Are financial bubbles bad ? A lie we have been living with.

Economics and Business

The phrase "bubble" had at first been brought forth by William Shakespeare, who depicted it as "fragile, empty and worthless". These days, Charles Kindeldegber, an economic historian from MIT, portrays bubbles as when price climbs over a prolonged stretch that later collapses.

The Dot-Com bubble, the 2007 financial crisis and the Great Railway Mania are all examples of bubbles. From the turn of the 21st century, we have perceived financial bubbles with visions of unemployment, recessions and social unrest. In history, we learn about financial bubbles through events such as the great depression, meanwhile in economics we learn about preventing financial bubbles: how to stop recessions. So much that we begin to intertwine the definition of a recession and a bubble. However, what we aren't taught is that financial bubbles give rise to exponential economic, social and political benefits. Companies such as Google, Amazon, Uber, Tesla have transcended from bubbles. Financial bubbles are a cauldron for bursts of creative innovations in different industries that have the possibility to change the path of how we spend our life. I would argue that to profit from bubbles we need to find a way to control them. Bubbles are necessary; they provide a frictionless and swift path to inventing new ideas in human society. Over the next few paragraphs, the discussion will fold into; the benefits of bubbles, how to predict recessions, examples of beneficiary bubbles and finally how to control them. 

Bubbles are sparks for a greater future. Firstly, they stimulate innovation and give rise to entrepreneurs, such as Amazon founder Jeff Bezos and the founder of SpaceX, Starlink and Neuralink, Elon Musk. Secondly, bubbles provide growth at an unprecedented rate. Third, they provide capital for risky ventures that are unavailable at other times. All of this contributes to a fully efficient market where new technologies combined with market conditions stimulate new discoveries, disruption and capital. In addition, historians associate the boom of bubbles with the invention of railroads, bicycles, automobiles, fibre optics and the Internet.

The first bubble 

King Carlos II of Spain suffered from seizures and learning difficulties due to years of inbreeding to consolidate power. His death in 1700 had inadvertently led to the first bubble. Without any children, he named the grandson of Louis XIV of France, Philip, Duke of Anju. Philip had the strongest genetic similarities to Carlos, but his rise would unify French and Spanish empires. Threatening the British And Dutch empire who instead proposed that Archduke Charles of Austria should be king. By 1702 diplomatic attempts had failed and they declared war on spain. Lasting 13 years with the conclusion leading to Philip to remain as king of Spain as long as he removed any association to the French throne. The war led to huge government expenditure, issuing debt securities resulting in unprecedented levels of debts to all countries. France reached 2 billion livres in 1715 which amounted to 83-167% of gdp. Britain had debts of 40.3M around 52% of GDP from a post war of 5.4M. Defaulting was not an option as it would harm their position to finance future wars. Even as the French tried to wipe off its debt it wasn’t enough they needed new tricks, provided by John Law a Scottish financial theorist. He came up with the idea of a general bank foreshadowing central banks in the coming years. It was his proposal to collect all of the King’s revenue substituting it for banknotes which then could be changed with coins. Banks only need to hold a fraction of the outstanding bank notes in coins: since it will be unlikely that all the bank notes will be exchanged for coins at a single time. Soon bank notes were accepted as a payment for tax. In 1777, John Law opened the Mississippi Company whose order was to develop land next to the Mississippi river.

They began to sell shares and to further their growth laws sought to purchase other companies such as the Senegal company and the French monopoly on tobacco products. They continued to use money collected from shares to purchase rights to conduct all foreign French trade including tax collection and the right to mint coins which collectively was worth 85% of french revenue. In 1719 the market increased to 27.5 million. In turn, law began for the central bank of France by raising money by selling shares he obtained cash but also state bonds. In return helped the French repay its debt. With increased marketability and speculation lead to upheavals in people purchasing the stock. The bubble was created to get rid of government debt increasing marketability, speculation and capital, however the inability for the government to control a bubble stopped it from reaping the rewards of a bubble. The bubble was the only way the french government could get rid of debt without it a default would have left them unable to fund future wars that would be bad. 

The Great Railway Mania 

The great railway Mania bubble quoted by the “Economist” in 2008 said it was “arguably the greatest bubble in history”. Starting off in 1825, companies were able to sell shares however marketability was severely limited by parliament, who were hesitant to grant business the title of limited liability. However, that changed in the 1840s where parliament granted more charters to over hundreds of railway companies. The hot invention of the steam train encouraged parliament to erect new railways, and was arguably the start of the bubble. With the success of train lines in Liverpool and Manchester a scheme to develop it for the rest of the country was adopted. With the approved 59 new railways totalling a massive 1500 miles. However this excitement led to a boom in price of 65% and then falling to 45%. Described by experts as the ‘first railway mania’. This led to more projects being abandoned. However the following act of 1844 required that one train per day would carry passengers at a rate of one penny per mile. These decisions signalled to investors that railways could become very profitable and expect to generate huge dividends. Flooding the railway industry with more capital, speculation and greater marketability, such as the Economist calling the boom of railways the epitome of free competition and trade.

From 1845-1846 there was a huge boom promoted by the growing number of new railways applications. Newspaper headlines exerted confidence and speculation to a growing market. By 1845 the application had reached 562 from 192 new petitions. With forecasts predicted to reach 1236 new projects according to the times. However in 1845 it collapsed. The railway shareholders blamed the times for purposefully feeding the public false news for their own pockets. However it was the accumulation of events starting from the dismantlement of the railway board meant the once well organised network started competing with one another. The Bank of England setting interest rate to 2.5% the lowest in 150 years it flooded the market with more capital than raising it. Finally speculation greatly stretches the bubble. The railway mania showed how bubbles when well organised could accelerate changes that would have taken years to do. 

Dot com bubble 

Japan’s post war financial regulation had finally ended, rushing in marketability, money and credit. This period unleashed the free market: lowering capital controls and regulations. While computers by the 1980 had devolved into a tool in many industries and the internet began to grow. The lacklustre opening proved the internet to be too complex for one without a computer degree. By 1993 the program was made user friendly resulting in 663 million users in 2002. Now Netscape, in 1995 the founders turned towards an IPO, an unusual task especially not having turned a profit; rolling out a huge marketing event that would generate millions. Despite running poorly on traditional metrics for stocks it opened at $28 reaching $58 at the end of the day. By December it had reached 6.5 billion. This model was held as a flag to those who wanted to reach the same heights. During the period between 1984-91 there was never more than 100 technology ipo every year. However by 1996 it reached 274 new IPOs with tech IPO in 1999-2000 reaching a valuation of 517 billion. However, it collapsed immediately in 2003. Robert Schiller a Yale economist notes that the market boiled over reaching a value 28-45 times worth of its earnings. Falling by 25% in just one week the selling finally flatten during October 2002 where NASDAQ value plunged 48% of its original value. Microsoft and Cisco saw themselves as the most valuable companies. However, the growth of technology stocks were parallel to emerging financial programs from CNBC, Bloomberg and more helping to revolutionise the financial news turning a gloomy, boring and uneventful subject to a get rich quick scheme. The bubble created some lasting success such as Amazon and more.  

How can we control bubbles 

Are financial bubbles unpredictable? No. By predicting bubbles it will help us grasp a greater understanding of when a bubble is occurring and potential solutions that can be envisioned. The book Boom and Bust refers to bubbles as a fire “destructive, self perpetuating and difficult to control once it begins… while fire can cause serious damage, they can also be useful in certain ecosystems, contributing, for example, to the renewal of savannas, prairies and coniferous forest”. A bubble just like a fire only requires 3 main tools: speculation, marketability and capital. Once a bubble has begun it can be stopped by the same tools that ignited it with the addition of narrative economics. The 1st tool marketability is defined as the ease at which an asset can be bought or sold for. One factor is the legality of an asset can fundamentally affect marketability. Another factor of marketability is how easy it is to find a buyer or seller. One characteristic of bubbles is the huge swarm of buyers and sellers buying certain items that rapidly stretch the bubble. Nowadays our ability to purchase stocks on our phone has tremendously eased the accessibility of markets. The 2nd tool to create a bubble is money and credit. A bubble can only be ignited with the prerequisites of sufficient capital for the public to invest in. Low interest rates and loose credit can help to drive up assets themselves. The last tool required to start a bubble is speculation. Speculation is the act of purchasing a stock with the intent of selling an asset for a gain. During bubbles speculation greatly exists among individuals due to higher consumer confidence and increased money supply purchasing stocks purely on emotions. However this can be very dangerous.

Conclusion 

Everyone loves a big boom but no one likes a bust. Marketability, credit and capital can be used as the solution to control an economy coupled with new economic policies. If we can manage the potency of the bubble, we can finally safely manufacture bubbles at a click. The resultant will leave us building quantum computers, jets to mars and renewable energy at the fraction of time pushing human ingenuity to a new height. Additionally bubbles represent a period of maximum economic output helping to reduce unemployment and promoting wealth distribution.