Famous First Bubbles: The Fundamentals of Early Manias

From The Critics

Indeed, tulip mania has become a catchall for irrational market behavior, particularly since the Nasdaq tanked in April.

Such is human nature, as Charles Mackay wrote in his classic Extraordinary Popular Delusions and the Madness of Crowds, "that whole communities suddenly fix their minds upon one object, and go mad in its pursuit." Had Federal Reserve Chairman Alan Greenspan been around, he too would have wagged his finger at Holland's irrational exuberance, right?

Not so fast, says economist Peter Garber in his slim yet fascinating book Famous First Bubbles. There's almost always a better explanation than crowd psychology for sky-high asset prices, he says. Garber, a Brown University economics professor and global strategist for Deutsche Bank, takes a mere 160 pages to debunk the myths surrounding tulip mania, as well as its sisters in mythology, the South Sea bubble and the Mississippi bubble.

There is a difference, Garber writes, between uncertainty about the future - which drives innovators, risk-taking entrepreneurs and eventually markets - and mob psychology. The Netherlands, for example, was a sophisticated trading center, with well-developed commodity markets. That rare varieties of tulip bulbs could fetch high prices among professional traders was not irrational. The tulips could be used to grow many more valuable hybrids and often earned their purchasers far more than they invested. Indeed, this pattern still exists today. In 1987, serious traders paid as much as $500,000 for a new breed of tulip, fully intending to make good on the investment.

That highly specialized market is not to be confused with the more speculative futures contracts made by Dutch laymen. Hunkered down in taverns, they traded common bulbs, and for one month in early 1637 provided the basis for all those hair-raising anecdotes.

But even those deals, Garber points out, were not spurred by madness. They were nonenforceable gambles on futures contracts by people who knew their margins would never be called. Indeed, when the government suspended all such contracts in early 1637, authorities let buyers off the hook on payment of 3.5 percent of the contract price - hence the legend of a disastrous price decline. "This was no more than a meaningless winter drinking game," Garber writes, "played by a plague-ridden population... ."

Indeed, the Dutch economy chugged along, undamaged by the "bubble," for another 10 years.

Then why the legend of a market gone berserk? Garber does a great job tracing all anecdotes back to a single source: the Dutch government, which spun the tale to discourage future speculation.

Although Garber's book is stuffed with potentially eye-glazing numbers and charts, he lays out his argument with an engaging whiff of irony. It is an argument especially worth noting as high-tech portfolios continue to slide. Crying "bubble" is the easy way out, Garber says, preferred by those who believe individuals are not to be trusted in determining the value of markets - Greenspan's famous "irrational exuberance" is a perfect example. But without the kind of speculation seen today and, yes, in 1636, there would be no new economy, because millions of investors have to bet on the next new thing to push along those few companies who ultimately succeed.

The only disturbing difference: Today's small-time dealers have to answer their margin calls and might lose more than a year's worth of provisions.