Ever since the great financial crisis, commentators have been prone to bubble-phobia: we are so frightened of-missing them that we see them everywhere. There is a property bubble, a bubble in defensive stocks, a bubble in junk bonds, a bubble in technology stock, another in healthcare stocks and biotech and of course a whopper of a bubble in the sovereign bond markets. Or is there? To remind ourselves what a real bubble looks like we should all turn to the classic work on the subject, Charles P. Kindleberger’s Manias, Panics and Crashes: A History of Financial Crises, first written in 1978 and now in its fifth edition.
It isn’t the easiest read for non-economists. Rather than being a chronological history that takes you through each crisis (from tulip to dotcom), it divides the material into chapters looking at their similar drivers and destroyers. But Spectator Life readers should be more than up to the job: it is witty, clever and, in essence, pretty simple stuff.
It is hard to come up with a very precise definition of a financial crisis, says Kindleberger in his fourth edition: ‘It may be that the genus is like a pretty woman: hard to define but recognisable when encountered.’ That said, you can come up with a generalised ‘anatomy of a typical crisis’. It begins with a change (a ‘displacement’). It could be the widespread adoption of a fabulous new invention (diving bells, cars, the internet, etc), a war, or perhaps an ‘unanticipated change of monetary policy’. But whatever it is, it ‘changes the profit opportunities’ available to investors. So they think about it for a bit. Then they start investing. And when it works out (a boom), they go nuts (a speculative mania). They buy, borrow to buy, and then borrow more to buy — not because they see any kind of intrinsic value in the asset, but because they reckon they can flip it for a profit. Once that bit starts, even those who would normally ‘stand aloof’ from markets join in (there is, says Kindleberger, ‘nothing so disturbing to one’s wellbeing and judgment as to see a friend get rich’).
Finally, you get to a point where the price of the asset is far too high to compensate the buyer for the risks and costs of ownership. Then you have a bubble. The fact that it is a bubble won’t be a mystery. It is a myth that no one sees a bubble when they are in it — of course they do; they just want to make money in it at the same time as everyone else. It is what will bring the bubble to an end that is a mystery.
Back to today’s bubbles. The truth is that there aren’t many of them. Some things are expensive (anything with a yield), but not many things are so horribly expensive that it makes sense to call the market for them a bubble. There is, of course, an obvious exception: the European and Japanese sovereign bond markets. If you accept that one definition of a bubble is that the asset in question doesn’t sufficiently compensate you for holding it, you need only look at bond yields (which move in the opposite direction to bond prices) for this to be obvious. Why? Because $13 trillion worth of global bonds (including 80 per cent of the German government bond market) now have negative yields. Buy them and you are guaranteed to make a loss when they are redeemed. That sounds silly for the simple reason that it is silly — and comes with the risk of huge capital losses as a result.
‘Hold such instruments at your own risk; danger of serious injury or death to your capital,’ wrote Paul Singer of Elliot Capital earlier this month. There is a view that our new bubble is different — it is fully supported by global central banks (the main buyers) so it just can’t collapse. That seems unlikely, given the history of manias (there is always a reason why this one is different). It will collapse and huge amounts of money will be lost. But as has been the case in every bubble ever known, that won’t be because the entire financial world didn’t know it was a bubble. It will be because they didn’t know when the end would come — and, despite having all read every page of Manias,-Panics and Crashes, they couldn’t quite bear to get out before the end. Just as has been the case in every bubble ever.
You can give yourself a better chance at-rationality by reading more: try Edward Chancellor’s Devil Take the Hindmost, J.K. Galbraith’s Short History of Financial Euphoria and my own favourite of the last few years, Treasure Hunt by Peter Earle, the story of the way the invention of the diving bell drove a speculative wave of deep-ocean treasure-hunting in the late 1700s.