A Short History of Financial Euphoria – John Kenneth Galbraith
As a matter of general decorum, it’s not proper for old wise economists to be too bullish, overly optimistic or sanguine. They must be vigilant—ever vigilant—and wary. Their years and experience must tell the cautionary tales we commoners cannot fathom. Particularly in an era of hyper-pessimism, as now, that’s the accepted nature of pop economic wisdom: senex, sitting and cynical.
Well, yes, except for the fact stock prices—overwhelmingly—tend to rise over time, economies tend to grow over time and periods of ruin are relatively short by comparison.
That basic fact is tough for folks to swallow these days but true nonetheless. To my mind, real financial wisdom avoids being too dour (like many are now), avoids euphoria (Remember 1999? It’s been awhile!) and otherwise understands over the long term, wealth is built via the stock market by disciplined focus on financial goals and reaping the long-run return of stocks despite their volatility.
So, here comes John Kenneth Galbraith, that old, wizened economist of the twentieth century, at once comfortable and perpetually disheveled in this Yoda-as-cynic posture. And to my mind, it’s this single disposition that often skews an otherwise lucid and sharp analysis.
In this book of 110 scant pages, A Short History of Financial Euphoria, Galbraith identifies most of the major psychological elements of a speculative “mania” and manages to include some great additional insights. But the whole thing comes from a perspective of perpetual ruin—it’s cycle after cycle of false folly and inflated prices doomed to only crash again and again. There is little accounting for the fact speculation is also generative of great progress. Economies and stocks only sometimes feel as if they don’t move forward and create great wealth—over time, they move up.
At some point in this space, we’ll loop back to the larger breadth of Galbraith’s work—which is worth studying if for no other reason than his relatively unique experiences. Also, Keynesian or not, he’s a member of a grand tradition of notable economists through time as members of the humanities: A hardy group possessing tremendous wit, intellect and writing skill—superb generalists of science/sociology/psychology all integrated into their economics. Galbraith understood modern economics’ and finance’s march toward rote empiricism lost some of its vital qualitative insights in the process. Economists mostly think and write and analyze like engineers these days, and it’s sad, skewed and no more accurate than the days of Adam Smith.
Here are some of Mr. Galbraith’s lessons regarding speculations and boom/busts. First, there are two broad modes of speculation:
Ever-higher prices driven by those who believe something about the world has fundamentally changed, justifying the persistent price rises.
From those who believe they perceive the speculative mood of the moment and wish to exploit it—believing they can get out before the crash (a.k.a., the Greater Fools theory).
And usually, it’s some combination of both. These two lessons are by now fairly tautological to professional investors. The trick remains, and has always been, how to indentify these phenomena. Galbraith also says speculations tend to end with a bang and not a whimper. But at least for stocks, this isn’t generally true. Basically without exception, the rolling over of stocks into a bear does the opposite—the banging big drops come at the end; the bear seldom announces itself so obviously. If it did, side-stepping most bear markets would be a cinch. If only.
He emphasizes the “extreme brevity” of the human financial memory. Which he believes has a frontier of 20 years. This is not only right, I’d argue it’s even less. Though, it is true folks tend to be gun-shy about whatever caused the last bear market when really they should be looking for other, newer causes. Nevertheless, Galbraith is right the psychology of financial forgetfulness seldom changes. (For much more, read Ken Fisher and Lara Hoffmans’s upcoming book: Markets Never Forget (But People Do), due in November.)
Galbraith calls the common association of money and intelligence “specious”—that there’s no clear link to success in investing and intelligence. Yes! He says markets are to many a “totem” in current culture, and belief in them as perfect often borders on the “theological.” Yes! Markets are profoundly efficient at pricing in what’s widely known and believed but are still subject to good ol’ human irrationality, particularly in the short run.
One of his most interesting points is there’s no true “innovation” in finance. All things thought to be new are really just some newfangled form of debt, equity or money in general. This is an idea worth contemplating—particularly in light of today’s proliferation of securitized debt, ETFs and so on. Further, Galbraith explains such faux innovations are often the locus for speculative episodes.
Ultimately, one exits this book heartened by Galbraith’s conclusion: though speculative booms and busts always repeat through time, there is no elite entity smart or aware enough—ever—to try and stanch the cycle without also destroying important parts of the productive economy. So, when he’s asked, “What can be done?” about such things, his answer is “little or nothing.” That, indeed, is uncommon wisdom.
Use this fine little book as a primer on the broad brushstroke history of financial speculation. Just don’t get caught up in Galbraith’s latent cynicism.