Book review: Extraordinary Popular Delusions and the Madness of Crowds by Charles MacKay

A person is intelligent; people are stupid. Whoever once said that must have been referring to stock market manias. It’s an astonishing and unsettling fact that, although first published in 1841, this book describes trends and manias that are as relevant today as they were back then.

In this internationally renowned classic book there is a multitude of information that traders can use to their advantage in understanding the “herding” nature of investing. Originally written way back in 1841, the observations by Charles MacKay of crowd behaviour are as prescient today as they were over 150 years ago. A not to be missed book!…

MacKay’s basic premise – that humans are dominated by greed and fear when it comes to money – states that you too will succumb to temptation when it’s prevalent all around you. He presents us with three episodes from the past where entire populations have resigned themselves to this madness, sacrificing their homes and committing acts of violence, just for a piece of the action. The dotcom boom of 2000 and the radio boom of the 1920s present similar stories.

Bubble trouble…

Perhaps the best known story is that of The Mississippi Scheme which details the life of John Law – the Scottish economist, gambler, banker, murderer, royal advisor, exile, rake and adventurer (and Evil Knievil’s ancestor). In 1716 he established the Banque Generale, a state chartered bank with the power to issue unbacked paper currency. He believed that increasing the money in circulation would benefit commerce. His scheme was a spectacular success – but a short lived one – as it collapsed after a bank run in 1720, plunging France into an economic crisis.

At the same time, Law created the Mississippi Company, a French colony trading precious metals in Louisiana. He had exclusive trading privileges in the territory for 25 years but needed funds to kick-start the operation. He did this by issuing shares and low-interest government bonds, which also served to aid French finances. Shares in Mississippi went sky high as people were drawn to the lure of trading in gold and silver. People of all classes jostled in the street outside Law’s dwelling, hoping to get their names on the share register, and soldiers had to be sent in by night to maintain order.

Pop!

Sure enough, the bubble became unsustainable and burst. As Law issued more bank notes, the amount of money in circulation caused the rate of inflation to reach 23% per month at its peak. He devalued shares in the Mississippi Company and, as people began realising their shares as capital for the more valuable coins, the price fell to its original value. This sudden crash caused Law to become a hated man overnight. His scheme had been flawed, but he had genuinely been working towards the good of the nation. It was the irrational speculation of the people that led to the inflated price and ultimate collapse.

Mackay’s narration is intelligent and detailed; he even throws in a good sprinkling of witty anecdotes (the sailor who ate a prize tulip bulb with his herring breakfast thinking it to be an onion and spent months in jail as a result). He goes on to describe The South Sea Bubble, the sequence of events during the same period in England; and Tulipmania, the 1834-6 tulip bubble in Holland when people would sell their entire estate to convert it into a few bulbs. And before you laugh too loudly at our Dutch friends, this book also points out how tulipmania spread to Britain and France (although to a lesser extent).

There are common threads in each mania. The initial run when that which is being advanced seems an almost sensible proposition (after all, the Internet was going to transform the world and slash the costs of doing business, wasn’t it?); the way that each mania is heralded as a way to end poverty and allow anyone to make money without actually doing any hard work; and how each mania distorts the economy such that productive industries are damaged by the rush of capital to speculation. The way to make real money in 1836 Holland was to buy property from those desperate for capital with which to speculate. And as each bubble bursts, we see the start of the blame game with individuals, institutions and – ultimately – Government’s attacked by those who lost out. With the horse miles away, the stable door is always bolted. But man is too greedy to be stopped.

Where will the next boom and bout of collective madness come from? Who knows? The thing about manias is that it is hard to spot them until they are well underway. But given man’s innate avarice, there is no doubt that they will still be occurring for centuries to come. This book should be compulsory reading.

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