How large can a bubble grow before it bursts?
Farther than you think. And there need not be a fatal pinprick that makes it burst.
And when it bursts, the crash that ensues can be deeper and more
discontinuous than you could ever imagine.
In May of 1982, while the bear market in US stocks was in its deepest throes, and the
epic bear market in US bonds was still completing its base, I was called to
advise on the greatest stock market bubble of all time---the Souk al Manakh in the Persian Gulf.
had had an organized stock market for some time. The great wealth created in Kuwait by the
rise in the oil price in the 1970's led to seemingly endless appreciation in
Kuwaiti stocks. In the Arab states in those days, only sheiks could grant
corporate charters, and only corporations could become publicly traded
companies. The royal family of Kuwait did not freely grant
corporate charters for companies that might become vehicles for stock
speculation, so there was a shortage of stocks to trade. This shortage and
the new unparalleled wealth that was looking for vehicles of speculation gave
rise to an over the counter market in Kuwait
city where shares in companies domiciled elsewhere in the Gulf---principally Bahrain and the United Arab Emirates---were
traded. Housed in a converted air-conditioned parking garage, this market was
known as the Souk al Manakh---the camel market.
I was asked at the time by the government of the United Arab Emirates
to advise on the creation of a stock exchange in the
Emirates. Great fortunes were being made in shares of companies domiciled in
the Emirates at the time. Why not bring all this wonderful new stock market
For six weeks I worked out of an office in the UAE
central bank in Abu Dhabi.
The city was modern, laid out along a crescent beach at the end of a
promontory into the Gulf. The central bank was a modern glass building behind
severe cement columns that met in graceful Moorish arches. From a great glass
window of this modern building, I could see along a turquoise backwater old
tanned fisherman working on brightly painted ancient fishing dhows that were
beached on the blinding sands. The Sheik of Abu Dhabi was the richest man in
the world then. Only a few decades earlier his brother, the former ruler, was
afraid to walk the streets of what was then a small sandy seaside fishing
village for fear of his creditors.
Being a macro oriented, top-down man, I set about to
see how great a supply of stocks had been made available for trading on a
formal market in the UAE. The results were simply unbelievable. The market
capitalization of the Kuwait
exchange and the Souk al Manakh combined ranked
third in the world, behind the US
It was greater than that of the UK with all its foreign listed
companies. How could this be? I asked, for both geographically and
economically speaking, these few countries---Kuwait,
and the Emirates (the former Trucial States under British domination)---were only postage stamps of sand on the globe. Oil had
brought wealth to these small countries but their combined economies were
still very small compared to those of the US
or Japan or the UK. More
striking was the fact that most of the visible wealth was not reflected in
these companies. The rulers of these sheikdoms owned the oil wealth. The
hugely expensive real estate was privately held, as were the extremely
lucrative import franchises. What assets and income underpinned these
multi-billion dollar market caps?
We did a bottoms up study
to find out. In Bahrain,
a financial center, there were banks, seemingly of
substance. There was a raft of companies that made cement and clinker. These companies
were domiciled in five former Trucial states whose names you never heard of
that, alas, had no oil. There was a company or two that imported sheep and
goats for slaughter. And then there was a handful of
other companies whose principal activities were not at all obvious.
The Sheik of Abu Dubai was the richest man in the
world at the time and the Ruler of Dubai was also quite well to do. The five
other sheiks who had no oil were poor cousins. For founders shares these oil
poor sheiks granted charters for corporations that could be traded on the
Souk al Manakh. I can remember driving one day to a
small derelict town that was the capital of one of these oil poor sheikdoms
to analyze a company with a high flying stock on Kuwait's OTC market. For the life
of me, on the balance sheet of this company I could find no assets of any
kind. It dawned on me that, behind most of this third ranking stock market
cap in the world, there were only a few cement and clinker plants, a
slaughter house or two, and quite a few shell games.
How do you tell your host government that the stock
market they want to bring home is a shell game? I pondered this diplomatic
quandary for weeks as I looked out my office window at those ancient painted
dhows in the desert sun. In the end I mustered the courage to tell the truth.
"It is all a bubble," I told my client-. "And it will
burst." To my relief and amazement, I was greeted, not with displeasure,
but with laughter. "You Westerners have been coming here for five
years", they told me, "and to a man you all have predicted a crash.
Don't you understand, there has never been a place
on earth like the Gulf with such unprecedented wealth? You will never
understand that the Gulf market cannot crash."
I had a long time friend in London. His name was Ali. He was one of
several Anglo Arab investment bankers that flourished in London in those years. When I passed
through London on my way back to the US I stopped
to tell him about my trip. Speculation on the Souk al Manakh
was financed with a curious type of informal margin financing by way of post
dated checks. So rapid was the rise in the Gulf market that post dated checks
paid an interest rate of 100% per annum. Ali was financing speculators in
this market. He listened and he smiled.
At the beginning of August I had completed my report
for the government of the UAE. I told them that the market they wanted to
organize was a bubble and that it would crash. Some weeks later I heard from
Ali. He called to thank me for my advice on my recent visit. He had called in
all his post dated checks. "Did you hear what happened to the Souk?", he asked. "No", I replied. "Well,
it topped quietly at mid summer after you left, with no provocation. One
can't quite say it declined or it crashed; it has just stopped trading."
The Souk al Manakh was the
greatest speculative mania of all time. One could not even speak of
valuation. Margin financing reached unimaginable extremes; one speculator,
who had been a customs clerk two years earlier, had at the peak $14 billion
in stocks financed with $14 billion of margin debt. The people involved
believed that the oil rich Gulf was truly a "New Era". It did not
take a trigger to burst this bubble; it simply crested sometime in the
dreadful heat of the Middle East's summer.
Its decline was so discontinuous it cannot be called a crash. There were simply no bids.