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[Re-post] what about bubbles?

Brian Albrecht · Economic Forces · ·14 min read
Commentary by Hex Index staff

Brian Albrecht dismantles the most seductive myth in finance: that asset bubbles are proof of human irrationality. Instead of peering into the "minds" of panicked investors, he forces us to look at the ledgers of governments and the mechanics of debt consolidation. For the busy professional tired of behavioral economics platitudes, this is a necessary correction that reframes market history as a story of political economy, not psychology.

The Political Engine Behind the Mania

Albrecht begins by challenging the standard narrative that bubbles are driven by "waves of emotions that drive asset prices as the moon influences the tide." He argues that this story is too convenient; it feeds our egos by suggesting that "we, the newly enlightened, can avoid the pitfalls of the past by conquering our emotions." But Albrecht insists this narrative misses the critical driver: "the archetypal historical bubbles that are frequently referenced are actually stories of political economy."

[Re-post] what about bubbles?

He turns immediately to the South Sea Bubble and the Mississippi Bubble, events often cited as the ultimate examples of speculative madness. Albrecht reframes them not as failures of market logic, but as successful, if chaotic, attempts by the state to manage its own debt. "Both the South Sea Bubble and the Mississippi Bubble are stories of attempts to consolidate and lower the interest rates of government debt." The South Sea Company, for instance, was created to convert illiquid government annuities into liquid stock, a move designed to reduce the British government's borrowing costs. The frenzy wasn't just about greed; it was about a government desperate to restructure its balance sheet.

"The success of this scheme inspired a subsequent plan to further consolidate the government's debt and reduce its interest payments."

The author highlights how the deal was sealed with bribes and favorable terms for insiders, yet the public hype was fueled by the very politicians who stood to gain. When the bubble burst, the political fallout was immediate. "Robert Walpole, a Whig, assumed the role of the white knight who came in to clean up the mess." Albrecht notes that the aftermath allowed the government to scapegoat political opponents while the state itself benefited from the restructuring. This suggests that what we call a "bubble" is often a calculated, if risky, political maneuver that goes off the rails.

Critics might argue that ignoring the psychological element of the crash is a stretch; surely, the public frenzy had a life of its own. Albrecht counters this by pointing out that "the ex ante expectations were not egregiously out of step with the information that investors knew at the time." The market was reacting rationally to a government-backed scheme, even if the scheme itself was flawed.

The Corporate Takeover of France

The analysis deepens with John Law's experiment in France, which Albrecht describes as "an elaborate attempt of a corporate takeover of France." Law didn't just manage a bank; he acquired monopolies on trade, tax collection, and even the right to mint coins. "By 1720, John Law was officially put in charge of French government finance."

The rise in stock prices was a direct function of this consolidation. Law issued new stock to buy government debt, creating a feedback loop where rising share prices allowed for more debt acquisition. "Law saw the rising share price as essential to continuing to grow his company." The collapse, Albrecht argues, wasn't a sudden realization of irrationality but a structural failure of the mechanism itself. When investors demanded payment in gold (specie) rather than paper notes, the system froze.

"In an effort to support the stock price and to avoid the withdrawal of specie, the bank was issuing notes to support the price."

The result was rapid inflation and a collapse in value. Yet, even here, the political outcome was clear. "The French government actually benefited from the collapse. It was able to retire some of its debt and reacquire the revenue-generating rights." Albrecht's point is stark: the "madness" of the market was a tool for the state to achieve its fiscal goals, with the public bearing the cost of the cleanup.

The Tulip Myth Deconstructed

Perhaps the most surprising section is Albrecht's treatment of Tulipmania, the favorite case study for irrational exuberance. He asserts flatly: "It turns out that this was not even a bubble."

The narrative of Dutch citizens bidding absurd prices for flower bulbs is, according to Albrecht, a historical misunderstanding of financial instruments. The prices cited as evidence of a mania were actually futures contracts that had been converted into options. "The quoted prices therefore reflect the strike prices on options contracts that would have been paid if the spot price had risen above the strike price." The apparent explosion in value was an artifact of legislation that changed the terms of the contracts, not a reflection of tulip mania.

"The purported rise in the price of the tulip bulbs was an artifact of Dutch legislation rather than evidence of a bubble."

This reframing is powerful because it removes the "irrationality" entirely. The market was pricing in the value of an option, not the emotional utility of a flower. Albrecht uses this to drive home his broader thesis: "the political economy of these events seems substantially more interesting — at least to me — than any attempt to understand the psyche of the investors."

Bottom Line

Albrecht's strongest contribution is his insistence that market anomalies are often rational responses to distorted political incentives, not failures of human cognition. The argument's vulnerability lies in its potential to understate the role of herd behavior in amplifying these political schemes, but the evidence he marshals for the South Sea and Mississippi bubbles is compelling. For the modern investor, the takeaway is clear: when prices detach from fundamentals, look first at the government's balance sheet, not the crowd's psychology.

"The archetypal historical bubbles that are frequently referenced are actually stories of political economy."

The most dangerous assumption in finance is that we can predict the future by studying the past's "madness." Albrecht shows us that the madness was often a feature, not a bug, of the system.

Sources

[Re-post] what about bubbles?

by Brian Albrecht · Economic Forces · Read full article

In a previous post, I outlined what financial market efficiency means (and does not mean). The most common criticism that I received was something to the effect of “what about bubbles?” History is replete with examples of asset price bubbles and speculative manias, or so we are told. People are purportedly driven by emotion and irrationality to bid up price of an asset beyond what it is truly worth, only to see the price come crashing down. People lose wealth from these bubbles, as Hemingway might say, “gradually, then suddenly.”

We are told that these episodes alone are enough to demonstrate that financial markets are inefficient. To understand this madness, we must understand psychology. We must get inside people’s minds and figure out what drives them to participate in this sort of phenomenon. Only then can we understand the waves of emotions that drive asset prices as the moon influences the tide.

This is an incredible and provocative narrative. It draws people in. It provides the perfect backdrop to write beautiful prose about excitement and loss. Who would not want to read about things like “manias” and “irrational exuberance”?

It also doesn’t hurt that it feeds our egos. We, the newly enlightened, can avoid the pitfalls of the past by conquering our emotions. We can be taught rationality by those who have discovered irrationality. These scholars can be our guides by illuminating our innate cognitive biases. These hero scholars can be given prizes and start hedge funds that purportedly (but don’t actually) employ strategies that profit from these biases.

Yet, despite all the good things that this narrative provides, it misses something that is critically important: a knowledge of history broader than the seemingly inexplicable path of the asset price. In short, the archetypal historical bubbles that are frequently referenced are actually stories of political economy. That isn’t as exciting as raw emotion, but it is nevertheless important to set the record straight. In this post, I will do something different when it comes to Economic Forces. I will attempt to provide some historical context by discussing three famous bubbles: The South Sea Bubble, the Mississippi Bubble, and Tulipmania. In other words, this week I am going to focus on evidence rather than theory. We can then ask ourselves if these bubbles have anything to do with irrationality or market inefficiency.

The South Sea Bubble and the Mississippi Bubble.

Both ...