A Brief History of Financial Bubbles

Written

A Brief History of Financial Bubbles

Economies all over the world have strained and burst throughout history.
The door of an abandoned house with caution tape in front of it
Fallout from the U.S. housing bubble, in Brooklyn, N.Y., 2011 | Reuters/Mike Segar

The word “bubble” has become a common way to describe an economy at risk of overheating. Consider the dot-com and more recently the real estate bubble. But long before the term joined the financial vernacular, there were moments in history when economies in pockets throughout the world strained as bubbles blew up and burst. Stanford GSB’s Peter Koudijs says a bubble is “where investors buy an asset not for its fundamental value, but because they plan to resell, at a higher price, to the next investor.”

Perhaps the most beautiful one came in the Netherlands when trading of tulip futures — especially bulbs infected by a virus that caused the flower’s petals to develop spectacular colorful patterns — brought rampant speculation in the winter of 1636-37. Bulbs, which have to stay in the ground for most of the year, naturally lent themselves to futures trading with the demand fueled by a highly unequal society looking for rare status symbols. The future contracts provided a cheap way for people to speculate. Hardly any money down was required — when the future contracts came due, prices had fallen and a large number of defaults rippled through society.

The term bubble came into official use with the passage of the “Bubble Act” in 1720 by the British Parliament. England had recently granted the South Sea Company the right to take over its war debt in exchange for exclusive trading rights in the gold and silver rich South American colonies. Investors quickly inflated the share prices of South Sea, similar trading companies, and other “bubble” companies that the act sought to curb.

The collapse of the Spanish empire a century later brought an opportunity to invest in debt for newly formed Latin American countries, and in 1822, Gregor MacGregor of Scotland took full advantage. He persuaded investors to purchase bonds in the government of Poyais, located in today’s Honduras. The only problem? Poyais only existed on his fictitious map. The overall bubble burst at the end of 1822, when among other things, investors grew worried that the Latin American governments would not be able to service their debts. Investors put their bonds up for sale and prices crashed. Faced with this capital flight, the countries had no choice but to default.

Here are five images from some of history's big bubbles:

Tulip Mania

Tullip
Wageningen UR Library, Special Collections

During the height of the Dutch tulip craze, the price of a bulb could run as high as 5,500 guilders, the equivalent of a nice canal house in Amsterdam. The collapse probably had little impact on the overall economy, but it damaged trust and financial markets would never be the same.

Mississippi Bubble

John Law
Leemage/Corbis

In 1716, John Law, an economic theorist born in Scotland, promised to revitalize a French economy ravaged by wars. He obtained permission to open a bank with the authority to issue notes and that would fund the government debt. A year later, the bank took over control of French trade in the Mississippi River valley. Law started to print banknotes to inflate the bank’s stock price, but the scheme collapsed when note holders rushed to convert their notes into coin.

South Sea Bubble

South Seas
The Trustees of the British Museum

From Aug. 31 to Oct. 1, 1720, the share price of the South Sea Company, which had taken on England's war debt, crashed from 775 British pounds to 290.

Latin American Debt Crisis

Courtesy of the John Carter Brown Library of Brown University.

Valuable timber and a strategic location near where a canal would be built were among the amenities Gregor MacGregor touted to lure investors in his fictitious land of Poyais, depicted here in his publicity material.

Great Depression

LCDM Universal History Archive/Getty Images

The heady years of the 1920s gave rise to technological innovation and towering skyscrapers in Manhattan, such as the 77-floor Chrysler building. But by the time it opened in 1930, the country was already mired in the Great Depression.

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