Good Writing. Serious e-Reading.

THE GRANDDADDY OF
ALL BUBBLES

The one thing we know about financial crashes is that another one will occur sometime in the near future. But that’s about it. They’re like major earthquakes—no one has a precise idea when the next will strike. As the economist John Kenneth Galbraith was driven to declare, after spending many decades at Harvard pondering such matters: “There are no answers; no one knows, and anyone who presumes to answer does not know he doesn’t know.”

Despite such highly recommended ignorance, there would appear to be certain salient features that precede, form an integral part of, and inevitably follow such financial episodes. And have done so from the outset. These are readily discernible in the first great financial crash, the South Sea Bubble, which burst in London in 1720. When we examine it we find that many of its features have all the hallmarks of lessons that could have been, but for the most part were not, learned.

The main feature to have preceded most all financial crashes appears, again and again, to have been a new and more ingenious method for obtaining credit. Here it is worth establishing the precise nature of this double-edged entity in its most simplistic form—that is, the form in which it appeared to those financially innocent speculators who in 1720 began investing in such huge numbers in something called the South Sea Company. Many of them were quite used to obtaining goods or services on credit, which was standard upper-class practice, with bills being settled at the end of the month, or quarterly. But with shares of stock, the truly miraculous nature of credit was revealed. When an investor purchased a £100 share, he could, on the security of that share, purchase a further £100 share on credit. In effect, the same amount of capital was used twice over.