Manias, Casinos, Bubbles and Crashes

By E. Ray Canterbery

With incomparable wisdom, writing and analytical skills, and wit, world renowned economist E. Ray Canterbery traces the history of the major speculative episodes in the world economy over the last three centuries. He begins with Tulipmania and ends with bitcoin speculation in exposing the way in which normally sane people display reckless abandon in the pursuit of profit. Canterbery shows how our notoriously short financial memory is what creates the conditions for market collapse. Throughout, the market is considered sacrosanct, much to the regret of the losers. By recognizing certain signs and understanding what causes them we can guard against future collapses and have a better hold on the country’s (and our own) financial destiny.

• Language: English
• Publisher: Austin Macauley Publishers
• Release date: May 24, 2024
• ISBN: 9781528958523

E. Ray Canterbery

A former Professor of Economics at Florida State University, E. Ray Canterbery is one of the most respected economist-writers of his generation. In 2003 John Kenneth Galbraith, who knew both Michal Kalecki and John Maynard Keynes, called Canterbery, “the best.” In his literary forays, he has authored the novel, Black Box, Inc. and co-authored F. Scott Fitzgerald: Under the Influence. The latter biography was the springboard for the present Scott: A Novel of F. Scott Fitzgerald. Canterbery conducted research as a Truman Scholar in 2004, which led to his recent biographical book, Harry S. Truman: The Economics of a Populist President. Canterbery is the author of many other acclaimed books and articles, including the forthcoming Inequality and Global Supra-Surplus Capitalism, a sequel of John Kenneth Galbraith’s The Affluent Society, and The Rise and Decline of Global Austerity. Before these came The GlobalGreat Recession, the tour de force Wall Street Capitalism, a light-hearted biography of Alan Greenspan: The Oracle Behind the Curtain, the classic The Making of Economics, and the best-selling A Brief History of Economics. Some of these books are now available in several languages. Canterbery served as President of the Eastern Economics Association in 1986–87 and of the International Trade and Finance Association in 1997–98. In January 1996, Prentice-Hall, Inc. selected him for one of their 100 Hall of Fame Economist Baseball Cards for “significant contributions to the economics discipline,” including “developing one of the first complete mathematical theories of foreign exchange.” The international Biography Centre in Cambridge, England includes Canterbery among 500 persons worldwide in its Living Legends (2002), among 2000 scholars worldwide in its Outstanding Scholars in the 21st Century, among One Thousand Great Intellectuals (2003), among 2000 Outstanding People (2003) worldwide, and among 1000 Great Americans (2003). The American Biographical Institute includes Canterbery in its Great Minds of the 21st Century (2002) and American Biography (2003). He is also listed in selected issues of Marquis Who’s Who in the World and Who’s Who in America, as well other biographical sources.

Book preview

Manias, Casinos,

Bubbles and Crashes

E. Ray Canterbery

Austin Macauley Publishers

Manias, Casinos, Bubbles and Crashes

About the Author

Dedication

Copyright Information ©

Acknowledgement

Introduction

Chapter 1: Tulip Mania

Appendix 1: Standard Model of Speculation

Chapter 2: John Law and the Mississippi Bubble

Chapter 3: The South Sea Bubble

Chapter 4: Alexander Hamilton and the Panic of 1792

Chapter 5: The Panic of 1819 and the Second Bank of the United States

Chapter 6: The Panic of 1873 and the Long Goodbye

Chapter 7: Rui Barbosa and Encilhamento

Chapter 8: J.P. Morgan and the Panic Of 1907

Chapter 9: The Great Crash of 1929

Chapter 10: The Stock Market Crash Of 1987

Chapter 11: Rational Expectations and Bubbles: Comedy Relief

Chapter 12: The Dot-Com Bubble and Crash

Appendix 12: List of Companies Significant to the Dot-com Bubble

Chapter 13: The Great Financial Crisis of 2008-2009

Chapter 14: Bitcoin Speculation and the Blockchain Revolution

Chapter 15: Casinos and the Casino Effect

Chapter 16: A Summation

About the Author

A former Professor of Economics, E. Ray Canterbery is one of the most respected economist-writers worldwide. John Kenneth Galbreath, who knew both Michal Kalecki and John Maynard Keynes, called Canterbery, the best.

Canterbery conducted research at the Truman Library in Independence, Missouri, which led to the biographical book, Harry S. Truman: The Economics of a Populist President. Canterbery is the author of many other acclaimed works. Among these are Inequality and Supra-surplus Capitalism, a sequel to John Kenneth Galbraith’s The Affluent Society, and The Rise and Decline of Global Austerity. Before these came The Global Great Recession, which Canterbery and Business Week named. And, there were many others: the ones still in print can be viewed at Amazon.com. Some 57 of his many articles have been published in a collection titled The Collected Works of E. Ray Canterbery (Singapore, London: World Scientific Publishers, 2017). Some of his books are available in several languages.

Canterbery served as President of the Eastern Economics Association in 1986-87 and of the International Trade and Finance Association in 1997-98. In January 1996, Prentice-Hall, Inc. selected him for one of their 100 Hall of Fame Economists Baseball Cards for significant contributions to the economics discipline, including developing one of the first complete mathematical theories of foreign exchange.

The International Biography Centre in Cambridge, England includes Canterbery among 500 persons worldwide in its Living Legends, among 2000 scholars worldwide in its Outstanding Scholars in the 21st Century, among One Thousand Great Intellectuals, among 2000 Outstanding People worldwide, and among 1000 Great Americans. The American Biographical Institute includes Canterbery in its Great Minds of the 21st Century, among many other awards. He is also is listed in selected issues of Marquis Who’s Who in the World and Who’s Who in America.

Dedication

To those who have written of financial speculation, but especially my late friend, John Kenneth Galbraith and the late Charles Kindleberger.

Copyright Information ©

E. Ray Canterbery 2024

The right of E. Ray Canterbery to be identified as author of this work has been asserted by the author in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the publishers.

Any person who commits any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages.

The story, experiences, and words are the author’s alone.

A CIP catalogue record for this title is available at the British Library.

ISBN 9781528907286 (Paperback)

ISBN 9781528907293 (Hardback)

ISBN 9781528958523 (ePub e-book)

www.austinmacauley.com

First Published 2024

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Acknowledgement

I thank every member of my family.

Introduction

Irrational exuberance is a phrase famously coined by Alan Greenspan, head of the Federal Reserve in December 1997. He used it in a luncheon speech at an annual meeting of the American Economic Association. The audience of economists sat in awe of him, in an almost worshiping mode, usually reserved for rock stars. Sensing an overpricing of some 20 percent in the Dow, Greenspan hoped to talk the market down without a crash. Though the market immediately recoiled in reaction to Greenspan’s remarks, it quickly recovered. The Dow had climbed another 20 percent by spring 1998. Still concerned with overvalued assets Greenspan was reluctant to raise interest rates for fear of setting in motion the greatest stock market crash in American history. Greenspan apparently believed that an irrational bubble was driving the stock market. Some will see the irony, Greenspan, an outspoken opponent of and regulation of financial markets, repeatedly has praised such markets for their efficiency. During the first crisis on his watch, he contemplated going back on the old Gold Standard.

Figure 1.1

Greenspan Contemplates Going Back on the Gold Standard

A variety of formal definitions of a bubble exist. However, the intuition remains the same. If the price of an asset is high today only because buyers believe that the selling price will be high tomorrow, a bubble exists. Put differently, today’s price is not fully explained by fundamentals (variables having a direct effect on future income streams from, for example, equities). Often, it appears, a self-fulfilling prophecy is underway, because asset prices will cleave to the high side if buyers believe they will. In the short run, the high asset price is justifiable, because it yields a return (dividends) equal to or greater than returns on alternative assets, including bonds.

Still, Greenspan’s view is contrary to the theories of efficient capital markets based on rational expectations. In the stronger version of rational expectations all asset prices are not only always correct but reflect market fundamentals. In the rational bubble models, even the bubbles are rational because investors can believe that an asset’s price is above its fundamental value but continue to hold the asset anyway. This reasoning applies to many investors and many assets. That is, each believes that someone else (a greater fool, perhaps) will buy the asset for a higher price in the future, preventing a pricking of the bubble. In a rational bubble, therefore, asset prices can deviate from their fundamental values for a long time, because the bursting of the bubble can be predicted and so there are no unexploited profit opportunities. A single player in the market, such as George Soros or Warren Buffet, can never beat the market. Not only will any differences from the optimal forecast of any asset’s price (its fundamental value) sum to zero, so will differences from the optimal forecast of the bubble. Such deviations, therefore, are unpredictable; asset prices walk a random walk.

For now, we will not trifle with the efficient market theories. Suffice it to say that most historians and some economists side with Greenspan. Ultimately, they say, we much come to grips with the reality of financial excess, a form of mass hysteria. Patsy-Cline-like crazy behaviour—maniac, obsessed, haunted, mesmerized and orgasmic—leads to abnormal outcomes. When the players overdo financial opportunities, a mania follows, that must somehow end, usually an atrabilious end. In this view the great financial bull market of the 1990s in the US came to such a gruesome finale on Friday, the 13th of October 1989, with a mini-crash. This was followed in the early 1999s by a recession in reaction to the invasion of Kuwait by Iraq in July 1990, causing oil prices to soar. The Dow dropped 18 percent more in three months, from 2,911.63 from July 3rd to 2,381.99 in October.

Rather than differences in fundamental and bubble prices, it is sometimes useful to contrast tranquil markets with turbulent markets. A tranquil market has no internal contradictions and no external shocks; expectations based upon experience are confidently held and constantly justified. Current prices can be confidently expected without rational (or forward-looking) expectations. Still, internal contradictions can evolve in any market, especially in a financial market. Moreover, when a market turns from tranquil to turbulent, it is difficult to say whether the turbulence is caused by external shocks. If a market is so delicate that a shock causes it to collapse (become ill-liquid), we might even question the basis for the players’ confidence based on experience or even forward-looking expectations. Besides since markets are interdependent, does one market adversely affecting a second, comprise an external shock? Since the interest rate on a long-term bond may be used as the discount rate on valuing equities, an unexpectedly dramatic fall in bond prices may be an internal shock to stock markets and prices. If an equity-market player believes that movements in bond prices do not matter, is the player being rational?

We cannot answer all such questions in an introduction, but we can shed some light on the issues involved. Certainly, irrational exuberance defies the rational individual behaviour and general equilibrium models based on rational behaviour, including Lucas’ critique as well as rational bubbles in assets.¹ Then irrespective of theory, those who deny bubbles must go to the barricades against at least four great bubbles in modern history—tulipmania, the Mississippi Bubble, the South Seas Bubble, and the Great Crash of 1929. This is precisely what has happened; recently, rewriting the history of bubbles has become a cottage industry, barricades aside. If these revisionists were to write the history of the Titanic, the iceberg would have sunk! Meantime a dramatic end to the Great Bull Market of 1990s provides still another historical case.

We will proceed to restate the history of the classic bubbles. Notably, these revisions have been written by rational expectationists. Then, we will critique the revisionist histories of these bubbles. Along the way, we will consider the standard model for such bubbles. Finally, though considering the lessons learned from history, we will suggest an alternative theoretical approach.

First, we return to the first great historic bubble, tulip mania.

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Lucus’ Critique contends that it is naive to predict the effects of a change in economic policy entirely on historical data, especially highly aggregated historical data. More formally it states that the decision rule of Keynesian models cannot be considered as structural in the sense of being invariant to changes in government policy variables such as national debt. Economic equations estimated on one policy regime is unlikely to fit another policy regime.↩︎

Chapter 1

Tulip Mania

Kipper and Wipper

Perhaps the first financial crisis in history happened during the start of the Thirty Years War (1518-48). Beginning around 1521, city-states in the Holy Roman Empire began to heavily debase currency to raise revenue for the Thirty Years’ War, as effective taxation did not exist. The name, Kipper and Wipper, refers to the use of tipping scales to identify not-yet-debased coins, which were then taken out of circulation, melted, mixed with baser metals such as lead, copper or tin, and re-issued. (Kipper and Wipper literally means Tipper and See-saw.). When the states did not debase their own currency, but instead manufactured low-value imitations of coins from other territories and then spent them in yet other territories as far as possible from their own lands. They were hoping that the resultant damage would occur to the economies of those other regions rather than their own. It was a kind of beggar thy neighbour policy. This worked for a while, but after a time, the public caught on to the manipulation, resulting in pamphlets denouncing the practice, local riots and the refusal of soldiers and mercenaries to fight unless paid in real-non-debased money. Also, the states began to back their own debased coins in taxes and customs fees. Due to these problems, the practice largely stopped around 1523; however, the damage done was so large that it created financial instability in almost all the city-states of the area. The same thing re-occurred on a smaller scale near the end of the century and again during the middle of the 18th century; moreover, the debasement spread from Germany to Austria, Hungary, Bohemia and Poland.

What is interesting about this financial crisis is the specie (metal coin) was debased, not paper money. In contrast, the Tulipmania of 1536-37 related to speculation in the value to tulip bulbs. What ended the metal coin speculation? More and more mints were established until the debased metal coins were so worthless that children allegedly played with them in the street, which became the basis for the short story by Leo Tolstoy, Ivan the Fool.

Speculative Mania with Tulips

Ordinarily, we think of tulips as something you tiptoe through. During the Dutch Golden Age, it was more like romping through the tulips. This was a period during which contract prices for bulbs of the recently introduced tulip reached extraordinarily high levels and then collapsed. At the peak of tulipmania, in March 1637, some single tulip bulbs were sold for more than 10 times the annual income of a skilled craftsman. A tulip, known as the Viceroy Bulb cost between 3,000 and 4,200 guilders (florins) depending on size. Skilled craftsman at the time earned about 300 guilders a year, which meant working a decade or more to buy one tulip. It is generally considered the first recorded speculative bubble. It was so spectacular that the term tulipmania is now often used metaphorically to describe any large economic bubble when asset prices deviate from intrinsic values.

The 1637 event was popularized in 1841 by the book, Extraordinary Popular Delusions and the Madness of Crowds, by the British journalist Charles Mackay. According to Mackay, at one point 12 acres of land were offered for a Semper Augustus bulb. Since about half of the Netherlands is below sea level, dry land is very valuable. Mackay claims that many such investors were ruined by the fall in prices, and Dutch commerce suffered a severe shock. Many modern scholars feel that the mania was exaggerated by journalist Mackay. True, research is difficult because of limited economic data from the 1630s--much of which come from biased and very speculative sources. Other flowers, such as the hyacinth, also had high initial prices at the time of their introduction, which immediately fell. The high asset prices may also have been driven by expectations of a parliamentary decree that contracts could be voided for a small cost--thus lowering the price to buyers.

The tulip became very special once it was introduced in Europe by Ogier de Busbecq, the ambassador of Ferdinand I, Holy Roman Emperor, to the Sultan of Turkey. Ogier sent the first tulip bulbs and seeds to Vienna in 1554 from the Ottoman Empire. Tulip bulbs were soon distributed from Vienna to Augsburg, Antwerp and Amsterdam. Its popularity and cultivation in the United Provinces (now the Netherlands) is generally thought to have started in earnest around 1593 after the esteemed Flemish botanist Carolus Clusius (1526-1609) had taken up a post at the University of Leiden and established the hortus academicus. In 1573 he was appointed prefect of the imperial medical gardens in lovely Vienna. Clusius planted his collection of tulip bulbs and found they could tolerate the harsher conditions of the Low Countries. Shortly, thereafter the tulip began to grow in popularity.

The tulip was different from every other flower known to Europe at the time, with a saturated intense petal colour that no other plant had. The appearance of the nonpareil tulip as a status symbol coincides with the rise of newly independent Holland’s trade fortunes. No longer the Spanish, Netherlands, the economic resources could now be channelled into commerce and the country embarked on its Golden Age. Amsterdam merchants were at the centre of the lucrative East Indies trade, where one voyage could yield profits of 400 percent. The new merchant class displayed and validated its success, primarily by setting up grand estates surrounded by flower gardens, and the plant that had pride of place was the sensational tulip. Thus, tulips rapidly became a coveted luxury item, and a profusion of varieties followed. They were classified in groups: the single-hued tulips of red, yellow, or white were known as Couleren; the multi-coloured Rosen (white streaks on a red or pink background); Violetten (White streaks on a purple or lilac background); and the rarest of all, the Bizarden (Bizarres), (yellow or white streaks on a red, brown, or purple background). The multi-coloured effects of intricate lines and flame-like streaks on the petals were vivid and spectacular and made the bulbs that produced these even more exotic looking plants highly sought-after. It is now known that this effect is due to the bulbs being infected with a type of tulip-specific mosaic virus, known as the Tulip breaking virus, so called because the virus breaks the one petal colour into two or more.

The biology of the tulip was itself a contributor to the supply-squeeze that fuelled the speculation, in that it is grown from a bulb that cannot be produced quickly. Typically, it takes 7 to 12 years to grow a flowering bulb from seed; bulbs can produce both seeds and two or three bud clones, or offsets, annually, but the mother bulb lasts only a few years. Properly cultivated, the daughter offsets will become flowering bulbs after one to three years. Before the broken tulips were developed, virus-free bulbs producing ordinary single-color variety were sold by the pound. Once affected by the virus, the broken exotics were an extremely limited commodity because the sought-after breaking pattern can only be reproduced through offsets, not seeds, as only the bulb is affected by the mosaic virus. Unfortunately, the virus that provided the sought-after effects also acted adversely on the bulb, weakening it and retarding propagation of offsets, so cultivating the most appealing varieties now took even longer. Taking this into account, quite probably from the time the speculation got started until its collapse, the number of rare bulbs that changed hands so feverishly never increased beyond the original number.

The pioneering Dutch were not limited to tulip innovations; they also developed many of the techniques of modern finance. They managed to create a market for tulip bulbs, where they were treated as durable goods. They wrote contracts before a notary to buy tulips at the end of the season (effectively futures contracts). A futures contract specifies quantities of a commodity or financial instrument at a specified price with delivery set at some future date. For example, a January futures contract for a pound of common tulip bulbs might be at a price of 35 guilders to be delivered in May. A short position is where the party is obligated to sell the underlying asset upon maturity of the contract. For example, a Viceroy might have a contract to sell in March at 2500 guilders, hence constituting a short sale. Being short is highly speculative. Short selling was banned by an edict of 1610, which was reiterated or strengthened in 1621 and 1630, and again in 1636. Short sellers were not prosecuted under these edicts, but their contracts were deemed unenforceable.

As the flowers grew in popularity, professional growers paid higher and higher prices for bulbs with the virus, and prices rose steadily. By 1634, in part because of demand from the romantic French, speculators began to enter the market. The contract price of rare bulbs continued to rise throughout 1535, but by November, the price of common unbroken bulbs also began to increase, so that soon any tulip bulb could fetch hundreds of guilders. That year the Dutch created a type of formal futures market where contracts to buy bulbs at the end of the season were bought and sold. Traders meeting in colleges at taverns and buyers were required to pay a 2.5 percent wine money fee, up to a maximum of three guilders per trade. Neither party paid an initial margin nor a mark-to-market margin and all contracts were with the individual counter-parties rather than with the Exchange. The Dutch described tulip contract trading as windhandel (literally wind trade), because no bulbs were changing hands. It was a virtual market. The entire business was accomplished on the margins of Dutch economic life, not in the Exchange itself.

By 1636 the tulip bulb became the fourth leading export product of the Netherlands, after gin, herrings, and cheese. Among these, only tulip bulbs could not be digested. The price of tulips skyrocketed because of speculation in tulip futures among people who never saw the bulbs. Many men made and lost fortunes overnight. Tulipmania reached its peak during the winter of 1636-37, when some bulbs were reportedly changing hands ten times in a day. The price of Dutch tulips increased by several hundred percent in the autumn of 1636, and the prices of the more exotic species of tulip bulbs were even larger. No deliveries were ever made to fulfil any of these contracts, because in February 1637, tulip bulb contract prices collapsed abruptly and the trade of tulips ground to a halt. The collapse began in Haarlem, when for the first-time buyers apparently refused to show up at a routine bulb auction. This may have been because Haarlem was then at the height of an outbreak of bubonic plague. While the existence of the plague may have helped create a culture of fatalistic risk-taking that allowed the speculation to skyrocket in the first place, this outbreak might also have helped to burst the bubble.

When tulipmania set in; prices began to rise wildly. The higher the prices went, the more attractive the bulbs became to