Flower Power: The Lessons
An article in the financial section of the New York Observer this spring described a company named NetJ.com Corporation. NetJ.com has no business operations, no revenue and no assets to speak of. To quote its business plan, filed with the Securities and Exchange Commission, "the company is not currently engaged in any substantial business activity and has no plans to engage in any such activity in the foreseeable future." This would seem to render NetJ.com worthless. Yet in February, it was capitalized at $22.9 million.
Despite the Nasdaq's recent gyrations, a market like this one can't help but bring to mind tulipmania, the brief period of fantastic speculation in tulip bulbs in seventeenth-century Holland. Ever since Charles Mackay wrote his 1841 classic, Extraordinary Popular Delusions and the Madness of Crowds, tulipmania has been a potent symbol of the euphoric irrationality of financial speculation. According to Mackay, in the late 1630s a single tulip bulb in the Netherlands might be sold for a price equivalent to that for four oxen. The high point of Mackay's story is the anecdote of a sailor who breakfasted upon what he believed to be an ordinary onion: "Little did he dream that he had been eating a breakfast whose cost might have regaled a whole ship's crew for a twelvemonth."
But Mackay wrote back in those old-fashioned days, when people believed that markets might be speculative, something other than arbiters of perfect truth and rationality. Today, trendy academics like to say that the tulip craze wasn't a bubble at all. In a paper published in 1989, economist Peter Garber argued that the dramatic increase in bulb prices simply reflected the great demand for rare varieties of the bulb. As the flowers multiplied, their price fell. The best-known bubble in history turns out to have been a rational response to fundamentals, after all. (Even Garber, though, was stumped by the twentyfold price increase for common varieties of tulip in the month before the crash; he conceded that this might not have been completely rational--but when you're an economist, it's the model, not the data, that counts.)
Now there's a new history of tulipmania to go with today's sky-high market. Tulipomania, by Mike Dash, retells yet again the story of the flower craze, emphasizing the economic context of the bubble and its effects on Dutch society and culture. Perhaps the strangest thing about this book is what it doesn't talk about: Clearly it's supposed to provide insight into the stock-market boom of the past decade, yet Dash scrupulously avoids saying anything direct about the Dow Jones, preferring instead to expound upon the finer points of tulip cultivation. Still, it's a colorful description of one of the oddest periods of financial history. And while Dash doesn't comment directly on financial euphoria today--wouldn't want to alarm anyone!--if one reads between the lines, Tulipomania offers its own sly commentary on contemporary market fever.
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For one thing, Dash attributes the tulip craze to inexperienced investors crowding into the market--not unlike today's day traders. Tulipmania exploded in 1636, during an economic boom in the Netherlands. But despite economic growth, artisans and laborers found themselves barely eking out a decent living, unable to cash in. For these humble sorts, the tulip market offered an irresistible temptation. "Growing bulbs was a lot easier than working an eighty-hour week hammering horseshoes or working a loom," writes Dash. Many of the people growing and selling bulbs were new to the flower business altogether and had little experience in the financial markets. At the same time, speculative financial instruments--like the futures market--were just coming into existence. One can almost hear Alan Greenspan's anxious sigh as Dash describes these novices to the market.
In a sense, Dash uses tulipmania to legitimize "normal" financial activity in the early seventeenth century, much as the recent flick Boiler Room told a parable of cheating bucket shops to demonstrate the virtues of real brokerages. Dash suggests that the tulip market was a "rough but intended parody" of the newly built beurs--the legitimate Amsterdam stock market. Tulips were more frequently traded in raucous pubs (substitute: chat rooms) than in the calm halls of the beurs. Instead of being staffed by experienced bankers or people who understood the complexity of financial markets, the tulip market was dominated by "country people and poor city dwellers who had, when they started dealing in bulbs, almost certainly never owned a single share in their entire lives."
The crash came on the first Tuesday of February, 1637. For no apparent reason, all of a sudden there were no buyers for the bulbs: "The market for tulips simply ceased to exist." Since prices had been rising thanks to simple speculation, they went into a free fall. As Dash puts it, the rout "was far more rapid and complete than history's most notorious financial disaster, the Wall Street Crash of 1929 and the Great Depression that followed it." However, there were few links between the tulip market and the real economy, which was hardly based on mass consumption: No generalized crisis followed the collapse of flower prices.
Tulipomania concludes with a few non sequiturs about horticultural history; Dash stubbornly refuses to say anything substantive about finance. (His other implicit analogies don't hold up. Most stock ownership is concentrated in the wealthiest 10 percent of the population. Novice investors and day traders aren't creating the boom; rather, they are riding on its coattails.) But other historians who aren't so allergic to generalization think the episode tells us something important about how financial markets work. For the great economic historian Charles Kindleberger, the tulip bubble serves as a prime example of speculation. Markets, he argues, though generally rational, are not immune to manias, which are by definition irrational. In a bubble, buyers purchase goods simply because they believe their prices will increase. This stokes demand for the goods, hence becoming, at least in the short term, a self-fulfilling prophecy.
However, the moment buyers decide they can no longer risk bidding prices up, they collapse immediately--since the product was only valued as long as people believed its price would rise. Kindleberger believed that an expansion of credit could feed such a speculative frenzy (and thus magnify the effects of a crash)--a useful reminder in times like these, when debt held by financial institutions, corporate debt and good old-fashioned credit-card debt are on the rise, making it seem likely that rising interest rates will call a halt to the party over time.
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So how about the trillion-dollar-plus question: Is today's market a bubble? Despite reading stories like NetJ.com's in the paper nearly every week, and the fabulously high valuations of other tech companies that seem to show little prospect of ever turning a profit, it's not so clear. For one thing, thanks to massive stock buybacks--and mergers and acquisitions--corporations are actually returning much more cash to shareholders than they have in the past, over 90 percent of after-tax profits over the 1990s, according to Left Business Observer editor Doug Henwood (about double the rate during the Golden Age of the fifties and sixties, when economic growth was distributed far more equally than it is today). It may make sense for investors to value their shares more highly. One might ask whether giving so much money back to shareholders is viable over the long term; as my friend who peruses the Flow of Funds like baseball box scores has noted, corporations are supporting this massive transfer of cash to shareholders through heavy borrowing. This can't endure indefinitely.
On a deeper level, the end of the Soviet Union, social democracy in Western Europe and anticolonial movements in the Third World have left capitalism with no political or ideological opposition to speak of. And what the stock market clearly does tell us about is the balance of power between labor and capital underlying the economy as a whole. From the standpoint of the very rich, there's plenty to celebrate. After all, the American labor movement was hacked down over the 1980s; the massive skewing upward of income distribution has kept moguls fat and happy. What better cause could there be for euphoria? For this very reason, a few good strikes or a couple months of rising wages may well prove the most effective antidote to market fever. If the balance of power between workers and owners shifts in the real economy, Wall Street will start to seem more dangerous. When the market falls this time--unlike the tulipmania--it's likely to be because of changes in the economy and politics that go well beyond the Dow Jones.