The Crash Course - Chris Martenson [45]
Bubble History
To better understand what bubbles are, how they form, and why they are economically painful, let’s take a look at a few historical examples, beginning with the tulip bulb craze in Holland in the 1630s.
In that period, a virus swept through the tulip farms and had the effect of creating beautiful and unique variants in tulip coloration that were transmissible to succeeding generations. Tulips were already an economically important crop for the country, so while it may seem strange to us now that a bubble could develop around flowers, tulips represented an important element of commerce to the people of Holland. Before long, incredible variants with brilliant streaks and accents were developed, and the more spectacular examples began trading at higher and higher amounts, building a speculative frenzy. Complicated trading routines built up around the products, and before long nearly all trades were conducted using credit.
At the height of the bubble, a single bulb of the most highly sought-after example, the Semper Augustus, which sported red petals and racy white streaks, commanded the same selling price as the finest house on the finest canal.
The tulip bubble could not have occurred were it not for the presence of ample credit. Credit is a necessary fuel for all bubbles; without it, no bubble can develop. After all, if the very definition of an asset bubble is that it grows “larger than incomes can sustain,” it means that funds to support the bubble’s growth have to come from somewhere besides current cash flows (i.e., current income). True to form, tulip-bulb trading soon outstripped the local money supply, and people began trading on credit.
Records indicate that the tulip craze ended even more suddenly than it began, crashing nearly to the bottom in a single day at the start of the new selling season in February of 1637. When bidding opened on that day, no buyers would bid, and prices rapidly cratered, never to recover. The people holding the last batches of purchased bulbs recorded major losses, creditors went bust, and an enormous amount of wealth evaporated, never to be seen again. Lives were ruined, fortunes were lost, and people promised themselves, Never again.
A second example of an early recorded bubble comes from the 1720s and is known as the South Sea Bubble. The South Sea Company was an English company granted a monopoly by the government to trade with South America under a treaty with Spain. The fact that the company was rather ordinary in its profits prior to the granting of the monopoly did not deter people from speculating wildly about its financial potential.
Even more startlingly, people were undeterred in snapping up shares of its stock, despite the fact that the company rather accurately billed itself as “A company for carrying out an undertaking of great advantage, but nobody to know what it is.” That’s about as clear a scam warning as an investor will ever receive, but bubbles have a way of shutting down critical thinking in the masses.
Sir Isaac Newton, when asked about the continually rising stock price of the South Sea Company, said that he “could not calculate the madness of people.” But then he, too, apparently went mad for company stock. He may have invented calculus and described universal gravitation, but he also ended up losing over 20,000 pounds,5