The Railway Mania of the 1840s proves that a world-changing technology can still lead to a catastrophic investment bubble. Despite railways transforming society, massive over-investment and hype caused an 85% collapse in share prices, wiping out fortunes and illustrating the danger of investing in frenzied sectors.
Even seemingly safe investments, like buying the S&P 500, involve speculation. An index investor is betting that U.S. companies will become more profitable and that future investors will continue to value them highly. This redefines speculation not as a binary choice but as a universal component of investing.
Bubbles provide cover for fraudulent activities, as rising prices mask underlying problems. In cases like the South Sea Company and Railway Mania, it wasn't until after the collapse that the full extent of financial engineering, corruption, and deception came to light, by which point it was too late for most investors.
In a telling sign of speculative excess, Japanese golf club memberships, valued for status, became a traded asset class. Banks offered 90% margin loans against membership certificates, turning a luxury good into a vehicle for stock market speculation and a bizarre indicator of the bubble's absurdity.
The concept of "Nihonjuron," the theory of Japanese uniqueness, was used to rationalize extreme asset valuations that defied Western financial logic. This cultural narrative created a national blind spot, allowing investors to believe that traditional fundamentals didn't apply to Japan's seemingly superior economic system.
The South Sea Company, the British government, and investors were all incentivized to push the stock price higher. The company could issue fewer shares, the government reduced interest payments, and investors saw immediate paper gains, creating a circular logic where a rising price justified itself.
Unlike waiting for a natural collapse, the Bank of Japan's new governor in 1990 took deliberate action to end the speculative mania. By aggressively raising interest rates multiple times, he intentionally engineered the bubble's deflation, showing that central banks can be active agents in ending market excesses.
The South Sea Bubble wasn't just a market mania; it was enabled by government corruption. Directors secretly gave shares to government officials who, in turn, had a direct financial incentive to keep the share price rising, regardless of the cost to the nation. This highlights how state actors can be complicit in creating systemic risk.
During the 1980s bubble, Japanese firms engaged in "Zytec," using profits from financial speculation to boost reported earnings. This created a circular feedback loop: rising share prices increased their ability to raise cheap capital for more speculation, which in turn fueled share prices even higher, detaching them from operational reality.