We're delving into the fascinating, yet often destructive, world of financial speculation, drawing on historical patterns to understand why these cycles of boom and bust continue to occur.
We explore the common features of speculative episodes, as outlined in John Kenneth Galbraith's work A Short History of Financial Euphoria, and discuss how these patterns manifest in various markets.
The book examines recurring speculative bubbles throughout history; analyzing common characteristics of these events, highlighting the role of mass psychology, short financial memory, and the flawed association of wealth with intelligence. Galbraith uses historical examples, including the Tulipomania, the Mississippi Bubble, and the 1929 stock market crash, to illustrate his points and warn against the dangers of speculative excess. He concludes that such episodes are inherent in free-market systems and that attempts to find external causes for crashes often obscure the underlying speculative mania.
Topics include:
• The Psychology of the Crowd: How mass psychology drives speculative frenzies, leading individuals to abandon reason in pursuit of quick riches. The role of public opinion in reinforcing these beliefs and condemning dissenters is also explored.
• The Allure of "New" Financial Instruments: The recurring tendency to perceive certain financial innovations as revolutionary, while in reality they are often just variations of existing, and sometimes unstable, designs. Examples in the source include bank notes, joint-stock companies, junk bonds, and holding companies.
• The Illusion of Financial Genius: How wealth is often mistakenly associated with intelligence and special insights, particularly in those who are profiting from a speculative surge. It also notes how this perceived brilliance quickly disappears during the inevitable crash.
• The Shortness of Financial Memory: The recurring amnesia that allows similar speculative bubbles to occur again and again, often with a new generation of participants. This includes a failure to learn from the errors of past episodes.
• The Inevitable Crash: Speculative episodes always end with a crash, often triggered by seemingly small events but fundamentally caused by the unsustainable nature of the boom. This is followed by finger-pointing and a search for scapegoats, while the underlying speculation is conveniently ignored.
• The Search for External Causes: In the aftermath of speculation, the market itself is never blamed. The search for external causes (scape goats) that are not part of the market itself begins.
• The Recurrent Nature of Speculative Episodes: Patterns of euphoria, crash and amnesia are not isolated events, but are a recurring feature of financial history.
We end with a reminder that while the specific timing and venue of the next speculative episode are unknown, the pattern of financial euphoria and its consequences are certain to repeat.
When will come the next great speculative episode?
"To these there are no answers; no one knows, and anyone who presumes to answer does not know he doesn't know. But one
thing is certain: there will be another of these episodes and yet more beyond. Fools, as it has long been said, are indeed separated, soon or eventually, from their money. So, alas, are those who, responding to a general mood of optimism, are captured by a sense of their own financial acumen. Thus it has been for centuries; thus in the long future it will also be."
Get the book: A Short History of Financial Euphoria by John Kenneth Galbraith