The Ascent of Money: A Financial History of the World

Chapter 3 describes the joint-stock, limited-liability corporation and the booms and busts that have accompanied some of the major stock market bubbles in history. Such entities are “jointly” owned by investors and, since corporations are considered “people” in terms of the law, the liability of investors is limited to only what each has put into the company, shielding their other assets.

Ferguson writes that financial bubbles have five stages: (1) displacement, a change that creates new sources of profit; (2) euphoria, also called “overtrading,” when share prices rise based on expected future gains; (3) mania or bubble, when investors flock to the stock hoping to make an easy profit; (4) distress, when share prices become so high that people begin selling after concluding that expected profits don’t justify such a high price; (5) revulsion or discredit, when everyone wants to sell, share prices fall, and the bubble bursts.

Bubbles also have three features. First, asymmetric information is the fact that people with more knowledge of a company exploit those with less knowledge. Second is the role of cross-border capital flows: bubbles occur more frequently in situations where capital can flow between countries. Finally, easy credit must be present to allow such speculation.