Last update 05 November 2003
As I have indicated on previous occasions, history tells us that sharp reversals in confidence occur abruptly, most often with little advance notice. These reversals can be self-reinforcing processes that can compress sizable adjustments into a very short period. Panic reactions in the market are characterized by dramatic shifts in behavior that are intended to minimize short-term losses. Claims on far-distant future values are discounted to insignificance. What is so intriguing, as I noted earlier, is that this type of behavior has characterized human interaction with little appreciable change over the generations. Whether Dutch tulip bulbs or Russian equities, the market price patterns remain much the same.
We can readily describe this process, but, to date, economists have been unable to anticipate sharp reversals in confidence. Collapsing confidence is generally described as a bursting bubble, an event incontrovertibly evident only in retrospect. To anticipate a bubble about to burst requires the forecast of a plunge in the prices of assets previously set by the judgments of millions of investors, many of whom are highly knowledgeable about the prospects for the specific investments that make up our broad price indexes of stocks and other assets.
Remarks by Chairman Alan Greenspan
Before a conference sponsored by the Office of the Comptroller of the Currency,
Washington, D.C.
October 14, 1999
Neoliberal economic orthodoxy assumes that markets can determine accurately the value of companies and their assets. However, the history of markets is littered with "bubbles" which inflated the value of resources which became scarce as a result of accelerating speculation.
The recent "Dot.com Bubble" has antecedents in the South Seas Bubble which caused a stock market crash in England in 1720, "bubble" denoting " something fraudulent; as well as an inflated body of air that can easily burst. A multidisciplinary web-based team of researchers is still working on the ramifications of this at
http://www.dal.ca/~dmcneil/bubble.html
They point out that the South Sea directors, with their monopoly of English trade to the South Seas were hoping to emulate John Law a Scot who, through the Mississippi Company, created a monopoly of French trade to North America. They point out that in part, the motivation was to halt the diversion of English capital to France.
During the seventeenth century the Dutch economy was severely disrupted by speculation in tulip bulbs. At its height, single bulbs of rare varieties were sold for as much as $25,000.
Everyone imagined that the passion for tulips would last forever, and that the wealthy from every part of the world would send to Holland, and pay whatever prices were asked for them. The riches of Europe would be concentrated on the shores of the Zuider Zee, and poverty banished from the favoured clime of Holland.
Nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney-sweeps and old clotheswomen, dabbled in tulips. People of all grades converted their property into cash, and invested it in flowers. Houses and lands were offered for sale at ruinously low prices, or assigned in payment of bargains made at the tulip-mart. Money poured into Holland from all directions.
The prices of the necessaries of life rose again by degrees: houses and lands, horses and carriages, and luxuries of every sort, rose in value with them, and for some months Holland seemed the very antechamber of Plutus.
Charles Mackay (1841)
Extraordinary Popular Delusions and the Madness of Crowds
In 1637, speculators took their profits and sold out, which made others in the know nervous, so they sold, too triggering a panic and prices plummeted.
The Japanese Bubble Economy was a more institutionally driven phenomenon, by which the reduction of investment opportunities via government deficit financing bonds meant that profits from Japan’s successful manufacturing sector was diverted into property speculation. The average price of residential land doubled during 1997 In the absence of other investment opportunities,. Property values then became the means of leveraging loans for further speculation. At the height of the bubble, the site of the Imperial Palace in Tokyo had a real-estate value greater than that for the entire state of California.
In December 1998 stock in Amazon.com hit $220 up from $22 a year previously, without any earnings whatsoever. At $220 a share, Amazon's capitalized value exceeded that of the Union Pacific Railroad.
The dot.com bubble burst early in 2000 in the USA. Laura Lorek, reported in Inter@ctive Week on May 22, 2000 that in the space of a month carOrder.com had gone from recruiting via fliers on the windshields of cars, to plans to lay off 100 employees to cut costs, while KBkids.com announced the elimination of one-third of its staff, and Quepasa.com, a portal aimed at Spanish speakers let go a third of its 90 employees to control costs. PetPlace, a privately held New York-based online information site for veterinary surgeons, laid off 19 of its 27 employees in Seattle leaving 28 employees, primarily in New York. By November established companies such as the UK based Freeserve had declined some 80% in share value from a high of 912p in March, earning relegation from the FTSE 100.
Such reversals can be self-reinforcing processes, occurring abruptly, most often with little advance notice. In the case of the dot.com bubble, panic reactions in the market damaged the value of established, profitable high-technology companies as well as those start-ups that had never had any realistic chance of achieving their projected earnings. From a distance of several years it is obvious that both sound and unsound buisinesse were affectd by the bursting dot.com bubble.
As with earlier bubbles, the dot-com bubble was driven, by speculation on projected future profits from scarce resources. This drove the stock values until confidence in the realism of the projections disappeared. Unlike earlier bubbles, however, these resources were intangible: cyberspace, as opposed to the tangible real estate of the Japanese bubble economy, knowledge and capabilities in the construction and maintenance of a company presence in that cyberspace rather than rare tulip bulbs, or exotic produce from distant locations.
This page is maintained by
Stephen Little
Senior Lecturer in
Knowledge Management
Open University Business School
Milton Keynes,
U.K.
s.e.little@open.ac.uk