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The mass delusion of financial crazes

By
Mary Kate Miller
January 23, 2018
15 min read
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Bitcoin. Bitcoin. Bitcoin. Lately, you’ve probably been hearing a lot about it.

The cryptocurrency has been making a lot of waves as of late, with news of skyrocketing prices, enormous returns on investments, and then declines that are just as rapid. As the bitcoin craze takes over the minds of those transfixed by the idea of making a quick buck, we’re looking at how Bitcoin stacks up against some of history’s biggest financial crazes (and their inevitable busts).

Tulip mania

As far as financial crazes go, this one was probably the most beautiful. Back in seventeenth-century Holland, a fervor for tulips took hold of the financial markets in what is now commonly referred to as “tulip mania.” It all began in 1594 when tulips were first brought from Turkey to Holland. The new flowers had an air of novelty that drove up the prices. As tulip mania took hold, people began dealing in bulbs. The specific numbers are difficult to calculate for how high prices got during tulip mania, which lasted from 1634-1637. However, according to Investopedia, at their highest, you could trade a single tulip for an entire estate, and at their lowest, a tulip was the same price as an onion.

Of course, eventually, people decided to sell and cash in on their sweet, sweet tulip cash. As more and more people sold, the prices dropped. Dealers didn’t honor contracts, and people were forced to realize that they’d traded their homes for a plant.

Given their recent arrival in Holland, novelty drove much of the short-lived tulip mania. Those looking for a similar equivalence might be reminded of the Beanie Baby craze in the late 90’s, where people paid outrageous sums for the tiny, stuffed toys. (Full disclosure: this writer’s mother hand sewed a replacement Beanie Baby that had been destroyed by a dog for a whopping $800, so that shows you something about the quality of goods that were being traded.)

South sea bubble

The South Sea Bubble was a complicated event in the eighteenth century that essentially came down to a bank staking its future on the outcome of a war – then relying on false advertising to spike prices. In 1711 England, the South Sea Company was founded, and it was supported as a Tory alternative to the Whig Bank of England. Things were looking good because they were promised a monopoly on all trade to the Spanish colonies in South America.

Sounds great, right? When do monopolies on trade in entire confinements backfire? It turns out that the answer is when that trade is tied to the outcome of the War of Spanish Succession (1701-1714). When the Treaty of Utrecht ended the war, Spain was given sovereignty over trade in its colonies. This drastically changed the outlook for the South Sea Company. Once its ability to trade in South America was curtailed, the South Sea Company had to look elsewhere.

In 1720, the company spread false rumors of their success, spreading stories of their South Sea riches. As a result, stock prices boomed. They went all the way from 128 to 1050 at their highest. Eventually, though,  investor confidence waned, and the stock prices plummeted.

1929 stock market crash

If there’s one craze you know, it’s probably going to be this one. The 1929 crash, which led to the Great Depression, was one of the biggest financial crises in history. But how? But why?

In the 1920s, the stock market saw rapid expansion.  By 1929, unemployment had risen. The stocks weren’t worth nearly as much as they seemed to be. Other contributing factors had put the country and the economy in bad shape, and it started to show in the declining stock prices from September to early October in 1929. Panic set in, and on October 24, a staggering. 12,894,650 shares were traded. It got worse the following week, and thus began the Great Depression.

But does that mean I shouldn’t invest in the stock market now? The problem wasn’t the stocks themselves, but the inflated value. Anytime you’re dealing with something where the value of the thing itself — be it a stock or a tulip — is less than the price it’s being sold for, you have cause to be skeptical.

The dot-com boom

Similar to tulip mania, the dot-com boom of the late 90’s was fueled by novelty. In this case, it was the novelty of the internet. As more businesses found a way to make money off this kooky new thing called the World Wide Web, the fever of the dot-com boom took hold. Everyone wanted to get in on the action. Investments were funneled into internet-based companies, with the hope that those companies would become profitable.

In March of 2000, when Dell and Cisco, two of the biggest players, placed huge sell orders on their stocks, people panicked. The beginning of the end had arrived. As investment capital dried up, companies failed, and just as quickly as the dot-com boom started it was over.

The common thread

There are a couple things that these crazes have in common. First, novelty. When something is new, it’s exciting. When something excites you, you lead with emotion. This domino effect leads people to make financial decisions they wouldn’t normally make. Their itch to get in early outweighs their instinct for due diligence. When something is new,  sometimes it’s impossible to know the value of an item, which brings us to the second commonality.

These crazes were fueled by the overvaluation of goods and commodities. When tulips arrived in Holland, it seemed like a single tulip was worth the cost of a house. The South Sea Company sold shares based on the riches you could square from the South Sea trade. Buying the stocks of the 1920’s gave you a chance at becoming Gatsby. The dot-com boom gave investors the opportunity to get rich quick on the internet. In all of these cases, the truth was too good to be true. The lesson that we should learn is that a single tulip is never worth the cost of a house, and you should be skeptical of anyone who tells you otherwise.

So, what does that mean about Bitcoin?

As exciting as it is that a friend of a friend managed to quadruple their money with the cryptocurrency, Bitcoin is a bubble waiting to burst. It’s not a safe enough investment to be worth putting your savings or your home into. Cryptocurrency is still new enough that we can’t tell what it’s really worth. Speculation is driving the price up. If we can learn anything from the other financial crazes of the past, it should be that it’s better to wait and see.

When it comes to investing, slow and steady often wins the race. Traditional investing in funds and the stock market will almost always serve you better in the long run.

https://www.ft.com/content/2b0d8926-96d9-11e7-b83c-9588e51488a0

https://www.investopedia.com/features/crashes/crashes2.asp

https://www.library.hbs.edu/hc/ssb/history.html

http://www.history.com/topics/1929-stock-market-crash

https://www.investopedia.com/terms/d/dotcom-bubble.asp

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