Zbigniew Piekarski on Bubble madness
"Chaos is a name for any order that produces confusion in our minds."
- George Santayana (1863-1952)
Only the life of an individual has a definite beginning and a precise end. Everything else is a process. Cycles in business and nature are influenced by a combination of factors and it is almost impossible to point to one or to a specific period of time as the end of one cycle and the beginning of the next. Cycles also vary in time and amplitude - of power. If you are a trader, making short-term forays into the market, then your life is ruled by cycles in terms of minutes and days. If you are an investor, holding for 'the long term', you will become far more successful if your investment decisions are in line with the cycle of Nikolai Dimitriyevich Kondratieff (1892-1938) which lasts for around 60 years but is subdivided into four seasons, each with its own characteristics.
Yet there are even longer term cycles. These cycles are more powerful and their effects more pronounced. They occur at crucial junctures in the rise and fall of civilizations and come to have lasting historical significance. To actual participants, they are a time of instability and doubt, of rapid change and dislocation, of the fundamental questioning of accepted wisdom and the proliferation of new solutions, of chaos.
Look to the past for an indication of what the future holds but not to the 1930s for that was merely two steps missed on the ladder of increasing prosperity. The only historical parallel to mirror the present are the early years of the 18th century when two countries, France and the UK, carried out an experiment with "fiat" currencies.
The state of French finances after Louis XIV's death in 1715 was so dismal that the Regent, the Duke of Orleans, turned to an exiled Scottish economist and banker John Law (1671-1729) for assistance. Law proposed the establishment of a state-chartered bank with the power to issue paper currency that would not be backed by gold but only by the confidence that a fair value would be repaid when called for (a fiat currency). The Banque Générale was established in 1716. At the same time, Law established the Mississippi Company, a monopoly designed to develop the then-French colony of Louisiana in North America. As everyone became convinced that riches existed in the New World, France experienced an incredible boom as vast amounts of fiat money flowed into the existing stock market buying up 'future prosperity'. The French market exploded. Soon, ordinary folks became day traders. Charles Mackay reports in his 1841 magnum opus Extraordinary Popular Delusions and the Madness of Crowds that one deformed hunch-back made large amounts of money by simply renting out his slumped back as a mobile writing table for the frenzied stock jobbers buying and selling French equities on the street.
Not to be outdone, the British started a mania of their own. The South Sea Company was formed in 1711 and was granted a monopoly for all trade to the South Seas once the war with Spain had ended. The war ended in 1713, then restarted in 1718. But the South Sea directors wished, in a sense, to imitate the manipulation of public credit that John Law had achieved in France and made a proposal to assume the entire public debt of the British government. Bribes were paid in fictitious holdings of stock to make this happen and then the Company immediately started to drive the price of the stock up through artificial means; largely new subscriptions combined with the circulation of pro-trade-with-Spain stories designed to give the impression that the stock could only go higher.
Once the mania spread it influenced the whole market. All kinds of joint-stock companies suddenly appeared hoping to cash in on the speculation mania including, "A company for carrying on an undertaking of great advantage, but nobody to know what it is." The founder of this company collected 2000 pounds in five minutes and was never heard of again.
On June 11, 1720, under the influence of the directors of the South Sea Company and in order to clean up the market, an act was passed requiring all joint-stock companies to have a royal charter. This added credibility. The confidence of the people was given an extra boost, and they responded. South Sea stock was 175 pounds at the end of February, 380 at the end of March, and around 520 by May 29. It peaked at the end of June at over 1000 pounds. (In 1720!)
With credulity now stretched to the limit and rumors of more and more people (including the directors themselves) selling off, the bubble suffered a puncture and began a very slow but steady deflation. By mid-August the bankruptcy listings in the London Gazette had reached an all-time high, an indication of how people bought on credit or margin. Thousands of fortunes were lost, both large and small. By the end of September, the stock stood at 135 pounds.
A committee was formed to investigate the South Sea Company and by early 1721 it had uncovered widespread corruption and fraud among the directors, company officials and their friends in government.
Like all exponential parabolic manias based on easy money, both bubbles soon collapsed plunging France, Britain and the rest of Europe into a severe economic crisis. The following depression set the stage for the American War of Independence (1763-1775) and the French Revolution (1789-1799). Indeed, the experience of Law's banking schemes for France was so traumatic that the term 'banque' was largely eschewed by French banks in order to avoid stoking up memories of Law's unfortunate institution (the common substitute term was 'credit', as in 'Credit Lyonnais' or 'Credit Agricole').
The two bubbles were the forerunners for three periods of depression: 1737-1740; 1743-47 and 1758-62. In future articles I shall outline a host of other factors, similar to the ones in play today, as we are on the brink of repeating this experience.
- George Santayana (1863-1952)
Only the life of an individual has a definite beginning and a precise end. Everything else is a process. Cycles in business and nature are influenced by a combination of factors and it is almost impossible to point to one or to a specific period of time as the end of one cycle and the beginning of the next. Cycles also vary in time and amplitude - of power. If you are a trader, making short-term forays into the market, then your life is ruled by cycles in terms of minutes and days. If you are an investor, holding for 'the long term', you will become far more successful if your investment decisions are in line with the cycle of Nikolai Dimitriyevich Kondratieff (1892-1938) which lasts for around 60 years but is subdivided into four seasons, each with its own characteristics.
Yet there are even longer term cycles. These cycles are more powerful and their effects more pronounced. They occur at crucial junctures in the rise and fall of civilizations and come to have lasting historical significance. To actual participants, they are a time of instability and doubt, of rapid change and dislocation, of the fundamental questioning of accepted wisdom and the proliferation of new solutions, of chaos.
Look to the past for an indication of what the future holds but not to the 1930s for that was merely two steps missed on the ladder of increasing prosperity. The only historical parallel to mirror the present are the early years of the 18th century when two countries, France and the UK, carried out an experiment with "fiat" currencies.
The state of French finances after Louis XIV's death in 1715 was so dismal that the Regent, the Duke of Orleans, turned to an exiled Scottish economist and banker John Law (1671-1729) for assistance. Law proposed the establishment of a state-chartered bank with the power to issue paper currency that would not be backed by gold but only by the confidence that a fair value would be repaid when called for (a fiat currency). The Banque Générale was established in 1716. At the same time, Law established the Mississippi Company, a monopoly designed to develop the then-French colony of Louisiana in North America. As everyone became convinced that riches existed in the New World, France experienced an incredible boom as vast amounts of fiat money flowed into the existing stock market buying up 'future prosperity'. The French market exploded. Soon, ordinary folks became day traders. Charles Mackay reports in his 1841 magnum opus Extraordinary Popular Delusions and the Madness of Crowds that one deformed hunch-back made large amounts of money by simply renting out his slumped back as a mobile writing table for the frenzied stock jobbers buying and selling French equities on the street.
Not to be outdone, the British started a mania of their own. The South Sea Company was formed in 1711 and was granted a monopoly for all trade to the South Seas once the war with Spain had ended. The war ended in 1713, then restarted in 1718. But the South Sea directors wished, in a sense, to imitate the manipulation of public credit that John Law had achieved in France and made a proposal to assume the entire public debt of the British government. Bribes were paid in fictitious holdings of stock to make this happen and then the Company immediately started to drive the price of the stock up through artificial means; largely new subscriptions combined with the circulation of pro-trade-with-Spain stories designed to give the impression that the stock could only go higher.
Once the mania spread it influenced the whole market. All kinds of joint-stock companies suddenly appeared hoping to cash in on the speculation mania including, "A company for carrying on an undertaking of great advantage, but nobody to know what it is." The founder of this company collected 2000 pounds in five minutes and was never heard of again.
On June 11, 1720, under the influence of the directors of the South Sea Company and in order to clean up the market, an act was passed requiring all joint-stock companies to have a royal charter. This added credibility. The confidence of the people was given an extra boost, and they responded. South Sea stock was 175 pounds at the end of February, 380 at the end of March, and around 520 by May 29. It peaked at the end of June at over 1000 pounds. (In 1720!)
With credulity now stretched to the limit and rumors of more and more people (including the directors themselves) selling off, the bubble suffered a puncture and began a very slow but steady deflation. By mid-August the bankruptcy listings in the London Gazette had reached an all-time high, an indication of how people bought on credit or margin. Thousands of fortunes were lost, both large and small. By the end of September, the stock stood at 135 pounds.
A committee was formed to investigate the South Sea Company and by early 1721 it had uncovered widespread corruption and fraud among the directors, company officials and their friends in government.
Like all exponential parabolic manias based on easy money, both bubbles soon collapsed plunging France, Britain and the rest of Europe into a severe economic crisis. The following depression set the stage for the American War of Independence (1763-1775) and the French Revolution (1789-1799). Indeed, the experience of Law's banking schemes for France was so traumatic that the term 'banque' was largely eschewed by French banks in order to avoid stoking up memories of Law's unfortunate institution (the common substitute term was 'credit', as in 'Credit Lyonnais' or 'Credit Agricole').
The two bubbles were the forerunners for three periods of depression: 1737-1740; 1743-47 and 1758-62. In future articles I shall outline a host of other factors, similar to the ones in play today, as we are on the brink of repeating this experience.
