Bursting the bubbles

Surely it would be better for economies if the markets were to run on a more even keel?

This article is taken from the November issue of The Critic. To get the full magazine why not subscribe? Right now we’re offering three issue for just £5.

In his last budget as chancellor in March 2007, Gordon Brown crowed: “We will never return to the old boom and bust.” He was right. The ensuing bust broke the mould. Six months later, the run on Northern Rock marked the start of the UK’s credit crisis, arguably the greatest of all crashes in terms of its impact on wider society. The ensuing recession was the longest in the UK for two centuries — only the current lockdown recession and that of the 1920s were deeper. Almost nobody saw it coming.

Having invested through the 1997 Asian crisis (interesting), the 2000 dotcom bust (farcical, inevitable) and the 2008 global financial crisis (not fun), I’ve become a connoisseur of crashes. Everybody says the experience is like a rollercoaster, but they are more gradual than that: more like a slow-moving mudslide punctuated with unpredictable lurches. Booms, I have to say, really are damn good fun.

Boom and Bust: A Global History of Financial Bubbles by William Quinn and John D. Turner, Cambridge University Press, £18.99

But why are there booms and busts? Surely it would be better for economies (and blood pressures) if the markets were to run on a more even keel? Are bubbles and busts inevitable, are there even positives? Are they becoming more frequent (if so, why?) and should they be stopped? Are there patterns to help us spot bubbles, or do they come out of a clear blue sky?

Boom and Bust is an action-packed romp through ten of the biggest bubbles and busts of the past three centuries. It deals with each bubble’s causes and consequences, well-peppered with background and charts and liberally sprinkled with anecdotes, before drawing conclusions on what they have in common. All in 220 pages, and without feeling over-compressed or over-edited. Some (most) finance books are arid and hard going; this one I couldn’t put down.

Contrary to what the man in the street might suppose, the history of finance is fascinating. People express themselves on the markets: their investments reflect their fears, hopes, expectations and aspirations. Whether, where and how much people invest reflects both the trends they think they see and the risks they certainly don’t. Many chapters read more like thrillers than dry essays.

The development and rhythms of the markets’ moves are entangled with history. Several of the bubbles discussed were created by governments to help finance wars or pay down war debt (including the South Sea Bubble), or to change the balance of power in spheres of influence, such as the first emerging markets boom in the 1820s, when British financiers helped loosen the grip of Spain on its former South American colonies. (Disraeli features as an extra.)

Technological advancement, to which investors are drawn like moths to a flame, leads to step changes in our quality of life. Walter Bagehot put it concisely: “John Bull can stand a great deal, but he cannot stand two per cent,” and it is this desire to push returns by allocating capital to interesting opportunities that moves the world on.

Greed might not be good, but where capitalism is more than simply a casino it is (as Matt Ridley has pointed out) the greatest problem-solving mechanism ever invented. Without a profit motive, capital simply wouldn’t have been allocated to the higher-risk technological investments of their day that have become basic elements of the world around us: mass electrification in the case of the bubble leading to the Great Crash of 1929, the development of bicycles in the late nineteenth century and the internet at the close of the twentieth.

While busts can be devastating, the ambition that inflates bubbles can float all boats; China’s attempts to invent a middle class through a state-sponsored transition to partial capitalism (discuss!) has led to the proportion of Chinese living below the poverty line reducing from 90 per cent in 1981 to 0.7 per cent in 2015. Some bubbles leave a trail of destruction, but the authors are astute in picking out which bubbles have helped and why.

As well as the broader sweep of history, sketches and anecdotes bring the stories alive — a favourite being the picaresque history of the fast-talking economist John Law. He escaped a death sentence in Scotland following a duel and fled to France, where he became minister of finance, inventing both the bubble and the concept of the fractional banking reserve along the way. He was later exiled when his bubble popped. I’d certainly read the book for these sketches alone.

And those of us who have dropped the odd investment clanger (raises hand sheepishly) might feel happier after reading about Chinese speculators buying shares randomly or based on lucky numbers, or reading of schemes that could not possibly have worked — or even those where investors weren’t told what they were backing.

Like Shiller’s set text Irrational Exuberance, the authors highlight the central role played by the press. As de Tocqueville said, “Only a newspaper can deposit the same thought in a thousand minds at once.” (I might be tempted to draw parallels with the Covid panic, but I will resist.) It was only when the financial press became a force that booms could really go bananas.

Quinn and Turner convincingly argue that there is a template uniting all bubbles: a heady trifecta of increased money flowing into a sector, an increased zeitgeist of speculation, and increased “marketability” of the particular asset (size of the market, development of an exchange, ease and legality of purchase, etc). But it takes a spark to really set things alight, which comes either from technological innovation (the internet, bicycles, electrification or railways) or politics (the need to pay for wars, decrease inequality, extend influence or rebuild economies after conflict).

Although their analysis is convincing, as a market participant I’m not certain the findings are specific enough to be “tradeable”. However, one observation that might give us pause is the casual closing remark that the current fashion for passive “index investing” might lead to bubbles inflating and bursting with greater amplitude than in previous waves. Given that this seems to be the way the investment world is going — lower fees, less active stock-picking — if there is another proper bust, well, hold onto your hats.

In their conclusion, the authors argue that the worst busts, from the point of view of economic harm to broader society, tend to be where a bubble is created by government action and then amplified by high levels of bank debt. These busts tend to be the humdingers, the haymakers, the truckers’ gut-busters. Bringing debt to a market bubble is a bit like bringing booze to a party: it makes things a lot more interesting, but there is often hell to pay. Eyeing grim economic news and some dire forecasts today, the fact that our banks have far less debt than when they entered the 2008 crash might give us all more than a crumb of comfort.

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