What causes financial bubbles? What pops them?
These questions have plagued investors, politicians, and the public more generally for years. In recent memory, we have seen bubbles occur more and more frequently – and more severely, as our experience with the 2008 financial crisis has shown. Understanding why bubbles happen is therefore of paramount concern.
William Quinn and John Turner offer their solution to this problem in Boom and Bust. The authors tackle financial bubbles – note that this is not the same as financial crises or recessions (though they can be linked). Indeed, a key argument of this book is that bubbles can sometimes be positive. Their main contribution, however, is an explanatory framework that not only helps us understand why bubbles happen, but which (so they argue) can help us predict when bubbles are about to occur. Their framework is built on the metaphor of the ‘fire triangle’ – apt because, just like bubbles, “fires can cause serious damage, [but] they can also be useful in certain ecosystems”. The three sides of the “bubble triangle” are speculation, marketability, and money (or credit). An increase of these three variables will create the conditions that make bubbles possible: all that it needs is a spark, which comes in the form of some political or technological change. To demonstrate the validity of this model, Quinn and Turner lead the reader through eleven cases studies of some of the worst bubbles the world has seen, beginning with the South Sea Bubble in 1720 and ending with the 2015 bubble in China. Each chapter follows the same formula, first outlining the build up to the boom, the dramatic rise, and then the subsequent crash. It then explores the causes, delineating the contributing factors and linking them to the different sides of the bubble triangle. Finally, Quinn and Turner explore the consequences of each crash, considering the knock-on effects, including both the positives and negatives.
The bubble triangle is a convincing model, and its applicability to each case study is carefully laid out. Its explanatory power might have been further demonstrated if the authors focused not just on the worst bubbles, but more on bubbles avoided. These are referenced in places, but more careful attention to conditions where one side of the triangle was removed would have made the argument even more convincing. The model is also relatively broad. This contributes to its ability to explain a variety of bubbles, but it also means that the three factors – speculation, marketability, and money/credit – were also present in instances where bubbles do not occur. Whether a bubble actually happens is a matter of degree, which, it seems, is immeasurable. Indeed, these factors increase the “likelihood of bubbles occurring”, but predicting bubbles “chiefly comes down to being able to predict [political or technological] sparks” – an incredibly difficult task, to say the least. The predictive power might be increased had the authors explicitly built into their framework the factors which contribute to each side of the triangle. Channels of information, for example, especially the media (print newspapers historically; television recently), play an undoubtedly important role in increasing speculation, as the authors clearly demonstrate. This might form a more explicit aspect of their theoretical framework. Ultimately, therefore, this means that the framework has limited predictive power; it seems that bubbles are only truly evident after the fact. That being said, Quinn and Turner are able to offer some general (and important) advice to anyone connected to the financial markets, especially novice or private investors.
Each case study is well explained, with the story of each crisis told compellingly. Graphs are used in each chapter, and these clearly demonstrate the extent of each bubble and the depth of the crash after the bubble is burst. The authors are able to provide lucid accounts of relatively complex periods of economic and financial history. For the historical case studies, contemporaries are quoted well, and a retelling of their lived experience adds colour to what might otherwise be quite a dry subject. The authors show that these events, from past to present, affected real people from very different walks of life and all across the socioeconomic strata. This was especially true for the 2008 crisis, where homes became a speculative investment, and the resulting crash was a significant cause of homelessness. The rigour of the historical analyses is generally thorough, though at times, for example in the case of early-nineteenth century investment in Latin American mining companies, the authors rely on contemporary commentary without setting these observations in the context of contemporary debate. This issue is not pervasive, however. The authors also do well to explain some of the key concepts as they go along. On page 109, for example, we are given a short but important explanation of how short selling was possible through the use of futures contracts. Given the nature of the content, this book might not be immediately accessible to a broader, more general audience. This is a shame, because the conclusions are deeply important. A glossary of key terms would have been useful. People need to understand how and why bubbles form, and how they can impact the economy more broadly, because these problems affect us all: it affects our jobs and our pensions, and even our homes. Citizens need to be well-informed so that they can put pressure on elected officials and the banks they use.
Some of the conclusions that Quinn and Turner draw are interesting, and even surprising. Their emphasis on different types of bubbles is enlightening, and their argument that some bubbles can even be positive (such as those that formed around the period of ‘bicycle mania’ in the late-nineteenth century, and with the more recent ‘Dotcom bubble’). These bubbles had a limited impact on the wider economy, and the technological advancements they led to have been revolutionary. The bicycle, for example, was important for women’s rights, as “cycling gave women an unprecedented level of personal mobility”. The worst bubbles were those where assets had been bought using loans, meaning that the bursting of the bubble had a broader impact on the banking sector, and therefore the rest of the economy. Another key insight is that bubbles don’t necessarily pop, as people assume (and, indeed, as the bubble metaphor implies!), but more often deflate. Prices fall slowly over months, and frequently over years. It’s rarely evident until some time has passed that the bubble has actually popped. At other points, especially with the subprime mortgage bubble of 2008, the aftereffects were long lived, affecting us still to this day. Later case studies reveal the difficulties that governments have balancing regulations that prevent bubbles against the need to expand GDP and grow the economy. Importantly, the media plays a striking role in contributing to bubbles. At times newspapers have been paid to write favourable stories about particular investment opportunities, or they have become overly reliant on advertisements for such investments. Recently, TV programmes such as Location, Location, Location in the UK and House Hunters in the US have been blamed for fuelling our obsession with treating homes as an speculative investment, rather than as a place to live.
What lessons do Quinn and Turner have for us? One is to inform yourself on how bubbles form (this book is a great place to start), and keep abreast of political and technological developments that could turn sound investments into a speculative mania. Another is to treat the media with healthy scepticism, and consider not just what they are telling you, but why they are telling you something. Finally, and perhaps most importantly, if you get in a taxi, and the taxi driver is recommending you some great get-rich-quick scheme, that’s when it’s time to stay away from the market.
William Quinn and John D. Turner, Boom and Bust: A Global History of Financial Bubbles (Cambridge: Cambridge University Press, 2020), pp. 296.