Published on 8 April 2021

In Part 1 we looked at what causes bubbles and some great examples from way back in 18th and 19th centuries. Now we look at boom and bust cycles in living memory from Japan in the 1980s up to the casino capitalism bubble of China in 2015.

In their book Boom and Bust, William Quinn and John D Turner seek to explain why financial bubbles happen and you can read their explanation in Part 1 of this book review. Here we bring the story up to date.

The Japanese boom and bust cycle

As we read earlier, war can be a significant factor in contributing to boom and bust cycles. They can be hugely expensive and governments often have to borrow colossal sums to fund them. In the case of World War II, the US government was faced with the prospect of rebuilding a Japan that it had spent many years trying to destroy. In large part this meant bringing the principles of a deregulated market to Japan to encourage economic growth. This culminated in the Plaza Accord signed in 1985. This hugely increased the supply of cheap money which, of course, had to find a home. Where did it go? In short, land. More specifically, urban land, as the country moved from an agricultural economy to a service sector one.

In the following 2 years, land in the 6 major Japanese cities increased in price by 44. By 1991, land was 40 times more expensive than in London. As Quinn and Turner point out, ‘by 1991 the total value of land in Japan was £20 trillion – five times the value of all the land in the United States, and twice as much as the entire world’s equity markets’.

Shares add to the pain

Share prices also soared in response to the loosening of regulations on buying and selling investments. In addition tax changes made it advantageous to trade shares rather than buy and hold them. When the index of leading Japanese companies (the TOPIX) peaked in December 1989 it had risen 386% in just under 7 years.

Having thus created a boom, the Bank of Japan got worried that things had gone too far, so to apply the brakes it increased interest rates. Share prices fell, and banks became unable to lend to fuel to property boom and prices also fell. It took until 2005 for land prices to hit the bottom by which time they had called 76%!

The arrival of the internet and the dot com bubble

The next bubble followed hot on the heels of the problems in Japan when the world wide web being formally opened to the public in January 1991. In the years that followed hundreds of companies were set up to exploit this new technology. Many were brought to the investing public through the process of IPO’ing – an initial public offering of shares in the new company. Chief amongst the early listings was Netscape, purveyor of the Netscape Navigator (remember that?) a new way to browse the web. This IPO was unusual in that Netscape went to market before it had even made a profit. Not the normal practice. Despite this the launch was a huge success and set the trend for future IPOs. You didn’t need to make money not seemed, you just needed a good idea, to launch on the stock exchange.

And this trend was supported by another. The deliberate underpricing of shares in these new companies in order to attract investors. This meant huge profits for those able to take part in the IPOs. In fact, in 1999 the average first day price increase for shares launched on US stock markets was 71%. Much of this boom was fuelled by private individuals, this in itself fuelled by the rise of stock market television channels like CNBC.

By the spring of 2000, the party was over. Quinn and Turner find it difficult to attribute one specific reason why the bubble burst, citing the rise of investment institutions which created conflicts of interest and flawed bonus structures as significant contributory factors.

No more boom and bust

These were the oft repeated words of Labour Chancellor and then Prime Minister Brown throughout the new decade of the 21st century. And yet the sub prime mortgage bubble and subsequent global financial crisis confirm these were hollow promises. I won’t labour the point on this one as most of us lived through it, but again cheap money lent to people who couldn’t afford it was at the heart of this boom and bust cycle. As most of us remember, it all ended in tears. Who can forget the people queuing outside Northen Rock to get their money out?

A decade of bubbles in China

The global financial crisis is well known to most Westerners. But the casino capitalism of the Chinese state between 2005 and 2015 was equally shocking. As Quinn and Turner say, ‘The playbook from nearly three centuries of bubble experiences was played out in China in just over a decade.’

The driving factor was the Chinese government’s push towards a more capitalist society by privatising many state owned companies. To do this they changed rules on share ownership to encourage the new Chinese middle class to invest. By 2007 the two main Chinese markets were 130% and 98% over one year as investors piled in to the newly privatised companies. Aided and abetted by the state media, markets were up over 400% in the two years to October 2007.

But following falls in 2008 the government again set about further liberalising markets by reducing state involvement further. Interest rates were lowered and banks were allowed to hold less money to cover the loans they made. A second boom period followed – new IPOs were frequent and hugely oversubscribed, some by 300 times. Bizarrely many firms renamed to make themselves look more like tech firms that people wanted to back. For example, a wood flooring company rebranded as an online gaming firm, a hotel became a high speed rail network and a fireworks company morphed into a peer to peer lender!

Ordinary investors pile in

More worrying perhaps was the nature of the investors buying these companies. Literally everyone was in on it. 30 million new trading accounts opened in the first 5 months of 2015 alone. In fact about 90% of all daily stock market transactions came from ordinary retail investors. And some had very odd ideas about how to pick shares, using lucky numbers, birthdays, numerology and feng shui to help them choose… As you can guess, it all ended badly. The authors outline a number of causes: a clamp down on cheap lending, an increase in interest rates for banks lending to each other being chief amongst them.

Should you read this book?

Well, in places there’s quite a lot of financial jargon. The authors sometimes explain it and sometimes it’s assumed you know it, so that is one downside. But anyone interested in investing now, should look at some of the classic investment cycles of the past.

The 1720s, when the boom and bust cycle was invented are a long time ago. But it’s surprising to read that factors which contributed then are still prevalent now. I also really like the theory they advance about the consistent nature of these elements. And also how their framework can be used to spot or even predict future bubbles. If nothing else, that should be useful to readers. Each chapter succinctly describes the bubbles and what changes led to them. Then there’s a useful analysis of the impact. The numbers are often shocking but really do hammer home the message about how things get out of control.

All in all I would definitely recommend this one. It’s just fascinating to look back in time in so much detail and see where we went (keep going) wrong!