INFECTED
BY A MANIA? NOT ME - I'M NOT THE TYPE ....
Most people these days
have heard of "Tulip Mania", the episode in history when investing
frenzy first registered on the public consciousness. Just to recap, it was in
the first half of the 17th century, in Holland (even then the tulip capital of
the world, although the plants were still a comparative novelty), when
enthusiasm for buying and selling these new bulbs spread from collectors to
investors and thence to speculators and sharpsters. In the beginning, it was
the merchants and the upper bourgeoisie who bought and flaunted their tulips -
rare, because they had to be imported from the East, and special, because the
blooms were exotic and strange. Soon however the need to keep up with the
Jones's meant that demand outstripped supply, and prices began to rise; sailors
began to smuggle in these rare goods, and the market began to broaden. Prices
were quoted in the press, public interest was aroused, the opportunity for
profit became evident.
High prices were
normal from the time of their initial introduction from Turkey into Europe some
time after 1550, but from around 1630 until 1637, when the market peaked, tulip
prices rose inexorably. Until around 1633 the market was mainly among
professionals - growers, specialists, and their wealthy patrons; for the next
three years, however, everyone wanted a piece of the action - it was, after
all, a one-way market, with "guaranteed" profits. Stories were told
of farms being mortgaged, extraordinary barter deals were arranged, forward
contracts became common - all to take advantage of these ever-rising prices.
The craze was not limited to Holland - a French brewery was reportedly swapped
for one tulip bulb, and the English were in the market as well, but the Dutch
were the principal participants.
However, early in
1637, the market suddenly found a vacuum; without any warning, the buyers were
no longer there. Sellers began looking for bids, buyers kept their heads down,
financially over-stretched speculators became increasingly anxious, buyers ran
away from their forward contracts, which were anyway classed as gambling, and
not legally enforceable. Prices collapsed, and panic ensued. The Government was
asked to help, and (after some consultation) a proposed "scheme of
settlement" was put forward, but this found no friends - after all,
close-outs at 3-1/2 percent of contract value were not particularly attractive.
With prices having risen twenty- to twentyfive-fold during January alone, value
was hard to establish.
So the Dutch - those
solid, dependable citizens of Europe who could be relied upon to keep their
heads when dykes were springing leaks - were swept off their feet by
"irrational exuberance". There were perhaps extenuating circumstances
at the time: a major outbreak of the plague which had decimated some cities in
late 1636 had created a psychological climate of "short-termism", and
the continuing war with Spain was a constant background factor. But the main
reason for the buying mania was the expectation of profit - the knowledge,
based on recent experience, that there would always be (tomorrow, or perhaps
next week) a buyer willing to pay more than you had paid. The fact that tulip
bulbs were basically useless had nothing to do with either the rise or the fall
in prices; academic theorists who have worked out that - given time - the most
expensive bulb (costing around US$50,000), if properly propagated, would have
paid for itself well inside a hundred years are looking at economic logic
rather than truth. The fact is that this was an example of unbridled greed.
And there are
innumerable other examples of this sort of mass enthusiasm. It has been pointed
out often enough that men, however sensible and logical they may be
individually, change in character and thought process once they become part of
a crowd. And the crowd does not have to be a gathering of many people in one
place - it needs only a commonality of purpose, an agreement on what appears to
be an obvious outcome, for the crowd mentality to become operative. That is why
newcomers are so frequently "flamed" when they join a new Internet
forum - they are not yet part of the crowd, they are still individuals waiting
to become assimilated. And that is why the Internet - although it may seem an
isolating process - is taking the place of the town square as a meeting place
for individuals who may transmogrify into a crowd.
Other examples of
financial manias which are often quoted are the South Sea Bubble (around
1715-1720, in England) and the Mississipi scheme (in France at around the same
time). In both cases the public became so enthusiastic about the prospects of
easy money that common sense went out the window - for a while. In both cases,
the end came quite suddenly and unexpectedly; it is very hard to judge the top
in cases like these. Occasionally, however, common sense and dispassion can
provide the opportunity for profiting from a contrarian view. In 1959, an
attempt was made to squeeze May Wheat
futures in Chicago; for a time, the market moved inexorably upwards, but it
happened that deliverable supplies were available (although they were held
outside Chicago), and - such was the conviction that the squeeze would succeed
- it was possible to sell at good prices even after wheat began to move into
Chicago in volume. But then this was a squeeze rather than a wild burst of
enthusiasm, and the psychological underpinnings are very different.
Squeezes, or
"corners", are in fact rather more frequent than manias, and depend
on supply and demand rather than greed, fear or envy - as such, they tend to be
seen more often in the commodity markets, where control of deliverable supplies
appears easier to arrange. The most famous (attempted) squeeze of recent times
culminated in 1980, when the Hunt brothers (famous oil billionaires) managed to
ratchet the Silver price up from around $6/ounce in January 1979 to almost $50
a year later, spending and subsequently losing millions in the process. More
recently, fears of a squeeze in the Palladium market took prices during February 2000 from $491 at the start of the
month to $815 three weeks later (basis NY spot), and - to be flippant for a
moment - the current Pokemon craze among youngsters shows evidence of both a
squeeze and a mania, as carefully calculated supply is measured out to frenzied
buyers.
But a true squeeze, as
we said, has a different psychological effect on the traders in the market; it
is (or may become) a fact, and (depending on the perceived likelihood of the
squeeze succeeding), buyers may join in or not while shorts decide to cut or
run their positions. A mania affects the public rather than the specialist, and
depends on emotion rather than thought. In the move upwards, panic is evident
among the buyers at the thought of opportunities missed - in a squeeze, the
panic is likely to be among the sellers, or shorts.
Because equities have
appealed to a wider public for a longer time than commodities or currencies,
there are more examples of speculative excess to be found in the stock markets
than elsewhere: railroads - particularly in the US - provided a wonderful
playground for the bulls in the 1850s, with the big bust coming on one day,
August 24th, 1857. Radio was one of the technological wonders of the 1920s, but
the share price of RCA (a very successful and profitable company during that
era) fell 95% in the four years after 1929. Whether that was as the result of a
preceding mania may be arguable, but it demonstrates the difficulty of
establishing value in times of excess.
And that is the problem
with financial mania: there always appears to be good reason for the advance in
prices to continue, because (after all) "things are different this
time". The 1920s were years of
great technological change, particularly in the transport sector, and previously
valid cost and profit calculations were "obviously" no longer
applicable; but, for the time being, there was nothing else to take their
place. Price, therefore, took the place of value, and buying on dips became a habit, since
cheapness was rare and the opportunity had to be seized.
Sometimes an exogenous
shock will halt a mania, sometimes the hot air simply cools; there is no sign
hung out when the end comes, but a symptom is when serious, conservative
investors who have held out against all previous blandishments finally admit
that they might have been wrong, and the last remaining buyers come into the
market. Watch out for such symptoms, and beware!
[Written Sep 2000]
