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April 2003

 
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Your Engineering Heritage

It Didn't Begin with the Dot.coms: High-Tech and Market Bubbles Through History

by Robert Colburn

“The shares are a penny, and ever so many
are taken by Rothschild and Baring,
and just as a few are allotted to you,
you awake with a shudder despairing.”
— W. S. Gilbert

The year is 1284, about 14 years after the introduction in Venice of a high-tech electrical positioning technology developed from a Chinese toy — the magnetic compass. Venice’s trade has burgeoned. A new gold coin — the ducat — is about to be minted. Ships can sail all year-round, instead of only in the winter and summer. New technology has led to massive investments in infrastructure. Yet, investor mistrust of corporate governance, and the overhanging shadow of war, is threatening this prosperity.

If we only knew now what we knew in the late 13th century.

Historically, technology has led to speculative frenzies in financial markets in two ways. First, it provides opportunities to invest in new, exciting (but often little-understood) high-risk/high-reward companies. Second, it exacerbates market swings by accelerating information exchange and improving the way share transactions are processed.

Long before Enron attempted to transform itself from an energy supply company to an Internet play by selling broadband services over its existing infrastructure, U.S. railroads were cashing in on their infrastructure by providing bandwidth services in the form of rights-of-way for telegraph companies. However, the actual trigger of the 1857 financial crisis, was not so much over-investment in technologies as it was the sudden drop in wheat prices.

Too Much Information Too Quickly?

The telegraph, along with its related technology, the stock ticker, were blamed for market volatility almost from the day they were introduced. “The tendency to fluctuation has been greatly increased by added opportunities for information…the prompt transmission of news by telegraph,” wrote Theodore Burton. Inventing the telephone further increased investor participation further, and the New York Stock Exchange installed the first one on its trading floor in 1878.

Risky Investments

Thomas Edison’s various companies were especially risky investments, at least prior to the success of the phonograph. Edison’s research expenses frequently outran his investors’ outlays, and bills piled up unpaid while desperate creditors pleaded. In Edison’s case, he did not intend to mislead. The problem was more that new technologies are often more expensive to develop than originally projected, and return on investment takes longer to materialize.

Inflated Shares

False inflations of share value have a long history too. In the summer of 1906, shocked investors in the American de Forest Company (AdFC) learned that the stock had been oversold. Further, AdFC’s assets were transferred to a new corporation, leaving the old company nothing more than an empty shell of debt. De Forest’s restructured Radio Telephone Company also found itself in trouble, and de Forest was indicted — but not convicted — for mail fraud.

The Marconi Company Scandal

Hard on the heels of de Forest’s radio stock irregularities came the famous Marconi scandal. Marconi himself was not involved; the scandal involved insider trading of Marconi Company shares by British cabinet officers and some of their families. In some ways, the Marconi scandal was similar to the insider access to IPOs that occurred in the 1990s. In 1911-1912, the British government negotiated with the British Marconi Company to build a series of wireless transmitting and receiving stations to connect Britain’s colonies. On 7 March 1912, a tender was signed for the first six stations, and the government and Marconi officials began working on the terms of the actual contract. That same March, the American Marconi Company decided to increase its capitalization by a huge new share issue. 

In April, British Marconi Company director Godfrey Isaacs offered some of these new shares to his brother (the Attorney General) and others, even though the shares were not yet approved and not yet available to the public. Ten days later, the shares opened on United States and British exchanges, closing the day at a value of roughly four times what the insiders had paid for them. 

In linguistic hair-splitting afterwards, the government officials claimed that what they had done was not improper because they had bought shares in the American Marconi Company while negotiating a contract with its British counterpart. The public was not amused by the distinction, especially when the American Marconi stock, after a brief run-up, sank back to its original — and more rational — level.

The Distant Memory of High-Price Tech Stocks 

The 1990s were not the first time that high-tech stocks outran their price-earnings ratios. In 1929, RCA shares leapt from $114 per share in February — already a huge run-up — to a high of $572, before plunging to $10 in the October crash. RCA was not unusual in the six-year boom market, which began in 1923. By 1929, share volume on the NYSE had grown so much that the Exchange installed a central quote system to provide instantaneous bid-ask prices via telephone. The frenzy was heating up.

Technology — specifically computerized program trading — was also blamed for the New York Stock Exchange’s largest one-day drop, the 508 point “meltdown” on “Black Monday” 19 October 1987. That particular drop was caused by a huge imbalance of sell orders, triggered mostly by a drop in futures prices. The proliferation of computers in the financial world had made the almost instant transfers of large blocks of capital from market to market anywhere in the world possible, to take advantage of even momentary and small differences in commodity or futures prices. Liquidity could vanish suddenly and with no warning. Many exchanges established trading “collars” to contain volatility, by halting trading if limits were exceeded.

Using either history or technology to explain or predict the stock market is always risky, but what has happened before has happened again, and a little bit of history goes a long way.

 

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Robert Colburn is research coordinator at the IEEE History Center at Rutgers University in New Brunswick, N.J. Visit the IEEE History Center's Web page at: www.ieee.org/organizations/history_center/

 

 

© Copyright 2003, The Institute of Electrical and Electronics Engineers, Inc.