orientation

This page offers orientations for considering the dot com, telecommunications and subprime bubbles.

It covers -

• boom and bust
• precedents
• punctuations
• the big picture
• behavioural finance

     boom and bust

Periods of rapid economic growth, sustained or otherwise, are not uncommon and are not confined to the West. They reflect factors such as good governance, access to new resources or markets, the emergence of new technologies and intergenerational change.

There is dispute about what constitutes an investment bubble - broadly marked by "irrational exuberance in investment" - and when a boom becomes a bubble.

Bubbles typically involve four broad stages -

• disruption - commercial innovation or political change that alters investor expectations about the future
• boom - marked by a sharp increase in the price of investments and a shift in scepticism
• euphoria - claims that a boom is permanent (or merely going to be long-lived), along with perceptions among some investors that it will be possible to cash in before unsustainable prices return to reality
• bust - a cascading collapse in the price of investments and losses for many speculators.

US economist Hyman Minsky discerned a broader pattern in the investment cycle, with five stages -

• displacement - when investors get excited about something - an invention, such as the Internet, or a war, or an abrupt change of economic policy.
• boom -
• euphoria - financial institutions extend credit to ever more dubious borrowers, often creating new financial instruments (such as mortgage securitisation)
• profit taking - smart traders start to cash in their profits
• panic - often heralded by a dramatic event, such as collapse of a major financial institution.

In Australia, New Zealand, the EU, US and other parts of the globe the 1990s saw tremendous movements of capital as -

• governments deregulated financial markets, privatised critical infrastructure such as telecommunication providers and built budgets around licensing of radiofrequency spectrum or other intangibles
• interest rates fell and the money supply increased. In the US for example 30 Year Treasury Bond rates dropped from 8.17% in 1994 to 5.87% in 1999, while the M3 money supply measure grew by 34%
• changes to taxation and pension systems (and demographic trends such as aging of the 'baby boomers') pumped investment money into the economy
• businesses sought to lower costs, increase profits, aggrandize their executives or address the tyranny of the quarterly report by engulfing other enterprises
• investments were made in new communications infrastructure (in particular digital switches, servers, fibre and radio networks)
• expectations built that the "digital economy" - and in particular B2B or B2C electronic commerce - would enable fundamental economic growth (with significantly increased productivity through deployment of new methods and equipment) and result in rapid returns for entrepreneurs who addressed untapped local, regional and global markets.

That movement was reflected in -

• unprecedented growth in the availability of venture capital, arguably with too much money under the control of inexperienced managers chasing excessive returns, and uncautious lending by mainstream financial institutions
• political and technological triumphalism, with claims of the "end of history", "death of distance", "end of inflation", "death of the corporation", "end of scarcity", "permanent boom" and "end of the business cycle"
• a proliferation of enterprises (often characterised as 'dot-coms') that secured significant funding - whether through loans or from investors - that was disproportionate to their historic revenue and likely return on capital
• payment of astronomical prices for spectrum, for rollout of infrastructure (much of which has never been utilised) and for consolidation within the communications sector
• speculative acquisition of domain names and shares in dot-coms
• uncritical adoption by business, academia and government of "new economy" mantras and forecasts regarding such matters as disintermediation, the paperless office, the necessary fusion of content and carriage, the end of media dinosaurs, and frictionless global markets of one.

By mid 2001 many dot-coms were out of business or were trading at small fraction of their peak valuations, several of the major telecommunication groups such as BT and WorldCom MCI were spinning off units or heading towards collapse, cheerleaders such as Jupiter were on the rocks, media conglomerates such as Vivendi were unbundling (or underwater), billions of dollars had disappeared and observers were comparing the decade to tulipmania, the South Sea Bubble, the 1980s Japanese property bubble or the giddy excesses of the 1920s 'Lindbergh Boom'.

From the perspective of late 2008 the damage, however, looks to be less severe than the collapse of the 'subprime bubble' and it is tempting to see the demise of major financial institutions in that year as an extension of the giddiness that afflicted the world after two generations of deregulation.

     historical precedents

As we note in highlighting literature later in this profile there is considerable disagreement about the identification, nature and significance of bubbles, sector-specific crises, panics, crashes in financial markets and depressions that most business sectors.

In particular there is a chasm between many econometric analyses - for example Didier Somette's Why Stock Markets Crash: Critical Events in Complex Financial Markets (Princeton: Princeton Uni Press 2003) - and works that emphasise social history (generally the history of the 'masters of the universe' in the financial district) or merely a rollicking good yarn.

Several of the more interesting studies have accordingly questioned particular dogma, with Peter Garber for example dismissing hyperbole about the Dutch tulip bubble of the 1630s, John Kenneth Galbraith demonstrating the falsity of claims that in 1929 Wall Street brokers (or their unhappy clients) fell en masse from Manhattan skyscrapers like confetti and 'Models of Markets: Finance Theory and the Historical Sociology of Arbitrages' by Donald MacKenzie in 57 Revenue d’Histoire des Sciences (2004) 409-433 noting the extent to which financial theories (or misunderstanding of them) shapes behaviour and determines action.

Crises in securities markets (eg in 1873 and 1929) may however have a wider impact and reflect underlying problems in national/international economies. Mark Taylor's Confidence Games: Money And Markets In A World Without Redemption (Chicago: Uni of Chicago Press 2004) irreverently compared going off the gold standard to the economic equivalent of the 'death of god', after which anything - including some of the norms and institutional constraints that inhibit excess - goes.

Literature about causation and appropriate responses has embraced grand theory (eg the Kondratief Cycle) about macroeconomic changes, astrological mumbo jumbo and discussion of 'herding behaviour' in financial markets. One reader of this page explained that

financial crises, which are the most dramatic phase of the business cycle, tend to occur every 56 years in sequences. These sequences in turn are interconnected by sub-cycles based on multiples of 9 years to produce a 9/56 year grid pattern ... A 9/56 year effect may also be evident in earthquakes cycles ... After much research the 9/56 year cycle was found to correlate very closely with cycles of the Sun and Moon.

Useful starting points are Charles Kindleberger's classic Manias, Panics & Crashes: A History of Financial Crashes (New York: Wiley 1993), Carlota Perez' Technological Revolutions & Financial Capital: The Dynamics of Bubbles & Golden Ages (Cheltenham: Elgar 2002), Understanding Financial Crises (Oxford: Oxford Uni Press 2007) by Franklin Allen & Douglas Gale .

There is a gentler account in Devil Take the Hindmost: A History of Financial Speculation (New York: Farrar Straus Giroux) by Edward Chancellor, Separating fools from their money: a history of American financial scandals (New Brunswick: Transaction 2007) by Scott MacDonald & Jane Hughes and Money, Greed, and Risk: Why Financial Crises and Crashes Happen (New York: Times 1999) by Charles Morris. A History of Corporate Finance (Cambridge: Cambridge Uni Press 1997) by Jonathan Baskin & Paul Miranti, The Ascent of Money: A Financial History of the World (London: Allen Lane 2008) by Niall Ferguson and The China Dream (London: Profile 2003) by Joe Studwell provide perspective. There are pointers to other studies in the guide regarding venture capital and financing innovation in the 'information economy'.

For US financial markets insights are offered by Mitchel Abolafia's Making Markets: Opportunism and Restraint on Wall Street (Cambridge: Harvard Uni Press 1996), William Lazonick's 2005 Evolution of the 'New Economy' Business Model (PDF), Cedric Cowing's Populists, Plungers & Progressives: A Social History of Stock & Commodity Speculation, 1890-1936 (Princeton: Princeton Uni Press 1965), Alisdair Nairn's upbeat Engines That Move Markets: Technology Investing from Railroads To The Internet (New York: Wiley 2003), Patricia Beard's After The Ball: Gilded Age Secrets, Boardroom Betrayals and the Party That Ignited the Great Wall Street Scandal of 1905 (New York: HarperCollins 2003) and John Kenneth Galbraith's classic The Great Crash (Harmondsworth: Penguin 1967).

Thomas Helbling & Marco Terrone in the IMF's World Economic Outlook for April 2002 suggested that recent "equity price busts" have occurred on average every 13 years, lasted for 2.5 years and been associated with GDP losses of about 4% of GDP.

     punctuations

'Punctuations' highlighted in the timeline elsewhere on this site and in the Inflections page of this profile include -

1637 end of Netherlands 'tulip' bubble
1720 evaporation of South Sea Bubble in UK
1720 collapse of Mississippi Company in France
1772 Scottish Banking crisis
1857 end of 1850s UK railway bubble
1857 Wall Street crisis
1857 Lombard Street banking crisis
1866 Overend & Gurney banking crisis in UK
1873 financial crash in UK
1873 financial crash in US
1873 railway 'krach' and 'Wiener Krach' in Central Europe
1890 Barings crisis in UK
1893 Silver Crash in US
1893 Land Boom Crash in Australia
1907 Wall Street Panic
1922 Swedish bank crisis
1929 Wall Street Crash
1961 property crash in Australia
1967 'Transistor' Crash in US
1971 MinSec Panic in Australia
1987 Wall Street Crash and Australian stock market crash (share prices dropped 25% within a day)
1997 South East Asian crisis
2000 Dot Com and Telecommunications Crash
2008 global Subprime Crash

That list suggests that globalisation is not a new phenomenon, with past crashes involving several countries and several continents.

     the big picture

Entertaining accounts of digital giddiness are provided by John Cassidy's dot.con: The Greatest Story Ever Sold (New York: HarperCollins 2002), Maggie Mahar's Bull! A History of the Boom, 1982-1999 (New York: HarperBusiness 2004), Vincent Mosco's The Digital Sublime: Myth, Power, and Cyberspace (Cambridge: MIT Press 2004) and Roger Lowenstein's broader Origins of the Crash: The Great Bubble & Its Undoing (New York: Penguin Press 2004). Cassidy is particularly valuable for the detailed financial data at the conclusion of the work.

Cogent analysis of wider economic forces is offered in Irrational Exuberance (Princeton: Princeton Uni Press 2000) and The New Financial Order: Risk in the 21st Century (Princeton: Princeton Uni Press 2003) by Robert Shiller and in Charles Morris' The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash (New York: PublicAffairs 2008).

They might be read in conjunction with Daniel Ben Ami's bracing - but for us not altogether convincing - Cowardly Capitalism: The Myth of the Global Finance Casino (New York: Wiley 2001), Neil Fligstein's The Architecture of Markets: An Economic Sociology of Twenty-First Century Capitalist Societies (Princeton: Princeton Uni Press 2001), Jocelyn Pixley's Emotions in Finance: Distrust and Uncertainty in Global Markets (Cambridge: Cambridge Uni Press 2004) and Steve Fraser's Every Man A Speculator: A History of Wall Street in American Life (New York: HarperCollins 2005). Pop! Why Bubbles Are Great for the Economy (New York: HarperCollins 2007) by Daniel Gross is frothy and misunderstands Robert Fogel's Railroads & American Economic Growth: Essays in Econometric History (Baltimore: Johns Hopkins Uni Press 1964).

Martin Fransman's Telecoms in the Internet Age: From Boom To Bust To? (Oxford: Oxford Uni Press 2002) and Creative Destruction: Business Survival Strategies in the Global Internet Economy (Cambridge: MIT Press 2001) edited by Lee McKnight, Paul Vaaler & Raul Katz are particularly useful for the connectivity sector. There is a more acerbic account in Broadbandits: Inside the $750 Billion Telecom Heist (New York: Wiley 2003) by Om Malik.

Other perspectives are provided in the 2001 A Rude Awakening: Internet Shakeout in 2000 by Elizabeth Demers & Baruch Lev (PDF), The Internet Bubble (New York: HarperCollins 1999) by Anthony Perkins & Michael Perkins, The Coming Internet Depression: Why The High-Tech Boom Will Go Bust ... (New York: Basic Books 2000) by Michael Mandel, Big Deal (New York: Warner 1998) by financier Bruce Wasserstein, the modish The Boom and the Bubble (London: Verso 2002) by Robert Brenner and Asia's Financial Crisis and the Role of Real Estate (Armonk: Sharpe 2000) edited by Koichi Mera & Bertrand Renaud.

     behavioural finance

In February 2003 - some time after the bubble burst - Amazon.com had a market capitalisation (US$8.4bn) equivalent to 40% of General Motors. Yahoo! had a market cap of over 50% of GM, while eBay had a market cap of 110% of that of GM. That has been attributed to behavioural finance - essentially investor perceptions that they'll be able to buy in time to enjoy significant capital appreciation and sell before their peers drive the market down, in other words a manifestation of herd behaviour.

For a technical discussion of behavioural finance see in particular Andrei Schleifer's Inefficient Markets: An Introduction to Behavioural Finance (Oxford: Oxford Uni Press 2000) and Bertrand Roehner's Patterns of Speculation (Cambridge: Cambridge Uni Press 2002).

There is a more accessible account in James Montier's Behavioural Finance - Insights into Irrational Minds and Markets (New York: Wiley 2002), Sian Owen's 2002 Behavioural Finance and the Decision to Invest in High Tech Stocks (PDF) and Hersch Shefrin's Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing (Boston: Harvard Business School Press 2000).

Nasdaq: A History of the Market That Changed the World (Roseville: Prima 2003) by Mark Ingebretsen offers - from our perspective - an unduly indulgent view of NASDAQ. Pointers to studies of investment in high tech, risk and venture capital feature in the E-Capital Guide elsewhere on this site.

Peter Hartcher's prescient Bubble Man: Alan Greenspan and The Missing Seven Trillion (Melbourne: Black Inc 2005) and Jonathan Chait's The Big Con: The True Story of How Washington Got Hoodwinked and Hijacked by Crackpot Economics (Boston: Houghton Mifflin 2007) offer a view of the Fed chairman that is at odds with more laudatory accounts such as Bob Woodward's Maestro: Greenspan's Fed and the American Boom (New York: Simon & Schuster 2000) and Justin Martin's Greenspan: The Man Behind Money (Cambridge: Perseus 2000).

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