Harding on bubbles and tulips....
BEING STREET SMART
by Sy Harding
IT'S TOO BAD HISTORY IS SO ELUSIVE! August 26, 2005.
Sometimes I wonder why we humans have such a difficult time learning from history. After all, there is a large amount of truth in the age-old warning that “Those who ignore history are destined to repeat it.”
Yet generation after generation does repeat the mistakes of the past, over and over and over. We do it in our individual lives, not often willing to learn from the previous mistakes of others, preferring to first repeat them ourselves.
It certainly shows up in the history of nations. How many wars have been fought, unsuccessfully, all the way back to biblical times, to try to change the religious or political beliefs of another country through force?
The economic cycle has also repeated with remarkable consistency for hundreds of years, with the list of catalysts that produce the reversals not changing all that much. Yet each time we insist on ignoring history, either because we’re unaware of the history, or because we’re sure that this time will be different. But it never is.
The business cycle is pretty much controlled by changes in the supply/demand equation. Get too many buyers chasing a limited supply of Barbie dolls, baseball cards, beluga caviar, gold bullion, crude oil, stocks, or real estate, and their prices will soar. When something happens to either decrease the demand, or increase the supply, the prices decline.
Most often the change takes place in the form of a drop in demand rather than an increase in supply. Prices just get so high that buyers back off, or even begin to sell to take their profits (not only lessening the demand but adding to the supply).
Yet each time we insist that this time will be different.
A brief segment on a TV show last week may have provided a partial explanation, by indicating how quickly the facts of history disappear, fading into the hazy realm of dinosaurs.
High school seniors were quizzed regarding significant events that affected the lives of their parents and grandparents. Asked what the word Watergate recalled for them, not one answer was even close. Some thought it was the name of a 1980’s rock band. Others thought it was the name of a movie in the 1990s. Greenspan, Shock and Awe, and Kissinger, were placed in similar categories. Understandably, even recent history was ‘back then’. After all, they were just 10 years old five or six years ago.
Is it any wonder then that economic cycles, even market bubbles, seem like unique events each time they take place, that similarities to previous such events have become so lost in time that it’s easy to think this is different?
This is an appropriate time to be discussing bubbles. On Friday, Fed Chairman Alan Greenspan issued his strongest warning yet that the current housing boom could end badly, saying, “Such increases in asset values are too often viewed by market participants as permanent. . . . . . but history has not dealt kindly with the aftermath of such protracted periods [of rising prices].”
It’s interesting that markets have been lofted into unsustainable bubbles much more often in the last 20 years than in previous eras. I don’t know what that says about the enthusiasm of the current generation. But we had the real estate bubble in the U.S. in 1989, the Japanese stock market bubble in 1990, the real estate and stock market bubbles in Asia in 1997, and the U.S. stock market bubble in 2000.
While they are underway, rationales are devised to make it reasonable that an Amazon.com, or Sun Microsystems, could be worth 200 times their annual earnings, or a house could be worth 30 times its annual rental value (versus the normal 10 times). But after the bubbles burst, the foolishness of the previous extreme of enthusiasm is readily recognized.
On that score, one of the most interesting bubbles in history was the Tulip Mania. The story began in 1559, when a handful of tulip bulbs were brought from Constantinople to Holland and Germany. People who saw the resulting flowers were fascinated. Tulips soon became a status symbol for the wealthy, not only because of their beauty, but because they were hard to get.
As demand rose, the prices of tulip bulbs soared. Speculators then got involved, not for the beauty of the flowers but for the money, and soon active trading of tulip bulbs and tulip futures began on the commodity exchanges. At the top of the bubble, a single tulip bulb was trading for the same price as two tons of butter, or in today’s dollars, roughly $35,000. People were selling everything they owned, even their homes, to come up with more money for a few more tulip bulbs.
At the time, it seemed to make sense. Supply would remain scarce, while demand would grow internationally. Of course in the financial collapse that followed, the truth regarding the true value of tulip bulbs became obvious.
Which brings up the question of whether anything has changed that makes a house worth double, or in some cases triple, its value of a few years ago, in spite of very low overall inflation. Could it be that as with most bubbles, the demand/supply equation got out of whack once speculators (who accounted for 23% of homes sold in 2004) got involved, aided by very creative financing by lenders (which incidentally may have put some home-buyers in harm’s way)?
Sy Harding is president of Asset Management Research Corp., DeLand, FL, publisher of The Street Smart Report Online at www.StreetSmartReport.com and author of 1999’s Riding The Bear – How To Prosper In the Coming Bear Market!
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