Keep a Wary Eye on the Bitcoin Bubble

In times like these, it’s important for all of us to remember how speculative markets occur, how they work, and what their inevitable outcomes are. Toward that end, here are some speculative investment market moments, courtesy of Investopedia.com, that are enlightening.

The classic business school example of a speculative market is the “tulip mania” during the 1630s, in Holland (now the Netherlands). Following the importation (from Turkey) of the first tulips, the Dutch aristocracy went on a tulip bulb buying frenzy.

Aided by Dutch banks’ virtually unlimited lending, the price of a single tulip bulb soared to the equivalent of $1 million in today’s dollars. However, to restore some sanity into their economy, the Dutch government outlawed lending on tulip bulbs, the market for them collapsed, leaving many Dutch aristocrats with very expensive gardens.

The South Sea Bubble isn’t as well known, but it’s equally as instructive. In 1711, Great Britain formed the South Sea Company to reap trading profits from South America, as the East India Company had done with India. Based purely on hype from the company, its stock became hugely popular, increasing over eight-fold by 1720, as “the” investment to be in. When trading prospects with South American countries proved far less than expected, the company collapsed and many investors lost their money.

Then there was the Japanese real estate and stock market bubble of the 1980s. Fueled by government stimulus programs, Japanese stocks and urban real estate started to rise in value, which ignited speculation for continued increases. Within the next three years, prices tripled to unrealistic levels, and when the bubble burst in 1990, it took the Japanese economy a decade to recover.

The takeaway here is that sound investing is based on actual value behind an investment. Simply counting on someone to pay a higher price than you did is called “the greater fool theory” for a reason.