Published on 24 March 2021

We haven’t written a book review before on the Steps blog, so I thought it was about time we dealt with that omission. In Boom and Bust William Quinn and John D. Turner explain the cycle of stock market ups and downs, and propose a framework for spotting the next inevitable gyration.

One of the first things that’s evident from Boom and Bust is that the authors don’t really have much time for what I thought was the key text on this topic: Extraordinary Popular Delusions and the Madness of Crowds by Charles Mackay. Mackay covers some of the well know manias from 1720 up to publication in 1841 like the Tulip Mania of the 1830s where a single bulb of the species ‘Miss Fanny Kemble’ sold for £75. That’s about £9,600 in today’s money.

But Quinn and Turner discredit many of these mania on two counts. First that they aren’t, by their definition, ‘bubbles’. And second because they say Mackay’s accounts were more works of entertainment than of historical record. In way I wasn’t disappointed by this as reading Mackay’s work is hard going! His language is of its time and hard to follow in places. One to persevere with on another day I think…

What is a bubble?

So according to Boom and Bust, what defines a bubble? Well Quinn and Turner reckon there are three elements that form a triangle, much like the one for the ingredients for fire. The three sides are:

  1. Marketability – in other words, how easy it is to buy or sell an asset.
  2. Money and Credit – the amount of money available to invest.
  3. Speculation – put simply, the desire to buy something now and sell it later for a profit.

When these three elements combine the boom and bust cycle starts. However a spark must set the cycle alight. These are usually in two categories: technological and political. For example, new technologies can revolutionise a sector and cause share prices in the sector to rise. The growth of the internet and ‘dot.com boom’ of the 1990s would be a great example of this. Politics might be a change in government policy on interest rates which increases the availability of cheap money for speculating.

Why do bubbles burst?

There could be many reasons say Quinn and Turner. Perhaps a change of policy, maybe an upper limit on the number of speculators in the market. Or maybe new information about a product which spooks market participants. The bottom line is that in one way or another they run out of fuel.

It’s important though to understand the impact of the bursting of a bubble, not just the reasons for it going pop. These can vary from damage to the bank balances of the speculators, to widespread economic damage as we saw in the sub-prime mortgage crisis running from 2003 to 2010 (and with a much longer tail of misery) which led to many thousands of ordinary people out work, austerity, and the very high profile failure of a number of banks – with a devastating knock on effect.

The invention of the boom and bust: The Mississippi Bubble

The Mississippi Company was set up in 1717 to develop land on the banks of the famous river. Set up by John Law, who had been ‘helping’ the French government with its war debts after he was sentenced to death by a Scottish court in 1694, the Company soon expanded its horizons through a series of mergers and acquisitions.

In the end it’s biggest single concern was the reduction of the French government’s debt. Law did this by essentially swapping the debt the government had issued for shares (equity) in the Mississippi Company. In so doing he lowered the interest rate the government had to pay on its debt. But to convince speculators who would receive the lower rate he had to convince them the share price would only go up. Remarkably he pulled it off – the temptation of a rising share price proved too much for many. This clearly was a nonsense. Despite being appointed the Minister of Finance in 1720, it wasn’t enough to save him from his fate and when the rouse was spotted the company’s share price plummeted and by 1724 the cost of servicing government debt was exactly the same as it had been in 1717 – 87 million livres a year!

Boom and bust in the South Sea Company

It was the same sort of financial chicanery that led to the first British bubble at the same time, which became knowns as the South Sea bubble, after the name of the slave trading company involved in ‘helping’ the British government restructure its debt. That ended badly too! The share price of the company jumped from £126/share at the beginning of 1720 to £1,100/share in July. By the end of the year it was back to £126/share…

Emerging markets, trains and bicycles

The 1800s were not a good time for boom and bust cycles. In fact there were 3 major ones, relating to emerging markets (Latin America, in this case), construction of the British railway network, and also another new technology – the bicycle.

These centred around Britain, but other countries weren’t immune. Between 1886 and 1893, Australia suffered a a huge bubble relating to the property market, specifically around Melbourne which led to much human suffering and poverty – ironically the very thing the development of suburban property was supposed to be alleviating.

Cause and effects

One of the great things about this book is that not only does it describe in some detail what happened, it also tries to unpick what caused these spectacular implosions and what the wider effects were. In the case of the two described above financial engineering designed to deliberately create a bubble by a small number of people was to blame. And the impacts were wide-ranging, although the authors contend that this was overstated at the time by newspapers whose main job was to sell newspapers. Nothing much has changed there!

In fact it’s striking that some of the lessons from such a long time ago haven’t been learned. For a 100 years from 1720 there was no other significant boom and bust cycle. But all that was to change in the mid 1820s and these cycles have been getting more frequent ever since.

To be concluded…

In fact since the turn of the 20th century, there have five more major boom and bust cycles at least one of which most readers will have lived through: the sub-prime bubble and ensuing global financial crisis. But more on those anon in a future post. In the meantime check out this video about bull and bear markets which looks at what happens when things go pop.