Blowing Bubbles (part I)

The Andes stretch for more than four thousand miles like a jagged, crooked spine down the western side of the South American continent. Formed roughly a hundred million years ago, as the Nazca tectonic plate began its slow but tumultuous slide beneath the South American plate, their highest peak, Mount Aconcagua in Argentina, rises more than 22,000 feet above sea level. Aconcagua's smaller Chilean brethren stand like gleaming white sentinels around Santiago. But it is only when you are up in the Bolivian highlands that you really grasp the sheer scale of the Andes. When the rain clouds lift on the road from La Paz to Lake Titicaca, the mountains dominate the skyline, tracing a dazzling, irregular saw-tooth right across the horizon.

Looking at the Andes, it is hard to imagine that any kind of human organization could overcome such a vast natural barrier. But for one American company, their jagged peaks were no more daunting than the dense Amazonian rainforests that lie to the east of them. That company set out to construct a gas pipeline from Bolivia across the continent to the Atlantic coast of Brazil, and another - the longest in the world - from the tip of Patagonia to the Argentine capital Buenos Aires. Such grand schemes, exemplifying the vaulting ambition of modern capitalism, were made possible by the invention of one of the most fundamental  institutions of the modern world: the company. It is the company that enables thousands of individuals to pool their resources for risky, long-term projects that require the investment of vast sums of capital before profits can be realized.


After the advent of banking and the birth of the bond market, the next step in the story of the ascent of money was therefore the rise of the joint-stock, limited-liability corporation: joint-stock because the company's capital was jointly owned by multiple investors; limited-liability because the separate existence of the company as a legal 'person' protected the investors from losing all their wealth if the venture failed. Their liability was limited to the money they had used to buy a stake in the company. Smaller enterprises might operate just as well as partnerships. But those who aspired to span continents needed the company. However, the ability of companies to transform the global economy depended on another, related innovation. In theory, the managers of joint-stock companies are supposed to be disciplined by vigilant shareholders, who attend annual meetings, and seek to exert influence directly or indirectly through non-executive directors. In practice, the primary discipline on companies is exerted by stock markets, where an almost infinite number of small slices of companies (call them stocks, shares or equities, whichever you prefer) are bought and sold every day. In essence, the price people are prepared to pay for a piece of a company tells you how much money they think that company will make in the future. In effect, stock markets hold hourly référendums on the companies whose shares are traded there: on the quality of their management, on the appeal of their products, on the prospects of their principal markets.

Yet stock markets also have a life of their own. The future is in large measure uncertain, so our assessments of companies' future profitability are bound to vary. If we were all calculating machines we would  simultaneously process all the available information and come to the same conclusion. But we are human beings, and as such are prone to myopia and to mood swings. When stock market prices surge upwards in sync, as they often do, it is as if investors are gripped by a kind of collective euphoria: what the former chairman of the Federal Reserve Alan Greenspan memorably called irrational exuberance. Conversely, when
investors' 'animal spirits' flip from greed to fear, the bubble of their earlier euphoria can burst with amazing suddenness.

Zoological imagery is of course an integral part of stock market culture. Optimistic buyers of stocks are bulls, pessimistic sellers are bears. Investors these days are said to be an electronic herd, happily grazing on positive returns one moment, then stampeding for the farmyard gate the next. The real point, however, is that stock markets are mirrors of the human psyche. Like homo sapiens, they can become depressed. They can even suffer complete breakdowns. Yet hope - or is it amnesia? - always seems able to triumph over such bad experiences.

In the four hundred years since shares were first bought and sold, there has been a succession of financial bubbles. Time and again, share prices have soared to unsustainable heights only to crash downwards again. Time and again, this process has been accompanied by skulduggery, as unscrupulous insiders have sought to profit at the expense of naive neophytes. So familiar is this pattern that it is possible to distil it into five stages:

1. Displacement: Some change in economic circumstances creates new and profitable opportunities for certain companies.
2. Euphoria or overtrading: A feedback process sets in whereby rising expected profits lead to rapid growth in share prices.
3. Mania or bubble: The prospect of easy capital gains attracts first-time investors and swindlers eager to mulct them of their money.
4. Distress: The insiders discern that expected profits cannot possibly justify the now exorbitant price of the shares and begin to take profits by selling.
5. Revulsion or discredit: As share prices fall, the outsiders all stampede for the exits, causing the bubble to burst altogether.