Market bubbles: past examples and preventing future ones Sam Rose Upper Sixth
2008 market crash
A market bubble is defined, by Investopedia, as “an economic cycle characterized by the rapid escalation of asset prices followed by a contraction”. The sudden change in asset price inevitably has dire consequences for the market and sometimes the global financial system, as we will explore. No economist can say bubbles are not a problem; so how do they keep occurring? What allows them to get out of control? And what can we do to stop this cycle? Before we can attempt to treat the problem, it is first essential to understand real examples of bubbles in our history. One key example of a bubble occurred in the early 1700s when a French official called John Law had access to both the French Mississippi company and French monetary policy. As brilliantly detailed in Niall Ferguson’s book, The Ascent of Money (2009), Law encouraged all members of the public to purchase company bonds. This began to inflate their price as the market forces adjusted for increased demand. The key feature that made this a bubble, however, was when Law was granted the power of the Mint with his Banque Royale. He began to move French currency away from coinage to paper notes. This allowed much easier expansion of the money supply and Law used this to full advantage. He expanded the supply of money significantly and, to his credit, brought France out of a
deep recession. Law was granted the power of control over the French tax system. This was to become the final straw as Law began to finance debt collection by the issuing of more Mississippi company shares. “On 17 June 1719 the Mississippi Company issued 50,000 of these [shares] at a price of 550 livres apiece”. Furthermore, Law produced even more new shares at 1000 livres to maintain his monopoly over the Mint. This was substantiated by the promise of more profits coming from the company in Louisiana. This was not to be hence we now have a bubble. The price of the company shares was unprecedently high (9000 livres in autumn 1719) and continuing to grow. It was then only a matter of time before the collapse. This was accelerated by Law’s appointment as French Minister of Finance in December 1719.
forced to re-introduce gold and silver currency to promote stability. After all this France was virtually bankrupt and went on struggling from one desperate reform to another before the monarchy finally declared bankruptcy. This sparked the Revolution. One might have noticed that during this time the British South Sea bubble was beginning to occur, but the harsh reality is that its losses were nothing compared to that of the French. The key reason for this was that that the South Sea Company never got control of the Bank of England. The story of the Mississippi company demonstrates the huge dangers of bubbles perfectly. Minsky explains the five stages of a bubble to be: Displacement, Boom, Euphoria, Profit-taking and Panic. This final stage was all too eminent in 1720 France as the bubble caused such panic and unrest as to entirely overthrow the French monarchy in the later revolution. There is no doubt that certain bubbles can destroy economies.
There is no doubt that certain bubbles can destroy economies.
Sure enough, by 1720 prices began to fall and there was further mass inflation followed by deflationary controls and price manipulation. France lost almost all confidence in Mississippi shares but, more importantly, the Livre. In late May 1720 Law resigned and was placed under house arrest. By October the government was 40
This is further evidenced by the 2008 financial crisis, where a US housing bubble eventually caused the collapse of most of
