What's a bubble and how does it burst? A comparison of these three market crashes from long ago with our current financial crisis will reveal that the forces that make and destroy a bubble haven't changed that much. This article is the second in a series.
The Crash of 1929 was preceded by the optimistic and seemingly prosperous roaring twenties. The war was over and the stock market soared. It was believed the market was limitless leading to over speculation during the roaring 20s. The years leading up to Black Thursday (October 24, 1929) and Black Tuesday (October 29, 1929) were fueled by extreme
optimism in the stock market, lower tax rates for the wealthy, and easy credit for the not so wealthy. Couple these forces with the influx of naïve investors over the same period and the eventual downward turn in the market spiraled out of control contributing to the ensuing Great Depression.
Like America during the 1920’s, eighteenth-century England was a prosperous and optimistic nation with large segments of its population having the means and/or will to invest. Only a few companies offered stock at the time and investing was difficult but they were all strong, profitable corporations. Conditions were ripe for an accessible and potentially profitable investment. Enter the South Sea Company.
In 1711 the debt of the British Empire was assumed by merchants who were to receive annual payments at a rate of about 6% interest. This money was to be raised through duties placed on imports. Orchestrated by Robert Harley, Earl of Oxford the merchants were formed into the South Sea Company and given a monopoly on trade in the South Seas and South America. Harley believed Spain would offer significant trade allowances as part of the peace treaty that ended the War of Spanish Succession. This turned out to be untrue.
The South Sea Company first issued stock in 1720 and continued to reissue stock to meet the overwhelming demand. Faith in Great Britain’s dominance in the South Seas and the belief that stock in English corporations could not falter led to speculation and the emergence of companies with questionable purposes and merit. .
People invested wildly and stock prices climbed well beyond their actual value. The directors of the South Sea Company, knowing the true value of their shares, began to sell off their stock. Panic followed as investors realized they owned worthless paper and the market as a whole plunged.
Holland is always associated with tulips, and for good reason. After the flower was brought to the Dutch via Turkey in 1593, they became a sought after addition to gardens. By the seventeenth-century Holland was prospering through trade and wealthy merchants demanded tulips for their estates. Bulb prices increased and the already popular flower became even more desirable when a harmless virus gave its petals unique color patterns. Prices
rose higher and soon everyone was trading in bulbs. Garden centers of the day filled their inventories depleting the supply and pushing prices even higher. The prices were not accurate reflections of tulip value, however, and the bottom eventually fell out of the market causing widespread panic and an eventual depression