Gross: Neptune & the South Sea Bubble
The only iron-clad definition of a mania as opposed to a general rise in prices is one made in hindsight: a relatively rapid advance that is entirely retraced by a relatively rapid decline, “relative” being measured by some deviation from the long term rate-of-change. Manias in progress demand rationalization from believers. The rationalization of choice often latches onto the associated innovation within technology, industry or trade just described. Then as now believers in the mania justify inflated prices by insisting that a new era has dawned, some fantasized break with the past with a new set of rules. The internet was supposed to usher in a “new economy” in our own time. In 1719-1720 it was “new world” projections of easy wealth from North and South American trade that were offered as justification. Typically, the associated advance either proves non-existent or its promise, though real enough, falls short or is realized much later in time than the bubble optimists figure. When manias go bust their cheerleader’s emotional convictions reverse course with always typical results and rationalizations. Literature on the South Sea Bubble mimics present day commentary of our own high tech bubble. Some call it a monumental fraud, a scandal designed to enrich a handful of greedy individuals and corrupt government officials.5 Meanwhile, writers like Charles Mackay focus more on the folly and psychology of the victimized masses. This class of explanation often affects a decidedly preachy tone that recasts the tale as an instructive morality tale, a warning to the greedy and gullible to beware of following the madness of crowds. A third, more academic, perspective of recent vintage by economists argues for the rationality of markets and even bubbles. Economists’ models require a theoretical identity between information and price as mediated by rational choices. Psychology and emotions are not thought to affect price swings overall. There are no manias. The South Sea disaster from this perspective was less a function of folly and more the understandable adjustments to financial innovations of the day. Furthermore, academics allow for the formation of “rational bubbles” by investors and speculators who may rationally conclude that a durable preexisting trend should have further to go on that basis alone. This line of thinking was termed “momentum investing” during our recent “rational” bubble. Critics dub this argument the “Greater fool” theory since it is premised on there being an inexhaustible supply of bigger fools than oneself to sell to! Given this characterization our “rational bubble” in fact depends on the irrationality of fools. This brings us back full circle. At one time the Behavioral school of psychology denied the 5
For instance see: Malcolm Balen. The Secret History of the South Sea Bubble, The World’s First Great Financial Scandal. London & New York: Fourth Estate, HarperCollins, 2002.
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