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The First Crash: Lessons from the South Sea Bubble

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"The First Crash" by Richard Dale deals with the lessons from the South Sea Bubble of 1720.

According to the dust jacket Dale is Emeritus Professor of International Banking at Southampton University, England. As one might expect, the book contains much technical jargon relating to capital market theory and accounting.

Dale certainly knows his subject and is up to speed with the literature - the bibliography of this 198-page book has 148 entries.

The book might appeal to students or specialists such as bankers, accountants and investment advisors, but it is hard going for the rest of us.

You almost need a financial dictionary by your side and a calculator to follow the intricacies of most of Dale's technical explanations. There is a short Glossary in the book, but it is totally inadequate.

To be fair, it is possible to skip over most of the financial detail and still get a feel for the atmosphere and activities that led to the inflation and deflation of the bubble.

Prior to reading the book I was unaware of the sophistication of financial techniques available in the 18th century. Many of the investment tools in common use today (eg options, discounted cash flow calculations, futures contracts) were available in essentially similar form then.

They were also abused in much the same way (and by people of similar character) as they were in all subsequent bubbles. Human nature never changes, and the possibility of large gain attracts the greedy, the credulous and the scoundrel.

Chapter 9 contains a technical and rather pedantic discussion of the lessons from the bubble that will be of interest to specialists, but probably not to most general readers.

If you have the skills and want to pore over the financial technicalities of the South Sea Bubble you will enjoy the book and you will benefit from Dale's impressive knowledge.

If you just want to know what happened and why it happened, there are more suitable and accessible accounts than this book.

The author has done an excellent job of covering the South Sea Bubble of 1711-1721.He demonstrates that a few of the investor -decision makers of the time used technical, analytic financial tools based on the assessment of the riskiness of the asset. However,they did so without any regard to questions of the uncertainty of the knowledge base upon which the expected values were being estimated.His best example is Archibald Hutcheson.Hutcheson used the present value formula approach to calculate the current price of the security based on the discounted present value of the series of expected dividends.Unfortunately,he was not able to incorporate an analysis of the reliability /accuracy of the information base upon which the expected values were being calculated.Hutcheson understood that much of the information was in fact misinformation.The channels for this misinformation were (a) the coffeehouses which the London stock market speculators frequently visited and (b) the newspapers.The ability to assess the knowledge base would have required an understanding of a concept such as Keynes's weight of the evidence,w,developed by Keynes in 1921(1908) in his A Treatise on Probability.Hutcheson was essentially using an earlier version of Benthamite Utilitarianism.Hutchison was able to determine that the valuations were overvalued and that the bubble was being inflated.

The author correctly links his assessment to socalled " modern" developments in behavioral finance theory based on the work of Kahneman and Tversky,Einhorn and Hogarth,Slovic and Lichtenstein,etc.However, the theoretical foundations for the behavioral finance view, Prospect and Cumulative Prospect theory,can already be found completely developed in Keynes's A Treatise on Probability in chapters 3,15,17,20,22,26 and 29.The main conclusion of the KT approach is to establish the use by decision makers of non additive,non linear (non proportional, be it sub additive or super additive) decision weights.Such a technical apparatus was developed completely by Keynes in the TP.

The author also fails to discuss how Adam Smith integrated his study of the Soth Sea Bubble,as well as the Mississippi bubble of 1717-1721 into his discussios of money and banking in his The Wealth of Nations(1776).Smith's careful,detailed analysis of the negative impact of speculation on economic growth lead him directly to his modified usury law and dictum that bankers must be prevented from loaning money to borrowers who are projectors,prodigals and imprudent risk takers.The modern portfolio-Subjective Expected Utility (SEU) approach follows Bentham .Bentham was an avid suppoter of speculation who vehemently opposed Smith on the need for usury laws.Bentham's position on these issues was adopted by Milton Friedman and all Austrian economists,especially F von Hayek,Murray Rothbard,Ayn Rand,and L von Mises.
I highly recommend the purchase of this book.