Introduction
All,
First, I'm posting this from a throwaway account because I want what I write to be judged on the quality of my analysis.
Second, I've thought for quite sometime now that it would be interesting to put together a series of posts analyzing lessons that can be learned from historical bubbles in history. This post represents day 1 of this series.
Schedule of Posts
Here is my plan for this series:
| Day | Topic |
|---|---|
| 1 | Tulip Mania |
| 2 | South Sea Company |
| 3 | Silver Bust and Uranium Folly |
| 4 | Is Bitcoin Next? |
| 5 | Concluding Thoughts |
Is This a Personal Finance Topic?
When writing this series of posts, I tried to determine whether they belonged in r/personalfinance, r/investing, or somewhere else. Ultimately, my key take away from these posts is to remind you of the importance of investing in a diversified portfolio of assets and the dangers of engaging in speculation. This message seems to me to be at the heart of this sub's beliefs on investing and thus ultimately I believe that it is a personal finance topic.
What Is A Bubble?
To adapt a phrase from Justice Stewart, "I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description ["bubble"], and perhaps I could never succeed in intelligibly doing so. But I know it when I see it".
Ultimately, it is very difficult to identify a bubble (and making even relatively basic strides earned Dr. Robert Shiller a nobel prize).
However, at the risk of oversimplifying, I believe bubbles have a few key characteristics:
- They experience a dramatic, often very quick, rise in price.
- They often involve some degree of opactiy and/or market manipulation.
- They are accompanied by wide-spread speculative investment, often fueled by excess capital and/or debt.
- The market price of the underlying asset differs greatly from the asset's fundamental value.
Tulip Mania
Tulip Mania is perhaps the first widely recorded and analyzed bubble. In the early 1600s, Tulips rapidly gained popularity in the Netherlands as a status symbol due to the vibrant colors of Tulips, especially as compared to many of other available flowers at the time.
At the peak of the bubble, a single Tulip sold for approximately 10 times the annual income of an average worker (roughly $580,000 in 2017 dollars).
Additionally, the first "derivative contracts" were created as part of this bubble - individuals traded the right to buy future tulips.
The bubble collapsed when interest in Tulips diminished - ships found nobody willing to pay market price for their "valuable" cargo. Speculators found nobody willing to buy their futures contracts for a greater price. And, as with all bubbles, many of those left "holding the bag" were financially ruined.
Bubble Checklist - Tulip Mania
- They experience a dramatic, often very quick, rise in price.
Yes - the value increased by 20x-100x the original price (exact multiple depends on which source you examine) over a few months.
- They often involve some degree of opacity or market manipulation.
Unclear - there appear to be no specific instances of market manipulation, but certainly the "futures market" was unregulated and subject to manipulation/rumors. Additionally, by modern standards the market was certainly opaque and rife with insider trading.
- They are accompanied by wide-spread speculative investment, often fueled by excess capital and/or debt.
Absolutely - futures contracts required minimal/no upfront payment and allowed speculation based on future prices with essentially no current outlay of cash.
- The market price of the underlying asset differs greatly from the asset's fundamental value.
Yes - just as quickly as prices rose, they also declined (drop rate of 99.999% upon market collapse). The idea that a decorative flower could be worth a decade of wages clearly indicates a divergence between the stated market price during the bubble and the intrinsic value of the asset.
Visual Aid - Standardized Tulip Prices
Data Source - note that since I plan to show multiple bubbles, I re-standardized the data provided to be in multiples of the original price (i.e. a value of 100 represents a price 100x higher than the originally observed price). Further, while Appendix 1 helps provide pricing data, not all values are completely clear and in such cases I used my best judgement.
Submitted November 06, 2017 at 11:23AM by pfbubbleweek http://ift.tt/2zl3FQj
