Feel like maybe we are repeating history?
"The national debt amounted to 3000 millions of livres, the revenue to 145 millions, and the expenditure to 142 millions per annum; leaving only three millions to pay the interest upon 3000 millions."
From Memoirs of Extraordinary Popular Delusions — Volume 1 by Charles Mackay
From a review of same on Amazon
The thrust of this classic can be summed up in a single quote. The English South Seas bubble took direct inspiration from John Law's Mississippi scheme; though Law crashed and burned, the Seven Seas directors fancied themselves smarter:
"Wise in their own conceit, they imagined they could avoid his faults, carry on their schemes for ever, and stretch the cord of credit to its extremest tension, without causing it to snap asunder."
And so goes most every bubble to this day, as bankers, politicians and the investing public continue to fancy themselves smarter than their kind of yesteryear. Mackay's revered tome is as much an endorsement of Austrian Economics as it is a documentation of mob psychology. The boom and bust cycle is fueled by easy credit, let loose in hopes of keeping the party going. As the velocity of money increases, ever more disjointed arguments are trotted out to justify ever higher valuations. The frenzy intensifies to a point of unsustainability, the true believers falter, and then it all comes crashing back to earth again.
Mackay also touches on the nature of bubbles as a wealth transfer mechanism from the many to the few. As in all bubbles, a handful of individuals walk away with dubious fortunes intact, leaving the scene (and often the country!) before the tide turns.
Simple observation shows why the public must always lose: if a bubble is based on credit and speculation rather than real productivity and real gains, the excess valuations are not supported by any sustainable means, and the temporary wealth effect is actually just a crowd of people sending inflated sums back and forth. Like musical chairs, the only way to win this game is to stop playing before everyone else does.
There is another amusing aspect to the book: the attempt of some pointy-headed academics to prove Mackay's bubbles justified, i.e. to say that fundamentals asupported the valuations. This incredible stretch seems more herculean than attempts to maintain respectability for the flat earth society.
Whether or not a tulip bulb's DNA is sufficiently rare, regardless of the South Sea company's genuine trade prospects, only an ivory tower academic could be so willfully obtuse as to dismiss the sheer frenzy of the times. During the South Seas bubble--which touched off a number of lesser speculative schemes--a small fortune was collected (and spirited from the country) on the strength of the following prospectus: "a company for carrying on an undertaking of great advantage, but nobody to know what it is." (Does that ring a dot com bell or what?)
It's easy to look back and think, "How could those people be so stupid? Surely we couldn't be that stupid today?" But stupidity is not necessary for the inflating of a bubble. All you need is a positive situation with compelling fundamentals (and even the fundamentals are optional, if you have conditions that create an illusion of their existence).
If the fundamentals justify rational valuation R, then the bubble inflates as multiples are notched up to R x (HC / P), where H = hype, C = credit flows and P = prudence. As greed kicks in, a good story morphs into a fairy tale, rationalizations abound, and prudence goes on vacation. The hand is inevitably overplayed. Easy credit fuels the fire as investors play ring around the rosie. Eventually they all fall down.
Chances are, bubbles will always be with us; the necessary conditions for their forming are rooted in the human condition. New innovations and new growth stories--biotech, the rise of Asia, demographic shifts etcetera--will change the world in the long run while inspiring cyclical frenzy in the short run. The willingness of bankers, politicians and Wall Streeters to provide easy money is perhaps at a high point in history, and the public, as always, shows a remarkable lack of restraint with no sign of wising up. Game on.
This book can be found for free, here -- I am in the midst of reading about John Law
gutenberg.org |
