. Just get one and sell it at a higher price. So, they start selling their?“assets”?to purchase Tulips.
Check the below list of items that were clubbed together and exchanged for a?single bulb of Viceroy —?a name given to the particular Tulip flower’s bud. Check how many animals are being exchanged… for one bulb!
Many people have become rich overnight, and this has prompted others to jump into the mania too. Houses and shops are being sold and then search for “another fool” is being started.
Starting the Time Bomb!
If you notice, up till now there is no need to hurry for any owner of the Tulip bulb. If he resists the “desire” to become rich quickly, he can sell it any time in the future. At his or her ease.
But the problem begins when people start taking?loans?to purchase the damn flower!! And the loan has got a time ticker on it. It has to be repaid. On time.
Now the “desire” to sell becomes converted into the “need” to sell. And when no buyers are found at that time, the bubble bursts.
This is what happened in February 1637. Tulip traders could no longer find new buyers willing to pay increasingly inflated prices for their bulbs. As this realization set in, the demand for tulips collapsed, and prices plummeted—the speculative bubble burst.
Now that you know at the basic level how a bubble forms and bursts, let’s go through some of the most important and/or unique bubbles that the last 3 centuries have shown us.
South Sea Bubble (1720): Bubbling with the government
Let’s now cross a few kilometers across the sea and enter England.
In 1711, South Sea Company, a joint-stock company was formed in a public-private partnership with the government. The primary goal of the South Sea Company was to engage in lucrative trade with the Spanish colonies and generate substantial profits for its shareholders. The company's operations involved trading African slaves, importing goods from the colonies, such as silver, gold, and valuable commodities, and exporting British manufactured goods in return.
Two important events led to the rise in demand for the company’s shares—
(The second point is very similar to the case of the government borrowing money from you to purchase shares of the company).
Now, you can well imagine that if a government is?believing?in the positive future of a company, other small investors will also fall into it. Hence, this attracted significant attention and led to a massive surge in the company's share price.
As the share prices skyrocketed, investors began to speculate on the rising value, creating a speculative bubble. People from all walks of life, including wealthy merchants, politicians, and even the general public, eagerly invested their money in the South Sea Company, believing that the prices would continue to rise indefinitely.
However, the bubble eventually burst. In August 1720, the company's directors realized that the share prices were unsustainable and started selling their own shares, secretly cashing in on the inflated prices. This action caused panic among other investors, triggering a rapid decline in the share prices. As the share prices plummeted, many people lost their fortunes, and numerous businesses went bankrupt. The crisis had severe social and economic consequences, leading to public outrage and a loss of confidence in financial markets.
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The Panic of 1873: The long depression
The panic of 1873 was unique in two aspects — first, it had its impact across borders from Europe to North America to Asia and second, the depression lasted for several years. In fact, it was termed as the great depression before the depression of the 1930s happened.
While the previous two bubbles discussed can be attributed to a singular aspect like one flower or one company, this depression was caused by several events concurring together. The main factors behind this (not in the order of importance), were —
Speculative Investments:?In the United States, 53,000 km of new railroad tracks were laid across the country between 1868 and 1873, with much of the craze in railroad investment being driven by government land grants and subsidies to the railroads. Most of the capital was involved in projects offering no immediate or early returns.
Jay Cooke & Company goes down:?Jay Cooke's firm was a major financial institution heavily involved in railroad financing. Its bankruptcy on 18th September 1873 triggered a wave of railroad failures and bankruptcies of several banks. The impact was so huge that the New York Stock Exchange had to be closed for 10 days starting from 20th September, just 2 days after Cooke and Co had fallen. The event triggered a crisis in the railroad industry with massive strikes, riots, and layoffs in several cities across the country.
Coinage Act of 1873:?Also known as the "Crime of '73," this was a U.S. federal law that revised the nation's coinage system. It discontinued the minting of silver dollars and placed the country on the gold standard, effectively demonetizing silver as a legal tender. It led to discontent among silver miners, farmers, and others who relied on the silver-backed currency.
Major Fires:?Two massive fires broke out in Chicago (1871) and Boston (1872). The fire in Chicago lasted for 3 days and killed approximately 300 people, destroyed roughly 9 square kilometers of the city including over 17,000 structures, and left more than 100,000 residents homeless. The fire in Boston on the other hand, caused $73.5 million in damage (equivalent to $1.513 billion in 2021) and loss of 30 people.
The depression came to an end by 1879, lasting for around 6 years.
The Great Depression of 1929
This is the most infamous historic bubble and highly likely that you have heard or read about it. We will discuss this in short.
The Great Crash is mostly associated with October 24, 1929, called Black Thursday, the day of the largest sell-off of shares in U.S. history, and October 29, 1929, called Black Tuesday, when investors traded some 16 million shares on the New York Stock Exchange in a single day. The crash, which followed the London Stock Exchange's crash of September, signaled the beginning of the Great Depression. The United States was the epicenter of the crisis, but other major economies such as Germany, the United Kingdom, and France were also significantly affected.
To date, economists and historians have not reached a consensus on the causal relationships between various events and government economic policies in causing the Depression. After World War I, the period saw an increased and speculative economic activity. With several folds increase in manufacturing and purchase activity. Many people started taking home loans and hoarding shares of the company speculating to rise in the future. (Finding some similarity with the Tulip Mania?)
Many economists also attribute to the weak banking system and the international economic imbalances created due to World War I, for accelerating and deepening the depression. This was coupled with some flawed monetary policies that added fuel to the fire.
The impact: The impact of the depression was felt worldwide, with the most significant being in the United States. In 1930, 1,352 banks held more than $853 million in deposits; in 1931, one year later, 2,294 banks failed with nearly $1.7 billion in deposits. More than 28,285 businesses failed in just one year. By 1932, unemployment had reached 23.6%, peaking in early 1933 at 25%.
Beanie Babies
Let’s talk about a bubble that draws parallels with the Tulip Mania, in the modern digital times.
The Beanie Babies bubble refers to the period in the late 1990s when Beanie Babies, a line of stuffed animal toys produced by Ty Inc in 1993, became a highly sought-after collectible item. The craze was fueled by limited supply, exclusivity, and speculative buying, with prices skyrocketing for rare or retired designs. Media coverage and hype further drove demand. They have been cited as being the world's first Internet sensation in 1995.
Initially, Beanie Babies faced slow sales, resulting in many retailers refusing to purchase the bundled toys, and some retailers refusing to carry Beanie Babies altogether. At the same time, Ty Inc. made a strategic decision to limit the production and distribution of the toys. They imposed restrictions on the quantity of Beanie Babies each store could purchase per month, capping it at 36 of each character.
Additionally, Ty Warner, the founder of Ty Inc., introduced the concept of retiring characters, meaning that certain Beanie Baby designs would eventually stop being produced. These measures created a sense of scarcity, which led to a significant surge in sales and sparked the phenomenon of collecting and reselling Beanie Babies. As a result, the popularity of Beanie Babies rapidly escalated, eventually turning into a nationwide craze in the United States.
While the United States was the primary market for Beanie Babies, the craze had a significant impact in other countries as well, including Canada, the United Kingdom, and Australia. The $5 toy mass-produced in China became such a big craze that people, mostly adults, paid thousands of dollars to collect them as an?investment.
However, the bubble burst as the market experienced a significant crash, leading to a decline in demand, plummeting prices, and financial losses for many investors. Just a few years after Beanie Babies made their creator a billionaire, the stuffed animals became virtually worthless. The market eventually stabilized, with collectors adjusting their expectations and the focus shifting to the enjoyment of collecting rather than financial gains.
The above were some of the 5 unique economic bubbles that I believe gives you a broad overview of the working of bubbles, their impact and how they rise (and crush) the hopes of so many people in one blow. Please don’t think that these 5 were the?only?bubbles that happened and burst. History is littered with economic bubbles every now and then. The Dot-com bubble, the great recession of 2008, and several cryptocurrency bubbles have been some of the bubbles and recessions in the last 25 years.
While economic bubbles can lead to severe financial crises and significant losses, they also serve as powerful reminders of the importance of prudent investing, risk management, and a thorough understanding of market dynamics.
Feel free to ask any questions or share your thoughts on this article or any feedback you have.?This publication is for made for you!
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