Wednesday, May 7, 2014

The Madness of Crowds

Economic bubbles and the other follies of mankind are nothing new.   And while this sort of behavior has been noted for centuries, most folks don't heed the warnings.

A reader recommended the book "Extraordinary Popular Delusions and the Madness of Crowds" a while back, and I just got a chance to read it.

It is a fascinating book, in that it was written in 1841, (by Charles Mckay) and yet the writing style seems startlingly modern in tone and style.  After reading a number of Dickens' work recently (you can download the entire library for 99 cents as it is public domain) I was expecting difficulty with antiquated verbiage and phraseology.

But other than the use of the word "Peculating" the book could have been written today.

And the topics covered are certainly timely.  In a way, I feel I am channeling this guy, right here in this blog.   He is a bit of a cynic, to be sure, and rails against the ways in which the public is deceived - and deceives itself - time and time again.

As I noted in Efficient-Market Hypothesis, some folks think that McKay overstates his hypothesis about bubbles, particularly claiming that the "Tulip Bubble" of the 1600's was exaggerated or based on satirical pamphlets of the time.

Others might argue that the "Mississippi Company" bubble, which occurred in France, might be due to other causes.    You'll have to read the book, as truth is stranger than fiction.   A shady Englishman named John Law (no, I am not making this up) moved to France and persuaded the government to set him up with a bank-like company called the "Mississippi Company" which ostensibly was to exploit French possessions West of the Mississippi river.   What it actually did was print stock and sell it.  Law persuaded the French government to issue paper currency, far in excess of the gold to back it up.

Now, some gold-bugs might argue that this latter effect was the cause of the Mississippi Company bubble - that the devaluation of the currency caused the collapse of the stock.   But as Law notes, the gold-back coin currency was devalued even before paper currency was issued.   It isn't hard to do.  The government exchanged new Franc pieces for old ones, with the new ones having less precious metal in them, either by means of reduced weight, or by adding base metals - "debasing" the currency (and you wonder where that word came from!).

Of course, we did the same thing a long time ago here in the USA, when we removed precious metals from our coinage.   Even copper pennies are no longer copper - and yet they still cost more than a penny to make!

Yes, you could argue that a host of government actions and regulations lead to the crash of the markets in France (just as you could argue the same for the recession of 2009).   However, as Law points out, it was the frenzied buying and selling of stocks and the rampant speculation by "stock jobbers" that really drove prices into the stratosphere.   Just as we sell futures contracts today, stock jobbers back then would sell contracts for delivery of Mississippi Company shares - often with little put down by the buyer.   This form of leveraging resulted in the share prices going through the roof.   And when they crashed, well, a lot of people lost a lot of money.

The point is, the Mississippi Company never had enough profit or prospects to justify its share price, and eventually reality "corrected" the pricing.  In Great Britain, just a few years later, the same happened with the ill-fated "South Seas Company" which, while ostensibly chartered to trade with Spanish-dominated colonies in South America, never actually did any business, other than a ship or two of transport.   Most of the company's revenues were from assuming Royal debt and accepting interest payments.   Like the Mississippi Company, people crowded to "exchange alley" to trade in these stocks - and hundreds of other speculative stocks took off as well.   And many of these companies had no real plans, other than to sell stock and cash out before the buyers found out.
"Persons of distinction, of both sexes, were deeply engaged in all these bubbles; those of the male sex going to taverns and coffee-houses to meet their brokers, and the ladies resorting for the same purpose to the shops of milliners and haberdashers. But it did not follow that all these people believed in the feasibility of the schemes to which they subscribed; it was enough for their purpose that their shares would, by stock-jobbing arts, be soon raised to a premium, when they got rid of them with all expedition to the really credulous. So great was the confusion of the crowd in the alley, that shares in the same bubble were known to have been sold at the same instant ten per cent higher at one end of the alley than at the other. Sensible men beheld the extraordinary infatuation of the people with sorrow and alarm."
Sounds a lot like today, doesn't it?

As for the Dutch Tulip bubble, perhaps it was not the huge economic bubble that Mckay makes it out to be - although a lot of people lost a lot of money on tulips.    Perhaps it is more like the Beany-Baby bubble of a few years back - when people convinced themselves that ugly little bears were worth more than cars.

Mckay tackles other subjects as well, including the mania for persecuting "witches" (which he denounces in no small terms as madness) as well as the folly of the crusades.    He also has little patience for ghost-hunters, mediums, fortune-tellers, quack cures and the like.   He was a very modern man, I would say, except that today, our fellow citizens appear to more gullible than ever to these Extraordinary Popular Delusions.

One subject Mckay discusses is how catch-phrases and trends become wildly popular and then die out, overnight, in the big city.   For example, the phrase "Quoz" became wildly popular in London for a brief time, and then mysteriously petered out, only to be replaced with "what a shocking bad hat!" at which the mischief-makers would then remove the hat from some unlucky fellow and toss it into the gutter.   

Today, we have catch-phrases from television and the Internet, as well as "the knock-out game" - all trends promoted by the media (even as they claim to abhor them).   Not much has changed in 160 years.

Sadly, it would seem that today, as in 1841, the majority of Americans (and citizens of the world) still believe that stocks can make them money without work or labor - or showing of a profit.   People believe that whatever is hyped and promoted "must be good" because "everyone is doing it."

And we have ghost-hunters today (although that fad has died out somewhat) and people who are willing to start a next Crusade (or Jihad, take your pick) over perceived religious differences.  We are more superstitious than ever, even with our Internet and Smart Phones - or perhaps because of them.

Conspiracy theories abound, and one only need invoke a word or two to get a knowing nod from a fellow true-believer.   "Benghazi!" the GOP says, and the faithful nod, knowing that the 'inside story' hasn't been reported by the "mainstream media" - of soldiers being told to "stand down" while the attack took place, and of the Ambassador being raped and strangled (neither of course, are true, but why get in the way of a good story?).

The Internet, and the Wiki have become the new "crowd" for which madness attaches.  And we even embrace this term, in somewhat flawed ideas like "crowdfunding" - which illustrates to me that a fool and his money are still soon parted.  You give away precious money to someone to do a "startup" with no promise of any return, other than perhaps a free product once (and if) the company produces it.   I guess people aren't as broke as they make out to be.

I am only sorry that I did not read The Madness of Crowds 40 years ago, as it would have clued me into some things long before they happened - although I did pretty well with the bubbles, considering.

I guess what is interesting to me is that it appears that as a race of humans, we have not advanced as much as we would like to believe.    While we now have indoor plumbing and iPhones, we are still as primitive as the folks living back in 1841 - still prone to the same peer pressures and nonsensical behavior as always.

Act rationally in an irrational world, someone once said.   Do that, and you can make a fortune.