What History Tells Us About Bubbles
Or Why Complex Systems Have A Nasty Habit Of Exploding
I am a big fan of analogies, but bubbles are a fundamentally bad one. Regardless, history is littered with examples of the implosion of complex systems. From Tulip Mania and poorly named South Sea Bubble to Dot.bomb and the 2008 Credit Crisis — bubbles are a bursting. It is not nearly as inevitable as the contrarian bears of wall street would have us believe, but they are far more common and dangerous than many suspect. Most recently — California is struggling with one that will likely never be branded a bubble.
Why Bubbles?
As is often the case, you can fault the British. While Tulip Mania may go down as history’s first well-publicized economic bubble, 1711 brought us the most poorly named one. The South Sea company had nothing to do with the Southern Ocean (or Sea) and only a little to do with the South American trade monopoly that actually created its name. More on that later, but it should not surprise us that this was history’s first “bubble”.
The term bubble is defended because it aptly illustrates an inflated system that suddenly bursts. That is certainly fair. You could probably leverage some aspects of surface tension and drive this analogy a little deeper… but that is where it ends.
Real bubbles are transparent. The bubbles created by complex systems — rarely so. On this front — balloons are a better term (and one occasionally used). Real bubbles are filled with air — some would like you to believe that so were many financial crashes, but money, energy, and activity are the true inflating forces of complex systems. These forces are neither are quite visible and volatile — making bomb a better term as well (with or without a Dot).
Ask History — Complexity Matters
Real bubbles are simple and serene. Complex systems and their associated financial bubbles are never so simple. One could note that today, people like to keep things simple. This has not always been the case, intricacy was much in vogue when the bubble moniker was invented.
For as much as we want to pretend that Dutch exuberance for tulips, British love of exploration, the internet, and American love of Real Estate were the causes of our most popular “bubbles” — this over simplifies things tremendously. Exuberance is a necessary but not sufficient factor in any runaway system. A more thorough list would include:
- exuberance or the belief that too much is a “good” thing
- hidden stores — again no bubble is truly transparent
- indirect ownership and transfer
- a major change in participation — old players out, new player in
- a belief in a set of constraints
Exuberance or beauty?
Few bubbles have ever truly been fueled by greed, at least not the financial kind. Diseased tulips and the plague — that is prime fuel for some “mania”. It is hard to fight the power of a beautiful flower when everyone is dying of the plague. It is hard to fight the beauty of the internet when your jobs are being exported overseas. Home ownership is the American Dream. The list goes on.
This exuberance is hyped further if you just overcame some other hardship. Say you just overthrew your Spanish oppressors, you won the Great War, you survived the year 2000, or a war on terror. All the great bubbles have a chapter in their story just like this.
Scarcity or Hoarding
It is hard to know just how crazy things have gotten when diamonds, tulips, oil, and other “bubble” commodities are routinely hoarded. It is astounding to think of a time when everyone owned an “investment” home (or five). Brick and mortar companies are hard to fake, but every domain name is a potential online retailer.
Documents define the bureaucracy
At the height of Tulip Mania, people were trading paper, not tulips. The South Sea Company was buying paper debt by the ton. Stocks and stock markets, credit default swaps and housing titles. If no one is touching anything tangible, how does reality ever take hold? Violently!
Who just showed up? Hey, where did those other guys go?
The Dutch may be the historic owners of Tulip Mania, but they weren’t the only ones. As is often the case, the French had a hand to play. Just before it all went bad, Tulip mania spread to France. In 2002, cab drivers were day trading. In 2008, homeless people had investment homes and house flipping side-hustles. That last one was an exaggeration, but you get the point.
You can’t constrain, regulate, or prevent — energy, money, or activity.
Life, uh finds a way. It does so even faster with a credit card, trust fund, or plenty of spare time. The harder people try to contain, constrain, regulate, etc — the bigger the eventual explosion.
Returning to the theme of bad terminology choices, this last condition suffers greatly. Systems need throttles, vents, and exhaust systems. If regulation is a potato in the tail pipe (to stop pollution of course…) things will get ugly soon enough. But bureaucrats rarely try to redirect bad behavior… at least not until the “hidden stores” are already overrun, the former owners left town, and the contracts aren’t worth the paper they are trade on…
Not all bubbles are financial…
In 2007, the National Forest Service announced that forests are one of the greatest natural carbon sequestration systems. This was a poor choice of terminology and given they learned it from studies of the carbon released by a recent slue of California wildfires — they should have at least challenged the idea. Instead — exuberance for saving the world from Climate Change made it quite a bit harder to propose controlled burns.
Over the last decade, these hidden stores of carbon inflated. Unfortunately, dry shrubbery is the first step in fossil fuel. Despite the diligence of NFS or local fire fighters, life was going to find a way. Sadly, that has likely cost far more lives than it should have. What seemed like the preservation of beauty became deadly. I am sure that was no where in the papers that were written. Someone will inevitably blame the former managers or some new player.
But in the end, forests are a complex system, too. More complex than my synopsis above. All the more reason they are subject to bubbles as much as any financial system. And in the end, just as dangerous to life, property, and happiness.
To help the victims of the recent wildfires consider:
