The History of Futures

Trading in futures may be tightly regulated these days, but such was not always the case. At several points in history, market forces combined with such human natures as hope, greed and panic, have inflated - and swiftly deflated so-called “bubbles”, with the deflation typically much more sudden than the extended build-up to the inevitable crash, or “burst” if we invoke the bubble metaphor.

One of the first notable speculative frenzies is known to us today as “Tulipmania”, and the term is very apt for what happened in Holland in the early 17th century.

Tulips were not native to the Netherlands, having first been imported to the country in the 1590’s from the Ottoman Empire. Dutch growers began to compete against one another to breed hardier, more colorful flowers, often named after famous admirals. As the climate was harsh and the more desired colors and patterns were the result of a viral infection, some tulip varieties came to acquire significant value.

By the year 1635, prized bulbs like the exquisite candy cane striped Semper Augustus were selling for the equivalent of 35 times the average annual income! At about the same time, tulip bulbs began to be traded on Dutch stock exchanges, and “tulip futures” were eagerly bought and sold by all classes of society. Many traders grew rich on the rising speculative frenzy, but of course it all came to a crashing halt when prices appeared to reach their ceiling and a rush of selling quickly turned into a market free fall. Within hours, fortunes were lost and lives ruined. Dutch courts refused to lay blame or force redress as the debts incurred were declared to be the result of gambling.

Less than a century later in England, another speculative bubble rose and burst, bringing down a host of aristocrats, politicians and financiers who had floated loans based on the prospect of ever-rising share prices. The infamous “South Sea Bubble” began its inflation in the year 1711 when the Lord Treasurer of England was granted a monopoly on trade with Spain’s South American colonies. A speculative climate was engendered by the issuing of shares to powerful government insiders whose published names helped bring in smaller investors. Even though the actual profits of the South Sea Company never reached expectations, great efforts were made to hide this fact and publicize instead the immense potential of the company.

In January of 1720, shares in the company were priced at £128 each, rising to £330 in March, to £550 in May and to £890 in June. Word of the stock’s relentless rise filtered down through the stratums of English society, and people sold everything they had in order to buy South Sea Company shares. By August of 1720, the price per share had reached £1000 and selling pressures began to overwhelm the government’s best efforts to support the stock. By the end of September the share price settled at around £150, leaving in its wake thousands of financially ruined investors who were not able to get out of the market in time. One of these was the eminent scientist Sir Isaac Newton, who, ruminating over his £20,000 loss, famously stated “I can calculate the movement of the stars, but NOT the madness of men.”

As long as there are stock and futures markets, bubbles will rise and fall no matter how tightly they are regulated. Thankfully, stringent oversight by the SEC and other regulatory agencies as well as greater transparency in reporting has and will continue to limit the damage speculative bubbles can wreak. Even so, in the 20th century we have witnessed the 1929 stock market crash as well as the bursting of the Tokyo real estate bubble in the early 1990s.

 

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