Famous First Bubbles: The Fundamentals of Early Manias (review)

Famous First Bubbles: The Fundamentals of Early Manias. By Peter M. Garber (Cambridge, Mass., The MIT Press, 2000) 163pp. $24.95

Financial historians, besieged with queries by students, colleagues, and reporters about historical precedents for the violent price fluctuations in today's global capital market, will find this book a useful reference. Garber, well-known for his search for fundamental causes of the most famous examples of hyperinflations and stock-market booms, makes his arguments and evidence clear for non-economists, while taking a few potshots at some of his colleagues who continue to pander to the public's desire for simple, psychological explanations of present financial shocks. In this work, he deals with the Dutch tulipmania of 1637, the Mississippi Bubble of 1719/20, and the South Sea Bubble of 1720. All are frequently alluded to as examples of private capital markets gone berserk, usually accompanied by recommendations for increased government regulation of investors, traders, or the markets. Garber, by contrast, believes that these episodes demonstrate government policies gone awry and that much of the subsequent historical literature is an official cover-up.

Most persuasive is his dissection of the scanty historical literature dealing with the tulipmania in Holland in the year 1637. He brings together his previously published papers in the Journal of Political Economy and Journal of Economics Perspectives, and in Eugene N. White (ed.), Crashes and Panics: Lessons from History (Homewood, Ill., 1990), supplemented by a data appendix and a survey of subsequent writings by economists that ignored his analysis in those articles. Briefly, he reduces the dramatic episode of tulipmania to a month's worth of idle speculation by Dutch burgers in Haarlem at the height of the Thirty Years' War, during an outbreak of the plague. These individuals, short of capital and long on leisure, knowingly made unenforceable bargains to deliver common tulips to merchants in six months. In fact, their bargains were not enforced, save at 3.5 to 10 percent of the original amount, for those traders wishing to continue in the tulip business afterward. Authorities saw the capital bound up in these futures contracts as a diversion of funds from more useful investments in government bonds to continue financing the Dutch war effort. The prices usually quoted as examples of speculative excess were, in fact, normal for first-generation bulbs of extraordinary beauty that could be used to reproduce generations of subsequent blooms, which naturally fell sharply in price as production grew. Later markets for bulbs in normal times, whether for tulips or hyacinths, show similar high prices for the originals and subsequent rapid declines.

Less satisfying is his terse treatment of the "macro bubbles" nearly a century later in France and England. He relies mainly on standard sources that increasingly have reduced both the Mississippi and the South Sea bubbles to rational schemes by the French and British governments to reduce the burden of debt service, given weak governments that lacked the authority to raise taxes. They both sought to swap the bulk of their outstanding debt for equity in large joint-stock trading companies with monopoly privileges--the Mississippi Company (Compagnie des Indes) in France and the South Sea Company in Britain. Both efforts had the full support of the government currently in power, and both were successful ultimately in reducing the respective debt burdens, at the expense of debt holders who delayed converting their debt holdings or who failed to sell out their equity holdings before the crash. More could have been made of the connection between the two schemes through international capital movements and the total disruption of the European payments system in the summer of 1720. The latter was caused mostly by John Law's efforts to rescue his system from the dangers of capital flight, but complicated by the last outbreak of the plague on the European continent and the quarantines imposed by municipal authorities.

The comprehensive data appendix on prices quoted...