In the fourth episode of this ‘Financial Crises’ season, Simon and Bex discuss what we can learn from crises caused by financial ‘bubbles’ that burst.

Some key points of interest covered in this episode include the following:

• Simon explains that financial bubbles occur when the cost of an item rises quickly to a level that is much higher than it is actually worth. This happens because of speculation, with people buying into the product in the hope of getting rich quick; however, buying can suddenly turn into a frenzy of selling when it is felt that prices have reached their peak. [02:15]
• Investing, on the other hand, involves committing to a financial venture and then sharing in the profits as the investment grows over time, resulting in a positive-sum game. [04:05]
• A key difference between investing and speculating is the time scale, with investors committing for the long haul while speculators aim to take the money and run as soon as they think that the highest price has been reached. [05:12]
• Bex and Simon discuss two historical financial bubbles, the first one being ‘Tulip Mania’, which caused chaos in Amsterdam’s financial market in 1637. In fact, the collapse in the price of tulips did not have a long-lasting effect on the economy, mainly because buyers had generally paid only a small deposit on their purchases; nevertheless, it became the classic example of a financial bubble bursting because it was the first widely known example of the phenomenon and also because it is such a good illustration of a product being ridiculously overpriced. [06:22]
• Then, in 1720, a major financial crash – the South Sea Bubble – occurred when investors started regarding the South Sea Company as a surefire bet because of its trading rights and its widespread support from investors, politicians and even royalty. Once the share price started to go down, however, it became evident that their confidence was misplaced and its value then proceeded to fall at a much faster rate than it had grown. [08:58]
• The dot-com boom and bust events between 1995 and 2002 were the most striking recent example of a financial bubble bursting. The hype surrounding the potential profits to be made from investing in technology companies was so extreme that the situation became untenable, resulting in the Nasdaq Stock Market losing 75% of its value (15 trillion dollars!) in just two and a half years. [12:17]
• In reply to a question from Bex about the possibility of overpricing of shares in Artificial Intelligence companies causing a new financial bubble, Simon suggests that this will depend on (i) whether or not prices retain a meaningful relationship with the actual value of assets, and (ii) whether or not the technology companies ultimately deliver significant added value through their products and innovations. [15:16]
• When it comes to a strategy for investing in products and companies that are attracting high prices but may be significantly inflated, Simon suggests going for a balanced and diversified portfolio that is aiming for long-term growth rather than short-term gains. [16:42]
• As far as a Christian approach to investing is concerned, Simon suggests that our motivation should be to resist the allure of getting rich quick and, instead, to follow biblical principles of stewarding wealth in a responsible and prudent manner. [19:47]
• Any listeners wishing to hear more of Simon’s thoughts on investing might want to listen to previous podcast episodes on this topic, especially from Season 1. [22:12]
• Our next episode in this season will be published in a fortnight’s time (on 28 October) rather than coming out next week, as suggested by Bex. What we can agree on, however, is that the content of that episode is being kept under wraps for now! [22:28]

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Simon

Welcome to ‘Where Your Treasure Is…’, the podcast where faith meets finance.

Bex

I'm Bex McGregor.

Simon

And I'm Simon Glazier. Each episode, we're going to explore how biblical wisdom can guide our everyday money decisions.

Bex

We'll be looking at how we can give generously, save wisely, and navigate the complex financial realities we face.

Simon

But remember, investments can go down as well as up.

Bex

This is ‘Where Your Treasure Is…’

Simon

Let's get started.

Bubbles. Bubbles is what we are talking about today. Last episode it was Ponzi. This time it's bubbles. Bex, give us a wee reminder - what is our theme for the current season, please?

Bex

We are talking all about financial crises, looking at different ones, how they affect us, what we can do about them.

And I'm going to be honest, when I saw the title, ‘The Thing About Bubbles’, my immediate thought was Glinda in ‘Wicked’ when she floats in in the bubble. I'm assuming that's not what we're talking about today!

Simon

Well, not all of our listeners will have watched ‘Wicked’ or seen it, so no, it's not that one; nor are we talking about the song, ‘I'm Forever Blowing Bubbles’.

We're definitely talking about financial bubbles, which have been around for a very long time, and they are a unique kind of financial crisis. They can affect just a few people or many people.

Of course, they are often very obvious… again, in retrospect! And what we're going to hopefully try and work out is, can you avoid being poorly impacted by a bubble by not necessarily spotting them in advance? It's really hard to do that! But by avoiding the temptation to get involved in something that might be a bubble, can we identify them, interpret them, understand them, and manage our emotions around financial bubbles?

Bex

It feels like we're going to have a little bit of overlap with our episode from last week, all about Ponzi schemes. So, maybe if you haven't listened yet, maybe you want to pause, listen to that… come back here, obviously.

But, Simon, why don't you kick us off by explaining to us what is a financial bubble and why is it relevant to this season of the podcast?

Simon

Sure. So, in the simplest terms, a financial bubble is generally when the price of something, usually a financial instrument, some kind of investment, something you can buy that costs money, rises quickly, reaches a much higher level than the underlying asset is actually worth.

And that's quite important. The price is more than the value of the thing you're buying. It happens because most investing in this thing is speculative. People aren't investing in the underlying value. They're investing in the hope or aim of getting rich quick, making a healthy profit within a short time scale, rather than holding it for the long term.

Ultimately, prices can't keep going up indefinitely or infinitely. Mathematically, that's impossible. They're not sustainable. And therefore, it usually leads to a sudden, sharp decline in the price of the asset, which means investors then try and pull out. And as they try and sell, the price goes down further. That's some basic economics of supply and demand.

And therefore, people end up losing if they've bought when it's high and they come out when it's low.

The bubble went up and then it suddenly popped and the price came down.

Bex

Maybe I'm being super naive and oversimplifying this, but it kind of sounds like there's a thing, whatever the thing is, it's doing well. Then people get excited and they're like, oh, I want a slice of that pie. And then people get overexcited and it can't be sustained and the pie's gone… but people still want slices of the pie.

Is that a fair summary? Too naive?

Simon

It's a fair summary. It's okay to have slices of pies. What we want is for the pie to get bigger. What we don't want is for the pie to get spread along more and more and more people. And again, like with our Ponzi schemes last week, those that get in early do the best. Those that get in late do the worst.

What we want in investing is a positive-sum game, which is something like this:

I've got this great idea for a new board game, but I need some money.

And Bex says, ‘Oh, I'll give you some money,’ so you give me your money, I invent the board game, we sell it to lots of people, make a profit, and we both get a return.

We have created wealth in the system using money and idea, money and effort.

The money gets rewarded rather than speculation that says, ‘Simon's got this great idea. Everyone's buying into it. I'm going to buy into it, but hopefully tomorrow I'll pull out because someone else is going to pay me more for the shares that I own.’ And that is speculation - speculation, even though there is an investment going on underneath… but you're speculating on the value rather than investing in the product.

And there's some great, really historical examples and some really modern examples of all things bubble.

Bex

And so, we're going to get into that in a minute. But, Simon, I'm aware we've talked about speculation quite a bit the last couple of episodes. How do we spot what is speculation and what is a legitimate investment in, like, thirty seconds?

Simon

I would say timescale is key.

If you're investing, you're investing for the long term. Save money for your pension, put the money in, buy an investment, typically a fund, sit on it for 10, 20, 30, 40 years.

When you come to retire, it should have grown if it's been well diversified, and then you take the return that's compounded over the years to live off.

Speculation says, ‘I don't really care if it's going to make money in the future or not. I just want to get money now. I'm going to buy it today, sell it tomorrow, next week, next month, even next year. I'm going to wait till it's made some money.’

You're not at all caring about the underlying investment, you're just waiting for the price to go up and then you're going to sell to the person who comes after you - the ‘greater fool’ theory. Someone else somewhere is going to want this more than I do. And then you sell it to them and they've got to wait and try and make money again by the greater fool than them coming along.

Speculate, short term; invest, long term, on the underlying true value and future return of an investment.

Bex

Thank you. Helpful to keep in our minds as we continue through this conversation.

So, financial bubbles. The first one, I'm going to be honest, just the name, the concept of this intrigues me - the tulip bubble, ‘Tulip Mania’! What was happening in Amsterdam?

Simon

Amsterdam, 1636-1637, and what happened was the tulips got poorly. Poor tulips!

So, rather than having beautiful, simple, single colours, someone spotted a tulip that was multicoloured.

Bex

Oooh!

Simon

It had stripes or it had two or three colours in it. And it was a problem, actually. It was diseased, but it looked very pretty.

And the wealthy among Amsterdam's merchants quite liked the idea of having pretty tulips, so they'd pay more for them.

And demand was so high and supply was so low because there were only so many of these diseased tulips, that prices began to rise really, really quickly.

At some point, the demand for these beautiful tulips was so high, people would plant them in their gardens and others would come and steal them from their gardens and sell them, sometimes for the price of a house!

Bex

Wow!

Simon

Just ridiculous amounts of money!

Anyway, that was just a crazy fad. In reality, people started creating these diseased tulips to make more of them that would eventually have met supply and demand. But what happened was the stockbrokers of the time, the share traders who would meet in the coffee house or the pub, would say, ‘You know what, this thing about tulips. I've got some tulips. Do you want to buy my tulips?’

‘Oh, I'd buy your… yeah, tulips are really good! I'm going to buy tulips. How much do you want for them?’

And the price went up and up and up. But they were now talking about your regular tulips, not your fancy tulips. Not the kind of things you'd put on the dining table and look at and appreciate - the stuff you just chuck in your garden and hope it grew for a few months.

The price of tulip bulbs rocketed until people kind of realised, ‘Hang on a second - these are just tulips! They can't really give you any return. They don't last forever. Thanks, but no thanks.’

And then, pretty quickly, the value of tulip bubbles dropped all over again. Now, it didn't, in fact, create a massive financial crisis for most people. They weren't investing lots of money in tulips. In fact, often they were just putting, like, a deposit on some tulips:

‘I'll buy some tulips, but here's 10% of the value. And when I get my tulips, I'll pay the rest of it.’

Great story, but it was the first time of recorded evidence of a sudden rise in the price of an asset that wasn't associated with the underlying demand for it from a regular perspective, but just from a speculative perspective.

Bex

So, we have learned from the tulip bubble that great flowers look beautiful but are not a good investment. What about the South Sea Bubble, Simon? We are still way back in history. We are starting in 1720.

Simon

It's like 100 years later, okay?

Now, this time there was money to be made. You may have heard of the phrases like, my ships come in.

The idea was that there was money to be made across the sea, but ships were really expensive. So, the South Sea Company, amongst many other big multinational companies, were created to pool together money, build ships, send them around the world to collect things from the far-flung places, bring them back to Europe, sell them, make a lot of profit.

Now, when a ship disappears off, it might be years until it comes back. And you've got no idea if it's ever coming back. There could be a typhoon thousands of miles away and your ship never comes in.

But in the moment your ship comes in, you can make a fortune! So, what happened was that there was a lot of hype around the idea of the South Sea Company getting exclusive trading rights to the South Seas - that's South America in today's terms.

They claimed they were going to make so much money they could pay off the entire national debt of the country just out of profits from this fantastic trading.

The King got involved because he was a governor of the company and people thought, therefore, ‘Oh well, if the King's involved, it must be all right.’

So, you could put like a deposit down, buy some shares, but you wouldn't pay for the price of the shares until some point in the future.

What then happened was that Parliament got involved, but they got involved in the wrong way - there was bribery going on: ‘Let's not look at the books too much because we're all making money here, thank you very much.’

The share price started going up because everybody wanted to get involved. Unfortunately, it didn't work out. The claims of profit were highly speculative, overinflated.

Even Sir Isaac Newton got involved. He had the fear of missing out. According to him, he says, ‘I can calculate the motion of heavenly bodies, but not the madness of people!’

He recognised that he got involved in this crazy scheme, a get rich, not quite as quick, scheme if you're going to wait for your ship to come back from the other side of the world!

But a lot of money was promised and failed to materialise! A lot of people lost a lot because of the volatility - the sudden rise in the price of the shares; the sudden fall in the price of the shares ended up about the same, but five times higher!

It grew and once it's grown five times higher, when it falls, it could fall 80% of its value to end up back where it was.

And if you got in at the wrong time and you had that fall in price, that could be your financial future in ruins.

That's a real personal financial crisis!

Bex

Gosh, it feels like if Sir Isaac Newton can't figure out the madness of people through a calculation, then the rest of us probably don't have a chance.

Taking it forward in time a bit more, probably the first thing deemed a bubble that I remember would be the dot-com bubble. Simon, tell us about that.

Simon

The dot-com bubble was interesting because the Internet was just taking off.

I remember I got my first computer in nineteen ninety-six, nineteen ninety-seven. And just the ability to do things online was so new, was so exciting that everyone was getting involved. There were companies popping up left, right and centre - not popping yet in terms of a bubble; they were just popping up, and everybody wanted in!

If you called your company something dot com, everyone assumed it was going to make money.

Share prices rocketed. Companies were raising so much money, vastly more than they ever needed, to create the products they were trying to sell because they could. Share prices were just so high!

People saw share prices going up and they wanted in. Nothing to do with the underlying true value of the companies they were buying into - just because the price was going up and they wanted in.

But as we know, share prices can't just keep going up.

I'll look at some numbers here. The Nasdaq, which is the North American technology index where all the big tech companies were listed and you could buy into the value of these companies - it lost over 75% of its worth in about two and a half years just as the dot-com bubble crashed. That was £5 trillion of market value!

Now that £5 trillion didn't really exist in that the companies didn't not produce the stuff that they were producing before. It was just the hyper-inflated share price. People put money into it and then the share price fell.

Now, someone was selling shares at that hyper-inflated price and making money. But as the share price falls, nobody wants to buy and so the price comes lower and lower and lower. So, some of the wealth was just disappearing. It was created out of nowhere and it disappeared to nowhere!

And it took 15 years for that NASDAQ index to come back to the previous valuation point it peaked at. It fell in two and a half. It took 15 years to recover!

Even those long-term investors holding on, waiting for the dot-com to come good had to wait a very long time.

And they reckon that thousands of IT technology startups went out of business. They were created and they went out of business!

And more than half of the companies that went public -those that you could buy shares from during the dot com years - didn't survive the crash, even if they weren't tech companies!

Bex

Absolutely wild and just fascinating that this promise of something new, of something potentially great can just drive people emotionally and then consequently sometimes with their wallets as well!

In a moment, I'm going to ask you to tell us some lessons we can learn from financial bubbles. But before we get into that, just as you were talking about the dot-com bubble, it made me think about some of the recent prices in US tech companies.

Would that be a bubble as well, or is that something else?

Simon

It's really hard to identify a bubble in advance.

Bex

Fair.

Simon

But there are some differences, OK.

In recent years, we have seen some huge rises in tech stock prices. There was one way back in twenty twenty-one called GameStop - its price just rocketed almost 400 times in a really short period of time.

And then it started falling, really fast! Nothing to do with the underlying value of the company - definitely speculation!

When we look at the recent change in prices of tech companies, and we're talking now really about the magnificent seven - the big seven tech companies over in the States, names like Nvidia and Apple and Amazon and Meta - these are well established companies making lots of money year in, year out.

But primarily due to advances in artificial intelligence, AI, their share prices have rocketed because people assume that AI is going to deliver - much like in the nineteen nineties and early two thousands, the dot-com revolution was going to deliver and everything went up.

Now, with the dot com bubble, it did deliver… eventually!

Our world has been transformed by the Internet. It is highly likely our world will be transformed by artificial intelligence. But you need to know, not just the transformation is going to exist, you almost need to know which companies are going to be the ones that will capitalise on it, or you buy them all!

And that's where speculation changes into diversification:’ I love the idea of investing in tech. I'm going to buy lots of tech companies, but still only in proportion to the value of tech companies across the world.’

Don't put all your money in tech and don't put all your money in one tech company.

But there's a little measure that you can use to test the waters. We spoke about tulip prices rocketing or the price of shares in the South Sea company. If you know what the underlying profitability of a company is, what are its earnings - basically, how much money is it making? - and you know the price of that company's shares, you can do some maths: price divided by earnings.

If you were to buy all the shares on the stock market for £2 billion and its earnings are £1 billion, then the ratio is 2 to 1. The price divided by earnings is 2.

And that's actually quite a low value company. Most tech companies trade at a ratio of about 20 to 30.

So, if it was worth a billion pounds of earnings, then 20 to 30 billion pounds to buy all the shares.

And what you're kind of saying is, ‘I'm prepared to invest and over the next 20, 30 years I'm going to make my money back.’

Because tech companies generally grow, they make profits. When I did some research just early this month, Tesla, as an example, has a ratio of over 330. If you buy shares in Tesla, you're basically paying for an expectation that over the next 330 years their earnings are going to pay you back for the value of your shares. That is obscenely high! That is speculative! That is people assuming it's going to make lots of money in the future… but it hasn't made it yet and they're hoping that happens!

Or if it's a bubble, it's people hoping that they can get in while the price is going up and get out before the prices pop and start coming down.

Tesla is a large established company making profits, but it feels like the prices are somewhat over exaggerated. There is value - it might take a long time to get it out and you might think it's not a risk worth taking.

There are other tech companies where you can buy the shares a lot cheaper at a lot more reasonable price, and they might be the ones that can still make you money in the shorter term, the shorter term being decades rather than hundreds of years.

Bex

Even just that reminder that shorter term is still decades, I think, must be a really helpful check for us in terms of if something's promising us a return in months or years, perhaps it has fallen into a get-rich-quick scheme… which is quite hard to say!

So we're coming towards the end of our episode. But what can we learn from financial bubbles - good or bad?

Simon

I think, as Christians, it's worth recognising that by nature we're called to be quite countercultural. We're not called to follow the ways of the world. We don't have the fear of missing out… unless it's the fear of missing out of heaven - fine. Any other fear of missing out… not so much!

We know and we've spoken about, God is the owner of everything; we are his stewards. He gives us resources to enjoy, to meet our needs, but also to use for his purpose.

If all the money that God gave all the Christians in the world was just invested for the future, it would never get used! Money's a tool. It's going to be used, and we need to use it wisely.

And what I think history has demonstrated, time after time after time, is that pursuing any kind of get-quick-rich scheme doesn't work for the average person. There are those that will get the timing just right, but it's speculation, it's chance - it's not strategy, and it's not investing.

And as we read through the hundreds and thousands of verses in the Bible that talk about how we manage our money, our wealth and our possessions, it talks more about being disciplined, about being deliberate, about being patient, about planning… not so much about scheming, about profiteering, about being greedy!

And if we can look at some of these potential opportunities to make money quickly and say, ‘No, that isn't the way the Lord asks us to manage our money. I'm going to stick with get rich slow, trust in the Lord for his provision. Use my money as he calls me to, rather than just try and get as much as possible,’ then I think we're going to have a good starting position for avoiding the risks and the dangers that bubbles do cause.

Now, you can invest in these tech companies, but if you spread your money, if you invest in a widely diversified fund of 10,000 different companies, you will have money in some of these tech companies, but small amounts, rarely more than 1% of your wealth in anyone, and often a whole lot less than that.

And you will benefit from the overall rise in the value of the economy, the value of stock markets if AI delivers.

But you won't get caught out by being in the one company that fails because it was hype and speculation and its idea didn't quite come off.

Bex

If you want to find more of Simon's wisdom on investment - what it is, what it isn't - I'd recommend heading back to some of the earlier episodes, particularly in Season 1, where some of the fundamentals of this conversation are laid out as well.

We will be back next week discussing another of our financial crises.

I'm not even going to say what it is - going to keep the mystery going! Clearly, it worked last time because people came back.

Simon

Remember, I told them last time!

Bex

Oh yeah; oh well!

Simon

But not this time! Come back next time for a new financial crisis.

Bex

It's an actual mystery this time, and we will see you then to discuss it!

Simon

So exciting!

Bex

That's it for this episode of, ‘Where Your Treasure Is…’

Simon

Thanks for listening. Let's keep learning to be good stewards of all we've been given.

Bex

See you next time.