From the tulip craze to the explosion of internet stocks: What are the similarities between the current market movements compared to the previous bubbles?

The factors that are similar to the periods in the past

About 300 years ago, financial authorities in Europe had placed great expectations on the prospect of new trading companies granted special powers by the French and British governments in international trade. Shares of trading companies – including the South Sea Company of England and the Mississippi Company of France, soared and then plunged in 1720.

Such periods have caused some economic historians to frown at what is happening in the financial markets right now. Wall Street is once again in a really confusing fever with new investment vehicles.

Bitcoin price has increased more than 6 times in the past year. Meanwhile, the SPACs massively listed, bought a bunch of companies and raised more than $ 100 billion this year, according to Dealogic. Not stopping there, investors also “hunt” for NFTs. So, are these investment instruments signaling the bright future of financial markets, or something else?

What happened in history shows that investment fevers are often associated with financial innovation. In other words, these are new tools created by Wall Street middlemen, surrounded by mystery and expectations of great future returns.

Sometimes things go very badly, the Wall Street Journal said.

The factor that led to the 2008-2009 financial crisis was the explosion of mortgage liabilities and credit risk swaps. Prior to that, in the 1990s, nonprofit internet companies were listed with high valuations. At these events, many investors have “burned out” accounts when not even earning 1 cent.

Before the commercial companies of the 1700s fell into crisis, the speculation of Dutch tulips in 1636 took place. This flower was then highly valued for its diversity and ease of replanting.

According to Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds, a Viceroy branch was worth 2 bunches of wheat, 4 bunches of rye, 4 cows, 8 pigs, 12 sheep, 2 barrels of beer, wine, butter, cheese, a bed, 1 suit and 1 silver cup of water.

Factors attracting investors: Innovation

Robin Greenwood, a professor at Harvard Business School, said: “The big stages of innovation are often interesting for investors, because they can see all the valuations are reasonable.” He gave another good example of a bubble burst in the 1920s for closed-end funds. Before the stock market plunged in 1929, the number of closed-end funds launched skyrocketed and prices were also higher than the fundamental value of the investments they hold.

He notes that sometimes financial innovation itself can “survive” crashes and bursts of bubbles, such as in the form of closed-end funds in the 1920s and internet stocks. the 1990s. Although new investment instruments booming dramatically could be a sign of uncertainty in the market, it is not always the case.

“There are things that look like bubbles, but they are not,” Greenwood said. He gave the example of technology stocks that skyrocketed in the early 1990s, when stocks continued to flourish a decade later. Uncertainty is one of the factors that makes bubbles possible, he said. Normally, investors still object to the view that the bubble is near.

Willem Buiter, a visiting professor at Columbia University and has studied other historic bubbles, says innovation is something that is always happening on Wall Street. What is striking about financial innovation during the bubble era is that new factors have become instruments of speculation.

According to him, innovation itself is not the problem. The problem is when investing in that vehicle is driven by increased leverage. “Leverage is murder,” Buiter observed.

That was certainly the case in the 2000s, when mortgage obligations helped spur mortgage lending. From 2000 to 2008, debt in the financial sector more than doubled from $ 8.7 trillion to $ 18 trillion. Household debt doubled from $ 7.2 trillion to $ 14.1 trillion, according to Fed data.

This time, although government debt is growing rapidly, debt in the financial sector is still below its 2008 peak and household debt is both growing more slowly than it was in 2000. From 2012 to 2020, household debt family increased from 13.6 trillion USD to 16.6 trillion USD.

Therefore, these numbers partly help Buiter reassure. “There are signs and indicators of rising debt, but we haven’t seen an unsustainable debt boom yet,” he said.

Refer to the Wall Street Journal