Remember the dot-com revolution, which was supposed to make so-called “brick and mortar” industries obsolete? Or perhaps the boom of 2004-07, supposedly founded on the basis of a “new paradigm” of low interest rates and financial innovation by banks is more deeply etched in your memory? At the height of these booms, there were all sorts of theories being peddled that sought to tell us that the boom was based on solid “fundamentals”. Of course, we all know how these bubbles ended. That’s why “this time it’s different” is perhaps the most dangerous phrase ever uttered by investors. Most investment booms, busts and bubbles follow a common pattern from euphoria to depression and the new-fangled theories that are supposed to usher in a new era are usually seen, in hindsight, as being mere justifications for the boom.
Odlyzko, however, has found one instance where things were indeed different and investors did make a lot of money, despite dire warnings from the experts. The British railway mania of the 1830s, says Odlyzko, is an exception that was really different.
Just how big was this mania? The author says: “At the peak of the financially exuberant early phase, British investors undertook to plough over 8% of their country’s GDP (gross domestic product) into the new infrastructure, equivalent to over $1 trillion for the US today. (By way of comparison, estimates of rebuilding the US telecommunications infrastructure with fibre range cost between $150 and $300 billion. The wasteful and wasted spending on long-haul fibre networks during the Internet mania amounted to only around $100 billion.) By the time they were done, half a dozen years later, cost overruns had led British capitalists to invest twice that much, equivalent to around $2 trillion for the US today.”
Illustration: Jayachandran / Mint
During the 1830s too there was no dearth of people saying that the huge investment was a mania and that holders of railway stocks would be fleeced. Two prominent economists of the time, John Stuart Mill and John Ramsay McCulloch, warned that most of the lines being built would turn out to be unprofitable. Both of them turned out to be wrong. In the fall of 1845, responding to a rant in The Times newspaper of London about the mania being a mad and dangerous folly, an observer had this rejoinder: “Of the 27 odd companies some have succeeded to the extent of more than 150 per cent advance on their original value; others 100, 80, 50, 30 per cent; and all, so far as I know, are paying a fair percentage, or in the immediate prospect of doing so, on the capital invested. These, therefore, are not speculations, but triumphant successes; and the absorption of so much capital in them is no more to be regretted than the outlay in the dwelling-houses of London, which brings in its return in rent.”
A more weighty opinion comes from The Economist, which wrote in early 1845: “The origin of the very favourable reception with which railways have met at this time, is no doubt to be traced to the fact that, of all the schemes which originated in the speculative period of 1835-36, they were the only ones which stood the test of the succeeding pressure, without any disastrous losses.”
But the paper doesn’t really tell us why the “Great Railway Mania” of the 1830s was different. Could it be merely the exception that proves the rule? But perhaps the explanation is that, as Odlyzko says, “Infrastructure construction funded by equity is radically different from the much more frequent, far more dramatic and attention grabbing financial crises that are associated with large accumulations of debt, typically for consumption.”