By Tezcan Gecgil, PhD
One of my favourite reading topics is the history of the financial markets. The story of each bull or bear market may initially look different, but if you dig deeper you’ll find that it isn’t.
After all, human psychology never changes – fear and greed are the two emotions that drive investors to the extremes. In other words, crowd psychology always impacts financial markets.
According to recent research by Peter Phillips and Shuping Shi of Yale University, “While each financial crisis has its own characteristics there is now widespread recognition that crises arising from sources such as financial speculation and excessive credit creation do inflict harm on the
As we end another volatile week in the markets, I’d like to share what I’d pick for my bookshelf on the history of finance, especially on the most famous market bubbles and crashes over the centuries.
Asset bubbles are not new phenomena
An asset bubble occurs when the price of an asset, such as housing or stocks, or a commodity like gold or oil, becomes over-inflated. Prices are usually driven higher because big expectations of future price increases bring new buyers into the market. Many investors or analysts say “this time it is different.” But it hardly ever is.
However, after a period of time the price of the asset becomes divorced from a reasonable valuation or even reality. A bubble forms and is usually followed by a bust – when prices fall off a cliff. Sometime later prices regain equilibrium.
John Galbraith’s book, “A Short History of Financial Euphoria” introduces the reader to several famous crashes. He wrote the book in the early 90s around the time when the junk bond bubble had collapsed.
During the 17th century, Europe and especially Holland experienced ‘tulipmania’ when all seemingly sensible people spent fortunes on tulip bulbs. “Tulipomania: The Story of the World’s Most Coveted Flower and the Extraordinary Passions it Aroused” by Mike Dash notes that at the peak of the bubble, a single bulb could easily sell for more than the cost of two grand Amsterdam houses.
Later, in the 18th century, France witnessed the rise and fall of the Mississippi Company which became known as the Mississippi Bubble. “The Mississippi Bubble: a Memoir of John Law” by Adolphe Thiers provides a detailed overview of the role played by John Law, a Scottish adventurer, in this prominent financial disaster.
You may be familiar with the South Sea Bubble that gripped the land in the 18th century. In 1720, the House of Lords passed the South Sea Bill, allowing the South Sea Company a monopoly in trade with present-day South America. Initially, the company was to help the government with its war debts.
In a matter of months, shares in the South Sea Company surged more than eight-fold, from £128 in January 1720 to £1,050 in June. Needless to say, the bubble burst and a severe economic crisis followed.
Euphoria followed by panics and crashes seems inevitable in free-market capitalist systems. It seems like only yesterday that someone else had just come up with a method to make a lot of money quickly!
I believe in investing for the long term in financially sound companies and assets. Disciplined and regular investing is possibly the safest way to ensure financial freedom.