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Tom Holland

Anyone interested in how China's A-share bubble is likely to play out would do well to dig out a copy of Charles Mackay's 1841 masterpiece Extraordinary Popular Delusions and the Madness of Crowds.

Mr Mackay set out to document and expose the dangerous irrationality of herd behaviour and as he put it, 'to show how easily the masses have been led astray'.

He succeeded brilliantly. In chapters on topics as diverse as witch hunts, prophecies of Armageddon, and 'The Influence of Politics and Religion on the Hair and Beard', he minutely examined the causes and consequences of 'moral epidemics' and mass manias.

His book is best remembered today for the chapters covering three speculative bubbles: the Dutch 'Tulipomania' of the 1630s and the South Sea Bubble and Mississippi Madness, which struck Britain and France respectively in  1720.

Strangest of these to contemporary readers will be the investment boom in tulips. Yet even that bizarre episode had some startling parallels with developments in modern financial markets.

When they first arrived in Holland in the late 16th century, tulips were considered the ultimate in luxury goods.

So desirable were rare or variegated specimens that bulbs began changing hands for astonishing sums. Before long tulips came to be regarded no longer merely as status symbols but as repositories of wealth and vehicles for speculation in their own right.

Prices soared. According to Mr Mackay: 'Nobles, citizens, farmers, mechanics, seamen, footmen, maidservants, even chimney-sweeps and old clotheswomen, dabbled in tulips. People of all grades converted their property into cash, and invested it in flowers.'

Some made fortunes. By January 1637, prices were rising at about  25 per cent a week and rare bulbs were changing hands for more than 40 times the average annual income at the time. In Hong Kong today, that would equate to a flower worth HK$5 million.

Alas, the craze could not last. At the beginning of February 1637, prices plunged by a third. The fall was exacerbated by tulip brokers selling the market short and by buyers of tulip futures failing to pay up when their contracts matured - both factors widely cited in more recent crashes. Many citizens were ruined, the banks stopped lending and commerce ground to a halt.

If Tulipomania is hard to understand,  the Mississippi Madness and the South Sea Bubble have much in common with modern manias.

At the beginning of 1719, the Mississippi Company was granted a monopoly over all French trade with North America, India and China. To raise capital, the company issued 50,000 new shares backed with a promise of handsome dividend payments. Beguiled by visions of riches, the French public overwhelmed the company with more than 300,000 applications.

More shares were issued, trading volumes shot up and the company's stock price rocketed 20-fold in a matter of months (see chart) as a frenzy of speculation seized Paris. Mr Mackay describes how 'the price of shares sometimes rose 10 or 20 per cent in the course of a few hours, and many persons in the humbler walks of life, who had risen poor in the morning, went to bed in affluence'.

Much of their wealth was spent in an orgy of consumption. Amid a glut of notes issued by the company's affiliated bank, money supply expanded sharply and 'new houses were built in every direction'.

At the same time, London experienced its own speculative frenzy as shares in the South Sea Company soared 10-fold after it was granted a monopoly over trade with South America (see chart). Eager to jump on the share trading bandwagon, speculators rushed out initial public offerings for hundreds of companies, some more credible than others.

These 'bubbles' as they became known included genuine iron and steel companies, property developers, paper mills, water companies, mines, insurers and banks. But they also included more dubious concerns such as one 'for extracting silver from lead', another 'for a wheel for perpetual motion', and  'a company for carrying on an undertaking of great advantage; but nobody to know what it is'.

Not surprisingly, both bubbles burst and share prices plunged. In London, Mr Mackay describes 'the extraordinary panic which had seized upon the people. Men were running to and fro in alarm and terror, their imaginations filled with some great calamity'.

In Paris, the army was called out to quell street riots in which dozens were killed. Leading financiers fled the country and the new paper currency was devalued more than 50 per cent. The economic crisis that ensued 'drove the country to the very brink of revolution'.

Hopefully the consequences of the Chinese bubble will not be so severe. But if they are, it will not be the first time.



Hubble bubble is a cautionary history