There’s a cottage industry within economics involving the production of historical arguments giving rational explanations of seemingly irrational historical episodes, of which the most famous is probably the Dutch tulip boom/mania. This Slate article refers to the most recent example, a complex argument regarding changes in contract rules which seems plausible, but directly contradicts other explanations I’ve seen.
Once opened, questions like this are rarely closed. Still, articles of this kind seem a lot less interesting in 2004 than they did in, say, 1994. In 1994, the efficient markets hypothesis (the belief that asset markets invariably produce the best possible estimate of asset value based on all available information) was an open question, and the standard account of the Dutch tulip mania was evidence against it. In 2004, the falsity of the efficient markets hypothesis is clear to anyone open to being convinced by empirical evidence.
We have seen billion-dollar valuations placed on companies that proposed to home-deliver dogfood at prices lower than those charged in discount stores. We’ve seen unimportant subdivisions of profitable companies valued at more than the companies themselves. We’ve seen a dozen different companies simultaneously priced at levels that made sense only if they were each going to monopolise the industry in which they were competing. And don’t even get me started on the US dollar bubble (now burst) or the bond bubble (still inflating).
In summary, is contradicted by our own recent experience far more thoroughly than by anything that might or might not have happened in Amsterdam in the 1630s. Everybody who cared to look at the numbers coming out of markets in the late 1990s knew they were crazy, but it didn’t matter. Those who bet on an early return to sanity (George Soros for example) lost their money. The only sensible course was to withdraw to the sidelines and wait the madness out.
It’s true that dramatic episodes like the dotcom mania don’t happen all the time. But even one such episode, occurring in a well-developed and sophisticated financial market like that of the US in the late 1990s is sufficient to undermine the assumption that asset markets ever yield the best possible estimate of asset values, except by chance.
fn1. That is, explanations consistent with individual rationality as defined by economists