Historian finds tech bubble that didn't pop (180 years ago)

Histories of speculative bubbles are popular these days, in large part because they have driven our economy for the last two decades. First came the tech bubble, whose quasi-utopian promises drew in billions of investment dollars, only to pop its cork in 2000, dragging the United States into a recession. That was followed by our recently retired real estate adventure, which threw us and much of the world into The Great Recession.
Given the consequences of these turbulent financial frolics, Bubble Studies has become a popular scholarly field. Its more well known offerings include John Cassidy's Dot Con, Charles Kindleberger's Manias, Panics, and Crashes, and the latest: Carmen Reinhart and Kenneth S. Rogoff's This Time is Different: A Panoramic View of Eight Centuries of Financial Crises.

The title of that last tome was inspired by the comment of a bitter investor of yesteryear. "More money has been lost because of four words than at the point of a gun," he warned. "Those words are 'This time is different'." As the quote suggests, investors in boom times know that the bubble threat is there, but invariably hope that their beloved industry or commodity will escape that fate.
But now one of our favorite telecom thinkers, Andrew Odlyzko, thinks he's found a bubble that was a bonfide Good Thing. Sorry speculators, it has long come and gone—the British Railway Boom of the 1830s, an example of a "giant, wildly speculative, and successful investment mania," as Odlyzko puts it.
Not only did this surge of development not go south, but "it resulted in the creation of a productive transportation system that had a deep and positive effect on the economy," Odlyzko argues. "It also occurred during the formative period of corporate capitalism, and its influence on the shaping of the legal, social, and institutional framework of modern society has been little explored."

The late strange Railway

One of the reasons why the boom of the 1830s has been ignored, argues Odlyzko, is because it was overshadowed by the British "Railway Mania" of the 1840s, in which a host of investors lost their shirts, among them computer pioneer Charles Babbage, Charles Darwin, and the novelist Charlotte Brontë, soon to recoup her losses with the success of her novel Jane Eyre.
"When I look at my own case," Brontë wrote to a friend, "and compare it with that of thousands besides—I scarcely see room for a murmer. Many—very many are—by the late strange Railway system deprived almost of their daily bread."
But the British railroad development boom of the 1830s was different, Odlyzko says. Here are some facts that he cites:

• At its peak, British investors put more than eight percent of the country's Gross Domestic Product into railway infrastructure—the equivalent of over $1 trillion for the United States now. Compare that to estimates for upgrading US telecom networks with fiber that go from $150 to $300 billion.
• Following that peak phase, cost overruns pushed British railroad boosters to double that investment—the equal of $2 trillion when all was said and done. "But within a few years they were happy," Odlyzko notes, "as they were earning above-market returns."
• This investment persisted into the late 1830s despite a huge bank panic and depression (we had a somewhat smaller crisis here remembered as the Panic of 1837). Investments in 1838 and 1839 equaled around two percent of GDP each year.
  By 1844, share subscribers to the London and South Western Railway were earning 9.68% on their pay-in. "This was regarded as exceptionally lucrative in an era when the risk-free rate on long-term government obligations was about 3%."

On the face of the matter

Despite this striking success, prominent economists warned that the great railroad expansion of the 1830s would fail, not in the sense that the railroads wouldn't be built, but that investors wouldn't see much gain from their money. “On the face of the matter it seems absurd to suppose that both the Great Western Railway, and the London and Southampton, can pay," wrote John Stewart Mill, "though it is just possible that either of them might, if the other did not exist."
On the contrary, both did offer nice dividends. Not that the precautions offered by Mill and others weren't sound, Odlyzko observes. It is just very hard to predict how these things will work out.
"The railway mania of the 1830s was an extremely speculative one," he writes. "Investors relied on an untested technology and an untested demand estimation methodology. Yet they succeeded!"
Does this mean that these bubbly financial outbursts aren't so bad after all? Odlyzko acknowledges that the railroad boom of the 1830s led in some ways to the disastrous mania of the 1840s. Many subscribers were required to respond to investment calls for more shares. Others did so willingly because of the success of 1830s era investment, as The Economist noted in 1845:

"The origin of the very favourable reception with which railways have met at this time, is no doubt to be traced to the fact that, of all the schemes which originated in the speculative period of 1835-36, they were the only ones which stood the test of the succeeding pressure, without any disastrous losses."

But he wants his readers to get the larger message: "The British railway mania of the 1830s is neglected and misrepresented in the literature," Odlyzko concludes. "It was a giant and very speculative undertaking that succeeded. That time was really different. This is something that policy makers should keep in mind in considering episodes of great investment exuberance."

So are bubbles good?

We're not sure what policy makers should conclude from these observations. We're also not sure whether we accept the periodization implied here, which seems to put the successes of the 1830s and the failures of the 1840s into separate historical compartments. And we'd like to see a few more historical exceptions like this one uncovered before we conclude that it doesn't prove the cautionary rule, so to speak, about bubbles.
Still, we appreciate the idea that these moments of social, financial, and technological fervor are not all bad. It's difficult to imagine, for example, that the open source code/database advances that we associate with Web 2.0 would have flourished without the spectacular wave of collective learning that took place during the height of the dot bomb era—1995 through 1999. Indeed, it is right during that period that the term "web log" was coined.
If Odlyzko is right, then the next question is how you let these speculative outbursts unleash their potential productive good, while making sure that the rest of us lemmings don't run off the proverbial economic cliff. That's a tough problem which waits, perhaps, for a less partisan and less ideological era than ours to take on.

0 comments