Investment Bubbles: From Dutch Tulip Mania to Housing

 Me in a bubble - Botanic Garden Cluj-Napoca

We are all familiar with investment bubbles, given that we’ve seen how sharp price increases in real estates in the early-to-mid 2000s were followed by a big drop in prices. Some folks have really been hit hard, as their homes have declined in value to a point where they’ve lost quite a bit of money. People that bought near the peak, and borrowed money to do so, discovered that the real estate bubble threat was in fact real.

Have we learned lessons from this experience? Or, will history repeat itself at some point in the future – even soon?

My prediction, based on history, is that there will be investment bubbles that emerge once again in our future. Not just one here and there, but plenty of them. It’s the way things have been with people over the last several centuries – and perhaps prior to that too, for all we know.  Let’s take a look at two historical investment bubbles of note:

Dutch Tulip Bubble, 1600’s.  As Holland grew in prosperity, certain Tulips began to increase in popularity. From there, the bulbs became hot commodities in a very short period of time. While the supply of bulbs didn’t increase, the number of people interested in purchasing them did. Soon, these people ran up the price of the bulbs to extraordinary amounts. By some accounts, people were paying multiple times their annual salaries, just for a tulip bulb.  Eventually, the lunacy gave way to a crash in prices, and many people were left in ruins – with tulip bulbs to show for it.

South Seas Company Bubble, 1700’s.  As England was in debt, it worked a deal with the South Sea Company to service its debt in exchange for “rights” to trade in places such as Asia, Africa, and South America. Stock was issued, and investors were caught up in the euphoria over this monopoly that had incredible potential (albeit in some business that was quite unsavory).  The stock price reached dizzying heights, before doubts crept in and the decline started. It was held up for a while by legislation (“Bubble Act”), but prices eventually dropped like a rock. Big money was lost by many, except perhaps those who sold high and took off with their money.

Clearly, investment bubbles have been occurring for many years.

In the late 20th and early 21st centuries, we have seen bubbles that are more ingrained in our minds:

Dot Com Bubble, late 1990’s/early 2000s.  This was quite a goldmine for those who sold at the right time, but a wealth destroyer for those who purchased at the wrong time. Companies with poor earnings (if any) had their stock prices pumped up based on future potential. Ultimately, the mania went out of control, and prices dropped. Here’s how the NASDAQ performed during the bubble, with the following closing prices during these months (Source: Yahoo! Finance)

  • February 1999 – $2,288
  • February 2000 – $4,697
  • February 2001 – $2,152
  • February 2002 – $1,731 

Housing Bubble, early 2000’s to Present. This is so recent (and the effects continue today) that we know what the effects have been on people. Home prices in some areas have dropped by well over 50% since their peak. In many cases, homes just aren’t selling, and people are deep underwater on their mortgages.  It’s a boon for first-time homebuyers or those just not currently owning but looking to buy.  For the rest – particularly those who bought at the peak – it’s been less than desirable. For some of this group, it’s been devastating. 

All of this historical information leads me to think of one more bubble:

The Baseball Card Bubble, 1980s. This probably eluded most people back in the day, and these days I wouldn’t be surprised if most people don’t know about this micro-market bubble. I do, since I was a baseball card collector as a kid – before moving on to the teenage years, when I soon dropped collecting all together for more exciting pursuits :)

As a huge sports fan, I started collecting cards and really enjoyed the older cards since I liked the game’s history. Then, the current cards started to skyrocket in popularity. Back in 1983-1987, it was crazy.  I recall that packs of cards were cheap, less than 50 cents each. However, if you got the right card, you could make nice chunk of change. For example, when Mark McGwire was a rookie in the 1980s, his card was worth as much as $50. Can you imagine? Now, you probably could get them for $1 without much trouble.

Personally, I “invested” in a large amount of Barry Bonds cards back in 1987 when he was a young player breaking in. Who would have known he would eventually be the home run “champion” around 2 decades later? I outlined this story in my post “The One That Got Away”. Not much was invested, but nothing was made, despite the player’s amazing statistics.  The baseball card bubble had already burst, and prices had plummeted.

Lesson Learned: Investment bubbles do happen, and we have to watch carefully for signs of them

My questions for you:

  1. As we look forward, do you think we might be looking at “The Gold Bubble of 2011 or 2012?” Prices are staggeringly high compared to a decade ago.
  2. Are there any other investments that you think may stand to lose significant value in the coming years?

photo credit: bortescristian

Comments

  1. says

    I remember reading about the tulip mania in detail from the tulip’s perspective in Michael Pollan’s book “The Botany of Desire”.
    I don’t know about gold being in a bubble. Prices in nominal dollars are high, but no in inflation-adjusted terms. Its purchasing power with respect to other commodities seems to be stable, although I haven’t checked in a while.
    I suppose the valuable lesson from reading about bubbles is to not chase the trend, but rather wait for the proverbial blood to flow in the streets.

    • Squirrelers says

      101 Centavos – I like your last quote. Not a bad way to look at it. Really, when bubbles burst there could be buying opportunities – such as with housing. Just have to make sure the bubble deflates enough.

    • Squirrelers says

      MoneyCone – agreed, and we saw that quite clearly with the dot com situation. Companies with no signs of profit much less cash flow shouldn’t all be viewed as high expected value ventures.

  2. says

    Gold is absolutely in a bubble, but whether it is only beginning or nearly at its end is hard to tell. Gold is a negative carry asset that makes sense only in ZIRP environments, and I’m generally not too interested in holding assets that don’t create cash flow. Wall Street usually is too, but with money being free, all commodities are positive carry.

    Watch what happens on the first rate hike. ;)

  3. says

    I thought asset allocation and your risk tolerance was intended to protect you from the extremes. I remember someone saying the market over forty years has a return of 8-10%. Of course, there are ups and downs and I don’t want to retire when there are downs. As I get closer to retirement I am thinking about this much more.

    • Squirrelers says

      krantcents – yes, asset allocation does help in that regard. Thing is, I think one has to pay attention to the difference between rebalancing and dealing with bubbles. As for the former, rebalancing is totally sensible as one approaches retirement.

    • Squirrelers says

      Robert – it’s human nature, it seems to be tempted to try to get more and more. That’s why I like the term “mania” as associated with the Dutch Tulip bubble. It could be applied to dot com stocks and housing as well too. Gold seems to be a bit short of mania based on anecdotal evidence, but there are some signs. I was at a mall recently and saw a kiosk where the guy was buying gold. Wouldn’t have seen this quite as often, in such a mainstream setting, just a few years ago.

  4. says

    Years ago I was really into speculation, commodities and gold prices. Unfortunately at the time I had no real money to invest. On paper I did very very well but I wondered at the time if I had the actual cash – would it have translated into the same profit margins? Meaning, did I do well only because subconciously I knew it wasn’t ‘real money’ I was playing with? I guess I will never know :) The tulip situation really intrigues me to this day though!

    Great post!!!

  5. says

    If rates start rising significantly I think JT McGee may have a point, but right now if you look at gold and other commodities there is not a huge relative disparity between them. The rising tide of free money has lifted all of the boats.

    Still, anything can go into a bubble; central bank policies and government regulations can certainly exacerbate them like in the housing crisis but psychology plays its role, too.

  6. says

    A lot of people — including the writer of a recent CNN Money article — think that gold is fairly priced right now, and not in a bubble. I disagree.

    When the market crashed in 2008, investors fled to the safety of US Treasuries and — the old standby — gold. We’re in a bull market now (in 2011), but the market is still volatile, and many investors are scared — they were burned too recently, and too severely. Freak events such as the “Flash Crash,” the economic woes of Greece, and instability in Libya/Egypt don’t do anything to reassure investors.

    And so, wary of the market, investors stay in gold, and prices remain high. But — mark my words — when confidence in the US stock market gets restored, gold will fall.

    I’m not normally certain about most things in the market (after all, no one knows the future), but I’m totally convinced gold is in a bubble right now.

  7. says

    Nice list of the past bubbles that we have. Investment bubbles have been around for years and we’ve witnessed the most recent ones such as the housing bubble and the tech stock bubble. However, even with these experiences, people still won’t learn from these lessons as we will continue to see new bubble in the future.

  8. says

    Bubbles will continue to exist, based on human nature. First, there is Greed which causes bubbles to form and grow. Then, there is Fear, which causes them to pop.

    Avoiding the bubble is the hard part. Jumping in to profit from the pop is the easy part.

    • Squirrelers says

      Bret – Good way to put it, about avoiding and profiting. I think many are viewing real estate this way now, though who knows whether or not that broad asset class still has room to drop in value on average. Bubbles don’t always pop quickly, sometimes they deflate over time.

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