[Bitcoin Twist] Is Cryptocurrency a Tulip Bubble? It’s Closer to the ‘Namhae Bubble’ That Even Newton Fell For

Namhae Company Created to Resolve Post-War Debt
Namhae Company Stocks Soared Then Crashed... Even Newton Bought at the Peak
COVID-19, National Debt, Real Estate and Stocks... And the Emergence of Cryptocurrency

The cryptocurrency craze is sweeping across the globe. It is even likened to a so-called 'mania.' However, the more intense the mania, the more necessary it is to pause and observe carefully. If problematic aspects are swept away along with the hype, they are bound to manifest as bigger issues someday. This is a time to calmly reflect on the cryptocurrency market, called 'Bitcoin Twisting.'

[Asia Economy Reporter Gong Byung-seon] Cryptocurrency pessimists often compare the cryptocurrency market to the speculative symbol of tulips. The tulip bubble was a speculative frenzy that occurred in 17th-century Netherlands. Tulip prices soared by 50 times in just one month, showing an enormous upward trend, but when the court ruled that tulips had no property value, prices plummeted rapidly. In other words, cryptocurrencies could experience a sudden price surge followed by a sharp decline, just like tulips in the 17th century.

However, strictly speaking, the cryptocurrency market seems closer to the 'South Sea Bubble' than the tulip bubble. The South Sea Bubble refers to speculation stemming from the 'South Sea Company,' established in Britain in 1711. The reason the South Sea Bubble is considered more similar to the current cryptocurrency market is that the macroeconomic conditions at that time resemble those today. So, what aspects of the South Sea Bubble are closer to the current situation than the tulip bubble? Let's examine them one by one.

The Tulip Bubble Started from Optimism

The tulip bubble originated from a boom. At that time, the Netherlands rose to become a leading nation as the multinational company, the Dutch East India Company, achieved great success. Moreover, the Dutch East India Company was the first company to issue stocks. This means there was enough economic and mental capacity to build a capitalist system. Additionally, the Thirty Years' War broke out in Germany 30 years earlier, weakening the crop industry in Bohemia and the Czech region, allowing the Netherlands to begin monopolizing the crop sector.

Based on this prosperity, nobles and wealthy people showed interest in tulips. Consequently, tulips were perceived as luxury goods, and their prices rose. The problem was that commoners, who also gained some wealth, began investing in tulips. Every household grew tulips, dreaming of making a fortune. As the entire Netherlands became obsessed with tulips, tulip prices increased by 50 times in just one month in 1637.

However, the bubble did not last long. In fact, even those participating in the bubble did not expect tulips to reach such values. They knew they were aiming for a quick profit. When supply began to exceed demand, tulip prices started to fall sharply. Within less than six months, tulip prices dropped about 95% from their peak.

The South Sea Bubble Started from War and Debt

The South Sea Bubble was different. Professor Hong Ki-hoon of Hongik University's Business Administration Department explained, "The South Sea Company was a measure introduced by the British government, which was struggling with debt after the war and had no suitable investment options. The South Sea Company was created strictly to resolve the nation's debt." In other words, the South Sea Company was established to solve the country's unfavorable situation.

In fact, Britain had significantly increased its debt due to raising enormous war funds to win the War of Spanish Succession from 1701 to 1714. By the end of the war, Britain's debt reached 10 million pounds, and 9% of Britain's fiscal expenditure was allocated to debt repayment and military expenses.

However, the South Sea Company had no proper way to generate profits. Although it obtained the right to supply slaves to Spanish colonies and exclusive trade rights in the South Pacific from the British government, it failed to make significant profits.

In 1718, when the South Sea Company made large profits from lottery issuance, it transformed into a financial institution. It declared its intention to make money through stocks. Struggling with deficits, the South Sea Company used a multi-level fraud scheme. The method was as follows: ▲ Exchange government bonds based on market price. For example, if the face value of South Sea Company stock was 100 pounds and the market price was 200 pounds, the company would bring in 200 pounds of British government debt at market price. ▲ However, since the allowed issuance quantity follows the exchange amount, stocks worth 200 pounds face value could be issued. In other words, while bringing in 200 pounds of debt, stocks worth 400 pounds at market price could be issued. ▲ Selling these stocks would leave 200 pounds of revenue entirely to the South Sea Company. ▲ As profits rose, the South Sea Company's stock price also increased, and so on. In short, the company made profits and stock prices rose without any substantial business activities.

The South Sea Company announced it would take over about 31 million pounds of British government bonds and paid a burden charge of 7.5 million pounds to obtain stock issuance rights. Including lobbying costs, it is known to have spent up to 8.8 million pounds. It is presumed that the British government did not fully understand the South Sea Company's methods. Of the British government's 50 million pounds debt at the time, 15 million pounds were illiquid long- and short-term annuity certificates with high interest rates, and the South Sea Company promised to reduce this debt, so the government had no reason to object.

The Bubble Begins to Inflate... Even Isaac Newton Got Caught in South Sea Company Stocks

As the South Sea Company's stock price began to rise through fraudulent methods, the public started overvaluing the company. Although the South Sea Company did not create substantial intrinsic value, rumors spread that it had secured trading rights in Spanish colonies and started operating silver mines. Expectations grew that the company could make large profits by utilizing the previously mentioned rights to supply slaves and exclusive trade rights. Moreover, South Sea Company executives spread false information to further boost stock prices, claiming Spain would hand over the Peruvian Potos? silver mine to Britain and that silver would become as common as iron.

As a result, the South Sea Company's stock price began to soar. The British government, which needed to repay its debt quickly, positively reviewed these methods, and the proposal passed Parliament. Consequently, the stock price rose sharply from 128 pounds in January 1720 to 550 pounds in May. It even reached 1,000 pounds in August.

The problem was that many companies imitated the South Sea Company's methods. Unauthorized companies sprang up riding the trend. People blindly believed stock prices would rise and bought any stocks without knowing what businesses the companies were conducting. Professor Hong explained, "Some companies only disclosed their business details after receiving money or even refused to disclose them, but people invested with the expectation of making money."

The British government judged the bubble to be excessive and passed the Bubble Act in July 1720. British writer John Carswell argued that the government regulated because companies that sprang up like mushrooms took the South Sea Company's share, but in any case, it became difficult to establish companies easily. Consequently, by the end of September, the South Sea Company's stock price plummeted to 150 pounds. While the tulip bubble is known not to have significantly harmed the Dutch economy, the South Sea Bubble was different. Of the South Sea Company's market capitalization of 164 million pounds, 103 million pounds disappeared. At the time, the South Sea Company's market capitalization accounted for more than 25% of the entire British stock market.

Isaac Newton, the scientist famous for the law of universal gravitation, was also a victim of the South Sea Bubble. In April 1720, he sold his South Sea Company stocks, recording a 100% return and making a capital gain of 7,000 pounds. However, after reinvesting, he got stuck at the peak and recorded a loss of 20,000 pounds. It is said that Newton suffered whenever he heard the word 'South Sea' afterward.

Comparing to Now... COVID-19, Real Estate and Stock Market, and Cryptocurrency

[Image source=Yonhap News]

Comparing the present, the situation before the cryptocurrency surge is quite similar to the South Sea Bubble. A quasi-war situation has occurred, and speculative-like situations are occurring alternately.

First, a quasi-war situation emerged with COVID-19. Although it is not a war, countries have mobilized all available means to cope with COVID-19. In April last year, former U.S. President Donald Trump invoked the Defense Production Act to order six companies, including General Electric and Hillrom Holdings, to produce ventilators. This was the first invocation of the Defense Production Act since the Korean War in 1950.

Liquidity is overflowing, but there are no suitable investment destinations. Real estate prices have already risen as much as they can. According to the monthly sales index statistics of KB Kookmin Bank's Liv Real Estate, from May 2017, when the Moon Jae-in administration took office, to last March, apartment prices in Seoul rose by 44.74%. This is not unique to Korea. In the third quarter of last year, the house prices of 37 OECD member countries reached an all-time high. The stock market is also burdensome for investment. The KOSPI surpassed 3,000 this year and broke through the 3,200 mark. In this situation, when short selling resumed, public opinion formed that stock prices would no longer rise.

National debt has also surged. According to the International Monetary Fund (IMF), Korea's national debt ratio is expected to reach 64.96% in 2025, an increase of about 24 percentage points from 40.78% in 2015. Moody's, an international credit rating agency, also pointed out that Korea's national debt is at a high level. This is not just a Korean problem. According to the National Assembly Budget Office's analysis, global government debt relative to GDP was 83% in 2019 but surged to 98.6% last year. There are also concerns that if advanced countries raise interest rates, emerging countries could be hit first.

In this situation, cryptocurrency emerged. Bitcoin suddenly became a new investment destination. There are even talks that it could replace traditional investment assets like gold. Last month, Mike Novogratz, CEO of cryptocurrency investment firm Galaxy Digital, said, "The participation of financial institutions in the cryptocurrency market is astonishing," and "Bitcoin will surpass gold's market capitalization."

As the South Sea Company's market capitalization surged, money poured into the cryptocurrency market. On the 7th, the daily trading volume of the four major domestic cryptocurrency exchanges (Upbit, Bithumb, Korbit, Coinone) reached 45 trillion won, three times that of the KOSPI. According to the cryptocurrency market data site CoinMarketCap, as of the 16th, the total market capitalization of the cryptocurrency market was $2.2283 trillion (about 2,518 trillion won). This is comparable to the total market capitalization of the domestic stock market, which is 2,615 trillion won. Also, recently, unknown-source cryptocurrencies like Jindoji Coin have caused multiple victims, and cryptocurrencies are also springing up like mushrooms.

However, due to unclear intrinsic value, volatility is high, and public skepticism is growing. On the 12th (local time), when Elon Musk, CEO of Tesla, announced on Twitter that he would stop Bitcoin payment systems, Bitcoin fell 10.73% at that time. After Musk criticized Bitcoin's environmental issues for two consecutive days, the price dropped below 60 million won. Since the person who raised the price denied Bitcoin, there are even predictions that it could plummet.

Government regulations, like the Bubble Act, have also begun to appear. On the 13th, the U.S. Department of Justice and the Internal Revenue Service announced they would investigate the overseas cryptocurrency exchange Binance for money laundering and tax evasion. On the 28th of last month, a public-private task force team involving U.S. regulatory and investigative authorities reportedly urged the Department of Justice to establish a special team dedicated to cryptocurrency seizures.

British writer John Carswell, mentioned earlier, said about the South Sea Bubble: "Hoping for additional rises beyond true capital value is just a fantasy. The only way to avoid falling for this is to sell early. And let the devil eat the last man."