floating financial bubbles

wars float financial bubbles

"When new money is printed, its effect is not felt instantaneously across all market sectors.

The effect moves from one individual to another individual and thus from one market to another market.

Monetary pumping generates bubble activities across all markets as time goes by.

Once, however, the bank tightens its monetary stance, i.e. reduces monetary pumping, this undermines various bubble activities.

The bubble bursts.

Since monetary pumping generates bubble activities across all markets, obviously the eventual bursting of the bubbles will permeate all markets." - Frank Shostak

"A Satire of Tulip Mania" by Jan Brueghel the Younger (ca. 1640)
depicts speculators as brainless monkeys in contemporary upper-class dress.

tulip mania bubble

Tulip mania or tulipomania (Dutch names include tulpenmanie, tulpomanie, tulpenwoede, tulpengekte, and bollengekte) was a period in the Dutch Golden Age during which contract prices for bulbs of the recently introduced tulip reached extraordinarily high levels and then suddenly collapsed.

At the peak of tulip mania in February 1637, tulip contracts sold for more than 10 times the annual income of a skilled craftsman.

The mosaic virus spreads only through buds, not seeds, and so cultivating the most appealing varieties takes years.

Propagation is greatly slowed down by the virus.

Tulips bloom in April and May for only about a week, and the secondary buds appear shortly thereafter.

Bulbs can be uprooted and moved about from June to September, and thus actual purchases (in the spot market) occurred during these months.

During the rest of the year, traders signed futures contracts before a notary to purchase tulips at the end of the season.

The futures contract promises to guarantee delivery of specificied assets, in this case tulip bulbs, on a specific date for an agreed upon at this point in time fixed price.

Short selling is banned by an edict of 1610, which is reiterated or strengthened in 1621 and 1630, and again in 1636.

Short sellers were not prosecuted under these edicts, but their contracts were deemed unenforceable.

1636 Dutch create a type of formal futures markets where contracts to buy bulbs at the end of the season are bought and sold.

Traders met in "colleges" at taverns and buyers were required to pay a 2.5% "wine money" fee, up to a maximum of three florins, per trade.

Neither party paid an initial margin nor a mark-to-market margin, and all contracts were with the individual counterparties rather than with the exchange.
No deliveries were ever made to fulfill these contracts because of the market collapse in February 1637.

On February 24, 1637, the self-regulating guild of Dutch florists, in a decision that was later ratified by the Dutch Parliament, announced that all futures contracts written after November 30, 1636 and before the re-opening of the cash market in the early Spring, were to be interpreted as call option contracts, or options to purchase in the future.

This change of law was done at the behest of major Dutch tulip investors who were trying to recoup lost money because of a German setback in the Thirty Years' War.

They simply relieved the futures purchaser of the requirment to purchase if they paid a small fixed percentage of the contract price as a default on the failure to purchase.

An option contract purchases the right to buy an asset at a date in the future at an agreed upon price.

This trade was centered in Haarlem during the height of a bubonic plague epidemic, which may have contributed to a culture of fatalistic risk taking.

the Mississippi bubble

"Imagine the following: a collection of debts owed by a highly leveraged borrower with a bad credit record is magically transformed into marketable securities with triple-A yields.

How is this miracle performed?

It is through the power of financial innovation and free capital markets!

It could be the story of subprime mortgages in the US; but it is not.

It is the story of government debt in France in the early 18th century.

In 1719-20, a financial whirlwind swept through France.

Shares in the Compagnie d'Occident, or the Mississippi Company, rose 1,000 per cent and then fell by 90 per cent in less than two years.

The story illuminates current events." - James Macdonald, Financial Times (London) March 6, 2008 HOW THE FRENCH INVENTED SUBPRIME IN 1719

By the end of the War of Spanish Succession in 1714 public debt had risen to over 100 per cent of national income and was subjected to forced reductions of interest and principal.

Confidence collapsed.

Government bonds sold for discounts of up to 75 per cent.

Louis XIV, the "Sun King," had consolidated French power in Europe but the Nine Year War and the War of Spanish Succession had effectively bankrupt France by 1715 the year of Louis XIV's death.

France defaulted on its debt, high taxes burdened the country and the value of gold and silver currency fluctuated wildly.

Louis XV turned to the Duke of Orleans who hired John Law, a Scottish adventurer, economic theorist, and financial wizard/engineer.

The charismatic John Law lived by his wits at the gambling table and had never held any post related to public finance.

The government would issue a new series of bonds, paying only 3 per cent in exchange for its old debts which paid 4-5 per cent, in exchange for shares in the Mississippi Trading Company, which held monopoly trading rights to the French colonies.

For the government, the cost of servicing the debt would fall sharply and the budget would look rosier.

The trading rights to the French colonies were largely worthless, for there were no profits at the time and the Mississippi Company had existed for a while without exciting public interest.

The market for government debts was moribund.

John Law's aim was to make Mississippi shares as actively traded as possible.

This provided an incentive to swap - to get a more liquid security and the prospect of speculative gains.

John Law repackaged a collection of "subprime" debts as marketable securities under a different name and thereby increased their investor appeal.

Law claimed that Mississippi shares would be so actively traded that they would constitute "a new form of money."

For this governmnet debt reduction plan to succeed a new bank must be founded to provide a massive monetary stimulus of easy money to get bond holding creditors to convert government bonds into Mississippi trading company shares.

1716 John Law established the Banque Générale, a bank with the authority to issue fiat bank notes.

In 1717 John Law established the Compagnie d'Occident ("Company of the West") and obtained a 25-year monopoly to develop the vast French territories in the Mississippi River valley of North America.

Compagnie d'Occident soon monopolized the French tobacco and African slave trades, and by 1719 the Compagnie des Indes ("Company of the Indies"), as it had been renamed, held a complete monopoly of France's colonial trade.

John Law took over the collection of French taxes and the minting of money.

In effect, John Law controlled both the country's foreign trade and its finances.

An effective marketing scheme was developed describing the Compagnie des Indes as a future profit generator due to its monopolistic controls of the exaggerated wealth of Louisiana.

This marketing scheme sent the price for a share from 500 to 10,000 livres , completely out of all proportion to earnings.

The debt was exchanged and became worth many times its previous value as Mississippi shares continued their dizzying ascent.

The economy recovered and everyone was happy -- even though the underlying reality was an unsustainable credit-driven boom.

1719 John Law had issued approximately 625,000 stock shares, and he soon afterward merged the Banque Générale with the Compagnie des Indes.

The Compagnie bought the right to collect all French indirect taxes, took over the collection of direct taxes, purchased the right to mint new coinage.

The center piece of this financial plan was the retirement of Louis XIV's debt.

Shares of the Compagnie des Indes were exchanged for state-issued public securities, or billets d'état, which consequently also rose sharply in value.

The French government debt, 1,000% of the annual budget, became property of the Compagnie des Indes.

A frenzy of wild speculation ensued that led to a general stock-market boom across Europe.

The French government took advantage of this situation by printing increased amounts of paper money, which was readily accepted by the state's creditors because it could be used to buy more shares of the Compagnie.

The underlying assets of the Mississippi Company were still questionable royal debts that did not provide enough income to pay its promised dividends.

Excessive issue of paper money stimulated galloping inflation, and both the paper money and the billets d'état began to lose their value.

Moreover, like many holders of collateralized debt obligations, speculators in Paris relied heavily on borrowed money.

The rise in Mississippi shares in 1719 was reversed in 1720 and the bewildered French find themselves holding subprime paper, merely relabelled toxic debt.

1720 The value of the shares of the Compagnie plummeted, causing a general stock market crash in France and other countries.

The financial engineer John Law was made the scapegoat and was forced to flee France.

The enormous debts of his company and bank were soon afterward consolidated and taken over by the state, which raised taxes in order to retire it.

the South Sea bubble

1711 South Sea Company, a joint stock incorporation is granted a monopoly to trade in the South American colonial possessions of Spain as part of a treaty during the War of Spanish Succession.

The South Sea Company assumes the bonded debt England incurred during the war in return for the monoploy.

Speculation in corporate stock led to a great economic bubble known as the South Sea Bubble in 1720.

The primary trading business of the South Sea Company was transporting slaves from Africa to America.

1719 South Sea Company proposed a scheme by which it would assume half the bonded debt of Britain (£30,981,712) with new shares and contractually promises to the government that the debt will be converted to a lower interest rate, 5% until 1727 and 4% per year thereafter.

The purpose of this is to allow a conversion of high-interest bonded debt into low-interest marketable debt as shares of the South Sea Company.

The South Sea Company then set to marketing the stock with "the most extravagant rumours" of the value of its potential trade in the New World which was followed by a wave of "speculating frenzy."

1720 The share price rises from £128 in January to £890 in early June even though trade with Spanish colonies is limited to one ship carrying not more than 500 tons of cargo and the slave trade.

When the speculative adventure collapsed the estates of the directors of the incorporation are confiscated and used to repay some creditors, and the stock of the South Sea Company is divided between the major creditors - the Bank of England and British East India Company.

In summation all three of these speculative run-ups in the value of tulip bulbs or 'stock' was caused directly by war.

Tulip investors were trying to recoup loses from betting on Germany winning the Thirty Years War while both the South Sea and Mississippi bubbles were designed to retire onerous government debt due primarily to the expenses involved in the War of Spanish Succession.

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