McAlvany
Extraordinary Delusions and the Madness of Crowds
. . . an extract

"In reading the history of nations, we find that like individuals, they have their whims and peculiarities; their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first.

"Money...has often been a cause of the delusion of the multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper... Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one." — Preface to the 1852 edition of Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay

"That the free enterprise economy is given to recurrent episodes of speculation will be agreed...This process, once it is recognized, is clearly evident, and especially so after the fact. So also, if more subjectively, are the basic attitudes of the participants. Those take two forms. There are those who are persuaded that some new price-enhancing circumstance is in control, and they expect the market to stay up and go up, perhaps indefinitely... Then there are those, superficially more astute and generally fewer in number, who perceive or believe themselves to perceive the speculative mood of the moment. They are in to ride the upward wave; their particular genius, they are convinced, will allow them to get out before the speculation runs its course...

"For built into this situation is the eventual and inevitable fall. Built in also is the circumstance that it cannot come gently or gradually. When it comes it bears the grim face of disaster. That is because both of the groups of participants in the speculative situation are programmed for sudden efforts at escape. Something, it matters little — although it will always be debated — triggers the ultimate reversal." — The Great Crash, 1929, John Kenneth Galbraith

"Anyone taken as an individual is tolerably sensible and reasonable — as a member of a crowd, he at once becomes a blockhead." — Schiller's dictum

"Those who do not learn from history are doomed to repeat the mistakes of history." — Santayana

"I can measure the motions of bodies, but cannot measure human folly." — Sir Isaac Newton, who lost a fortune in the South Sea Bubble of 1720

"History demonstrates that participants in financial markets are susceptible to waves of optimism. Excessive optimism sows the seeds of its own reversal in the form of imbalances that tend to grow over time. When the unwarranted expectations ultimately are not realized, the unwinding of these financial excesses can act to amplify a downturn." — Federal Reserve Chairman Alan Greenspan (2/26/97)

"Inexperienced investors who have known only the bull market of the last decade could react `precipitously' to a downturn, and at great cost to themselves and our markets." — Arthur Levitt, Chairman of the Securities Exchange Commission (2/26/97) in the London Financial Times

 

INTRODUCTION

America is today caught up in the biggest speculative bubble, the biggest buying mania since the stock market run-up and subsequent collapse in 1929 and probably the biggest in U.S. (if not world) history. The ultimate collapse and economic carnage which will follow this greatest-ever speculative blowoff in the U.S. equity markets will decimate the U.S. economy, impoverish most of the U.S. middle class, and will spread quickly to every nook and cranny of the world — precipitating the greatest depression in U.S. (if not world) history.

Speculative bubbles are not peculiar to this age — they have been around for hundreds of years (dating back to the collapse of the Roman Empire in the 400s A.D.) and are a function of human nature (and particularly greed) — which never changes.

There was the Mississippi Bubble (of 1719 and 1720); the South Sea Bubble (of the 1720s); the great U.S. stock market bubble of the 1920s; and the Japanese stock and real estate market bubble of the late 1980s.

There were lesser bubbles — such as real estate in California; condominiums in Hawaii; residences in the Northeast; commercial office buildings in the oil patch states; and other bubbles and collapses in the 1980s. Gold at $850, silver at $50, oil at $50, baseball cards, art goods, the "Nifty Fifty" and "Go-Go Fund" eras in the stock market were all mini-speculative bubbles which I have observed since entering the investment business in 1967. Each of them ultimately collapsed (as all bubbles do).

In 1841, Charles Mackay wrote his classic work on mob psychology, speculative bubbles and manias — Extraordinary Popular Delusions and the Madness of Crowds. This masterpiece analyzed (in depth) mob (or crowd) psychology and many of the great delusions (speculative bubbles) of history. As Wall Street financier Bernard Baruch wrote in the forward to the 1932 edition of Mackay's book: "I have always thought that if, in the lamentable era of the `New Economics' [ED. NOTE: in the "new era," "go-go" 1920s] culminating in the 1929 debacle, even in the presence of dizzily spiraling prices, we had all continuously repeated, `two and two still make four' [ED. NOTE: if they had remembered the basics], much of the evil might have been averted."

A speculative bubble is created when objectivity, reasoning, and valuation give way to greed and an insatiable desire for profits. John Kenneth Galbraith, in A Short History of Financial Euphoria, described some of the common denominators of past bubbles and manias, which inevitably eventuate in financial disaster:

1) The basic premise that investing involves a trade-off between risk/reward is lost as investors are "captured by the wondrous satisfaction from accruing wealth. The very increase in values thus captures the thoughts and minds of those being rewarded."

2) The belief that "some new price-enhancing circumstance is in control" — that there is "something new in the world" that justifies a permanently higher level of valuation.

3) The illusion that except for temporary setbacks, "values are going up permanently and indefinitely."

4) The "condemnation of those who express doubt or dissent...because of defective imagination or other mental inadequacy they are unable to grasp the new and rewarding circumstances."

Investech Research (2472 Birch Glen, Whitefish, MT 59937), in an excellent report entitled: The 1997 "New Paradigm Bubble," listed the difference between a healthy bull market and a dangerous speculative bubble:

Regarding the "new era of perpetual prosperity" arguments currently being given by Wall Street as justification for the rapidly rising Dow Industrials, Fed Chairman Alan Greenspan (in testimony before Congress on 2/26/97) said: "Regrettably, history is strewn with visions of such `new eras' that, in the end, have proven to be a mirage." The "new era" (which Greenspan referred to) which Wall Street is hyping as a justification for a permanent rise in stocks is supposed to be perpetually low inflation, low interest rates, and rising productivity which will give us perpetual prosperity through the next decade and beyond.

Wall Street is using these "new era/perpetual prosperity" arguments to justify the highest prices and greatest stock market overvaluation in history to over 75 million Americans, who have poured much of their life savings and retirement assets into equities or equity mutual funds believing that these high priced stocks will rise forever.

Wall Street has convinced tens of millions of these investors that they are smarter, better informed, more patient, and longer term oriented than the less sophisticated fundamental values oriented investors of earlier generations. In short, Wall Street has convinced much of middle class America (with the help of inflated, dishonest economic statistics from Washington) that this market will rise forever, bringing with it perpetual prosperity, easy wealth and riches, and a "new era" which guarantees the "good life" as far ahead as the eye can see. Charles Mackay would chuckle over the present extraordinary delusion and madness of the middle class America.

[ED. NOTE: How high is high in the stock market today? At the market peak, in October 1929, stocks were trading at 35 times dividends. Today they are trading at 61 times dividends — almost twice as high as the overpriced stocks which collapsed in 1929.]

 

A. THE ANATOMY OF A MANIA

MANIA: "An excitement of psychotic proportions manifested by mental and physical hyperactivity; disorganization of behavior and elevation of mood; a form of insanity marked by great excitement." — Webster's Third International Dictionary

"New all-time highs, again, led me to re-skim Gusgav Le Bon's The Crowd and Charles Mackay's 1841 Extraordinary Popular Delusions and the Madness of Crowds. I am more than ever convinced that we are witnessing a bizarre mania in the stock market — a `bubble.' Two things are common to these types of phenomena. First, they appear logical to the participants at the time, and they continue longer than would be expected until suddenly, for whatever reason, or for no apparent reason, they reverse course, and inextricably trap the majority of unwary participants; second, they inevitably end tragically, without exception." — Kennedy Gammage, The Richland Report, 6/14/97


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