Famous First Bubbles: The Fundamentals of Early Manias

by Peter M. Garber

Overview

The jargon of economics and finance contains numerous colorful terms for market-asset prices at odds with any reasonable economic explanation. Examples include "bubble," "tulipmania," "chain letter," "Ponzi scheme," "panic," "crash," "herding," and "irrational exuberance." Although such a term suggests that an event is inexplicably crowd-driven, what it really means, claims Peter Garber, is that we have grasped a near-empty explanation rather than expend the effort to understand the event.

In this book Garber offers market-fundamental explanations for the three most famous bubbles: the Dutch Tulipmania (1634-1637), the Mississippi Bubble (1719-1720), and the closely connected South Sea Bubble (1720). He focuses most closely on the Tulipmania because it is the event that most modern observers view as clearly crazy. Comparing the pattern of price declines for initially rare eighteenth-century bulbs to that of seventeenth-century bulbs, he concludes that the extremely high prices for rare bulbs and their rapid decline reflects normal pricing behavior. In the cases of the Mississippi and South Sea Bubbles, he describes the asset markets and financial manipulations involved in these episodes and casts them as market fundamentals.

Product Details

ISBN-13:	9780262571531
Publisher:	MIT Press
Publication date:	08/24/2001
Series:	The MIT Press
Edition description:	Reprint
Pages:	175
Product dimensions:	5.25(w) x 8.00(h) x 0.51(d)
Age Range:	18 Years

About the Author

Peter M. Garber is Global Strategist at Global Markets Research of Deutsche Bank.

Table of Contents

Preface
I The Bubble Interpretation
II Tulipmania Legend
1 A Political and Economic Background
2 The Traditional Image of Tulipmania
3 Where Does the Tulipmania Legend Come From?
4 Establishment Attitudes toward Futures Markets and Short
Selling: The Sources of the Pamphlets
5 The Bubonic Plague
6 The Broken Tulip
7 The Bulb Market, 1634-1637
8 Some Characterization of the Data
9 Post-Collapse Tulip Prices
10 Bulb Prices in Later Centuries
11 Was This Episode a "Tulipmania"?
III The Macro Bubbles
12 A Preliminary View: The Mississippi and South Sea Bubbles
13 John Law and the Fundamentals of the Mississippi and South
Sea Bubbles
14 John Law's Finance Operations
15 A Rehash of Mississippi Market Fundamentals
16 Law's Shadow: The South Sea Bubble
17 South Sea Finance Operations
18 Fundamentals of the South Sea Company
19 Conclusion
Appendix 1: The Tulipmania in the Popular and Economics Literature
Appendix 2: The Seventeenth-Century Tulip Price Data
Notes
References
Index

What People are Saying About This

Michael D. Bordo

Peter Garber has written the definitive book on the tulipmania and the South Sea bubbles. He integrates sound economic analysis with historical detail in a highly convincing manner. His bottom line that the earlier bubbles reflected sound economic fundamentals rather than 'irrational exuberance' should be heeded.

Rudi Dornbusch

This wonderful, short book takes us behind the curtains of financial folly. It skillfully offers both anecdote and analysis of events that we may bereliving just now.

Mike Dooley

This brief and to-the-point look at famous 'popular decisions' makes a good case for the view that governments rather than markets are the source of financial crises.

Eugene N. White

When stock markets boom, tulipmania, the South Sea Bubble, and the Mississippi Bubble are conjured up. These events are used to remind people that investors often yield to irrational euphorias. The authority of these famous first bubbles is invoked by journalists, policy makers, and economists to emphasize that swings in the markets are irrational and unpredictable. What is rarely remembered is that these episodes had fundamentals. In this book, Peter Garber identifies the fundamentals and debunks the ideas that these periods are bubbles. Thus, the stories of the bubbles are not cautionary tales that school us to expect a crash with every spectacular rise of the stock market.

Richard Sylla

Garber's careful and reasoned analysis of key events in financial history provides a reality check for those who mistake uncertainty about the future for irrationality here and now.

Robert J. Shiller

Famous First Bubbles is the most thorough, and thoughtful, examination of history's legendary speculative bubbles. We hear about these bubbles in popular discourse all the time, but almost never with any real insight or information about them. Garber shows that the reasons for these major speculative price movements are more subtle than is generally recognized. This book is important to read today, since our impressions of past bubbles influence our view of the current markets.

Charles Calomiris

This book is a wonderful antidote to the sloppy thinking and superficial research that underlies most of the talk about bubbles. Garber shows that fundamental changes were arguably driving the changes in price in the most famous historical examples of bubbles. The discussion of tulipmania is grounded in the political, social, and economic history of the Netherlands, a thorough examination of data and secondary sources, and a fascinating investigation of the biological origins of rare tulip bulbs. The treatment of the Mississippi Bubble rightly emphasizes the link between money creation and securities price fluctuations. Garber also captures the profound difficulty speculators must have faced when evaluating both the Mississippi and South sea companies, commercial schemes (which many scholars still believe might have worked), and the dangers of retrospective judgments about fundamentals based on actual collapses. The book is a model of how to combine careful theoretical reasoning with first rate-scholarship and a delightful sense of irony.

Endorsement

This brief and to-the-point look at famous 'popular decisions' makes a good case for the view that governments rather than markets are the source of financial crises.

—Mike Dooley, Economics Department, University of California, Santa Cruz

From the Publisher

This wonderful, short book takes us behind the curtains of financial folly. It skillfully offers both anecdote and analysis of events that we may bereliving just now.

—Rudi Dornbusch, Ford Professor of Economics and International Management, MIT

Famous First Bubbles is the most thorough, and thoughtful, examination of history's legendary speculative bubbles. We hear about these bubbles in popular discourse all the time, but almost never with any real insight or information about them. Garber shows that the reasons for these major speculative price movements are more subtle than is generally recognized. This book is important to read today, since our impressions of past bubbles influence our view of the current markets.

—Robert J. Shiller, Cowles Foundation for Research in Economics, Yale University

This book is a wonderful antidote to the sloppy thinking and superficial research that underlies most of the talk about bubbles. Garber shows that fundamental changes were arguably driving the changes in price in the most famous historical examples of bubbles. The discussion of tulipmania is grounded in the political, social, and economic history of the Netherlands, a thorough examination of data and secondary sources, and a fascinating investigation of the biological origins of rare tulip bulbs. The treatment of the Mississippi Bubble rightly emphasizes the link between money creation and securities price fluctuations. Garber also captures the profound difficulty speculators must have faced when evaluating both the Mississippi and South sea companies, commercial schemes (which many scholars still believe might have worked), and the dangers of retrospective judgments about fundamentals based on actual collapses. The book is a model of how to combine careful theoretical reasoning with first rate-scholarship and a delightful sense of irony.

—Charles Calomiris, School of Business, Columbia University

Garber's careful and reasoned analysis of key events in financial history provides a reality check for those who mistake uncertainty about the future for irrationality here and now.

—Richard Sylla, Henry Kaufman Professor of the History of Financial Institutions and Markets and Professor of Economics, Stern School of Business, New York University

Peter Garber has written the definitive book on the tulipmania and the South Sea bubbles. He integrates sound economic analysis with historical detail in a highly convincing manner. His bottom line that the earlier bubbles reflected sound economic fundamentals rather than 'irrational exuberance' should be heeded.

—Michael D. Bordo, Department of Economics, Rutgers University

When stock markets boom, tulipmania, the South Sea Bubble, and the Mississippi Bubble are conjured up. These events are used to remind people that investors often yield to irrational euphorias. The authority of these famous first bubbles is invoked by journalists, policy makers, and economists to emphasize that swings in the markets are irrational and unpredictable. What is rarely remembered is that these episodes had fundamentals. In this book, Peter Garber identifies the fundamentals and debunks the ideas that these periods are bubbles. Thus, the stories of the bubbles are not cautionary tales that school us to expect a crash with every spectacular rise of the stock market.

—Eugene N. White, Professor of Economics, Rutgers University

This brief and to-the-point look at famous 'popular decisions' makes a good case for the view that governments rather than markets are the source of financial crises.

—Mike Dooley, Economics Department, University of California, Santa Cruz

Editorial Reviews

"This wonderful short book takes us behind the curtains of financial folly. It skillfully offers both anecdote and analysis of events that we may be reliving just now."--Rudi Dornbusch, Ford Professor of Economics and International Management, MIT

& quot; This wonderful short book takes us behind the curtains of financial folly. It skillfully offers both anecdote and analysis of events that we may be reliving just now.& quot; --Rudi Dornbusch, Ford Professor of Economics and International Management, MIT

" This wonderful short book takes us behind the curtains of financial folly. It skillfully offers both anecdote and analysis of events that we may be reliving just now." --Rudi Dornbusch, Ford Professor of Economics and International Management, MIT

--Rudi Dornbusch, Ford Professor of Economics and International Management, MIT

From the Publisher

Now that tech stocks are in a rut, it's comforting to tell war stories from a different era. A favorite is the tale of how market madness in 1636 allegedly drove Dutch citizens to squander enough provisions to last a family a year for a single rare tulip bulb.

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.