“At the root of all financial bubbles is a good idea carried to excess”

Before the Americans, the British, the Dutch were the masters of the universe. Cornered and ruled by the Spanish, constraints turned out to be seeds of innovation for the Dutch. 

After gaining independence from a receding Spain, the Dutch experienced an age of innovation and creation. Starting from the early 1500s, the Dutch innovated all across science, arts, and business. 

The Dutch trade flourished, and due to it was created the Dutch East India Company (Vereenigde Oostindische Compagnie or VOC). In the early 1600s, the Dutch created arguably the greatest financial innovation to raise money for VOC.

It created the public stock market. 

Trade on the market flourished, and in the 1630s the trade for the exotic tulip started to go out of control. In February 1637, the price of one tulip was 10 times the income of an artisan.

Tulip prices would soon crash, resulting in the first-ever stock market bubble collapsing.

History may not repeat itself, but it rhymes. While the size of the Tulip mania may not be as future commentators made it to be, our recent history suggests that it is possible.

We may think we have evolved, but human beings are still driven by very basic instincts.

Human beings care about gathering as many resources as possible. The invention of money as one trusted medium to access resources has made it the focus of such expeditions.

Making money, and then more, is what we are programmed for. 

Every once in a while, the stock market begins to attract millions of people with the lure of making money. Money that can be made quickly creates a flywheel that gets faster.

Every minute a sucker is born.

People are driven by a cocktail of emotions – greed to get rich, envy of someone else getting rich, pride of making money. The stock market channels these emotions and whips it into a frenzy. 

As more people see a rising stock market, they jump in with shovels. The newest gold rush due to, ironically, an economically devastating pandemic is enabled by easy to use trading apps. 

People bored and sitting at home use these apps to day trade, and show it off socially. Influencer driven stocks are rising. With retail investors piling into the rising market, the real money is following. 

Large investors are using the little Davids to wage their money wars. Whipped by the frenzy of a market that inexplicably continues to rise, a lot of people are getting paper rich.

I elaborated on how people describe this behaviour as irrational. I think that people optimize for certain goals within their constraints. When we don’t understand their goals and constraints, we call them irrational.

The goal and constraint now is simple – get rich, in as little time as possible.

We are living in a financial bubble. This is primarily because money has been printed to such an extent that it is now chasing anything that moves (up). Human instinct combined with free money is a dangerous mix.

As a financial investor in private markets, I see this seeping into the VC industry. Valuations that didn’t make sense a year ago are par for course. Companies are raising money like there is no tomorrow.

But in the end, the only king is cash flow. You can only raise so much. All this will end, and it is only a matter of time. 

When it does, it won’t be pretty. 

But the interesting thing about bubbles born out of chasing higher paper returns is that they also end up financing highly risky propositions. As people will finance anything that remotely makes sense, unrealistic expeditions get financed. 

Only 20 years ago, the internet was assumed to be home to a crazy bubble with no meaningful outcome. Today, I use it to share this essay. 

What will get built out of this bubble?