Written by Adam Rida
Edited by Jimei Shen and Alexander Fleiss from Rebellion Research
We are living through a present day bubble with the spectacular rise of GameStop stock from $4 to $483 per share thanks to social media.
But will this bubble burst similar to the most famous bubble in history?
1634, Holland. Newspapers have experienced a major boom, and for several years have been featuring exotic flowers that have become a symbol of luxury. A very lucrative business developed for whoever imported plants to Europe. Among them, tulips and especially a very rare type that had different colors because of a virus infection became popular.
Like all other species, because of their scarcity and the image of wealth associated with it, the price of tulips bulbs went up significantly as figure 1 shows. Nothing alarming at the time though, but tulip business became serious, and more and more investors wanted to be part of what would later be called the tulip mania.
Figure 1. An index of prices recorded in Dutch tulip contracts
Source: Thompson, E.A., 2007. The tulipmania: Fact or artifact?. Public Choice, 130(1–2), pp.99–114.
An event that would completely change this ecosystem happened at this time, futures contracts were authorized on the tulip bubble.
There were two ways to invest, you could either wait for summer and buy tulips on the spot market or you could use the brand new futures market. This convinced more and more people to invest since people didn’t have to own the bulbs themselves. This was the start of huge speculation but on the contracts not on the tulips themselves.
It helped a lot to facilitate investment. In 1635, it became possible to buy part of tulips if you couldn’t afford to buy a whole. Some reports say that at the peak of the bubble the price rose to the point where a contract on one tulip could be negotiated at the price of 15 times the annual salary of a specialized worker.
Falling in the Liquidity Trap
Some transactions even needed to be done at a notary. Some people called this trading activity “wind trading” since there were no real bulbs behind it, so no real value. In 1636, people started to speculate on non-infected tulips. The more popular tulips grew, the more people were willing to pay the price, and at this time the best way to inform people was through newspapers. This is the core of the problem when it comes to feeding and growing an economic bubble. People can’t escape fear of missing out (FOMO), particularly when people already made money with it.
Some historians and economists think that the origin of the bursting of the bubble is the bubonic plague that hit Haarlem, the epicenter of the tulip mania. Investors couldn’t honor their future contracts so the price dropped. Fatalism and the major systemic event could be the reason for the burst. In reaction to this crisis, Amsterdam representatives canceled all the contracts, and Amsterdam judges classified tulip bulbs speculation as gambling, and therefore no one had the obligation to honor their contracts. With the help of the authorities, this bubble had a little if not no impact on the economy at the time.
Most of the facts before were reported by Mackay in his book “Extraordinary Popular Delusions and the Madness of Crowds”, yet no one really knows what happens in detail and there is definitely a lack of real data to perform any advanced analysis. In this context, some say that the speculation only hit a small number of people (1 Anne Goldar 2007). Peter Garber says that the speculation “was just a trivial winter pastime, played around a table by plague-haunted people trying to distract themselves by betting on a bustling tulip market”. Exchanges were mainly done between traders and wealthy workers.
Even though the price rose, no liquid money was exchanged between buyers and sellers except if a buyer was under debt. The drop didn’t cause significant losses In order to qualify the tulip mania as a bubble, bulbs value needed to be drastically shifted from its intrinsic value, but the rise and the speculation were only on the futures market. In 2002, Thompson an economist considered that the rise was natural since people were coming back from the war (30 years war) and wanted to earn more money, and faster to compensate their losses.
The fact that bulbs were already seeded during the hysteria can explain why it was sustained. The supply was fixed so the price elasticity was really low and the inflation has been brutal. The veracity of those elements has been contested but having bubbles happening, again and again, shows us that it wasn’t a unique event.
All of those elements are responsible for creating and feeding the bubble, but there is another factor that shouldn’t be underestimated. The vectors of information, media, and influential people. In the 17th century, an important industry has also been developed and scaled up, the newspaper industry.
Information and news (especially financial ones) have never been more easily reachable by the population. This is definitely a plausible factor for feeding the bubble. A new way to make money fast has appeared and everyone is talking about it and you don’t even need to store the bulbs to invest. This kind of deal could have been relayed easily through newspapers and influential people at the time, whose voice suddenly with the power of newspaper could attain thousands in a day.
A speculative bubble can only grow if there are more investors. In order to have more investors, more people need to know about this investment opportunity, therefore the information vector is at least as much responsible as other factors. In fact, when we look back at history, economic bubbles are happening more often as time goes by (internet bubble, real estate bubble with the subprime crisis, Altcoins after Bitcoin ATH in 2017…). At the same time news and information is becoming reachable faster, more easily, and in abundance.
The rise of social media and internet influencers is a perfect demonstration of it, if there is an “easy” way to make money, you can be sure that dozens of youtube videos are already online trying to sell you courses on how to use their methods and thousands if not hundreds of people would know about it. To put it in a more actual context, we can legitimately ask ourselves if bitcoin and cryptos are bubbles or not. Here is a picture of the value of a crypto asset called HOTDOG which is a token issued by a project working on DeFi.
Figure 2. HOTDOG prices
Even though it looks like it, it wasn’t a bubble since it was almost impossible to put a value on the tokens and the issuers were controlling the supply and the liquidity. The thing is, the crypto ecosystem is vast and with a lot of very different products. Most of them never existed before so they don’t have any “referential” value to consider their pricing as uncorrelated to its intrinsic value. The only aspect that you can see that could reflect a bubble is the FOMO and the number of investors increasing.
The biggest problem is how the information arrives to people.
People see Bitcoin as a complex thing that takes values. So when they hear about another cryptocurrency, they sometimes don’t bother to look in detail at what this product reflects and they buy it with the hope of it outperforming Bitcoin. The perfect illustration of the danger of this is the 2017 ICOs golden age.
A lot of projects raised millions but many of them were scams that used the power of marketing and social media to create hype around their product. Many scam ICOs didn’t even have a real company registered; they just used social engineering by leveraging social media, FOMO, and Bitcoin hype. Whoever masters the power of the internet’s attention could harm the economy dangerously. This power shouldn’t be underestimated.
We had a perfect demonstration of the effects that could be provoked by social media influence. A few weeks ago, a fake Elon Musk account tweeted about a cryptocurrency called the DogeCoin and the price went up 30% within minutes. The real Elon Musk this time tweeted about Signal the messaging application and the stock price of the toothpaste company went up. This shows us that people when presented with an opportunity will prefer having an argument of authority coming from a trusted person as opposed to fetching the information themselves. Today, this trusted source can be easily impersonated or sometimes with malicious intentions.
Word of mouth is also very powerful in the context of feeding bubbles, and today’s technologies make it almost instantaneous. The fastest ICO raised millions within minutes, for example, Brave raised $35millions in 30 seconds. Only by harnessing the power of an online community, a subreddit managed to reverse the market last week by buying simultaneously GameStop stock and therefore driving the price up, causing billions of dollars in losses to a major hedge fund who had short positions. The examples are endless and are happening more often than ever, those elements combined showcase perfectly the dangers of having mass and unregulated information.
When in the middle of an increase in the value of an asset, FOMO makes some people more vulnerable to fake news and scams. They don’t know what they are buying but it’s called cryptocurrencies and the tech behind it looks good. This is the exact same principle that triggered the tulip bubble, people were no longer buying and selling the bulbs themselves so they lost the notion of real value, it was pure speculation. In the future, we will obviously see more bubbles rise and burst more frequently because of the democratization of information sources.
Even though regulations are added after every bubble, there will always be something new that allows people to speculate. Whether it’s GameStop, tulips or internet sensations of the 90s, bubbles are a part of human existence.
Another thing to consider is the COVID-19 crisis and its impact. Most of the countries are entering into a recession, therefore the purchasing power will naturally decrease. This could encourage people to try to speculate and invest in order to make more profit as what happened during the tulip mania. This showcases another facet of the power of tech giants, they could influence the economy only by making some information available to other people. And 2008 showed us that a bubble can have a dramatic impact on the economy and on a country. We now have a kind of moderation when it comes to political content on social media, should we consider putting the same kind of regulation when it comes to investing?