Sunday, September 18, 2011

A Short History Of Financial Euphoria: Chapter 4

While there is no doubt that free enterprise gives rise to recurrent episodes of speculation, the features that are common to these episodes are rarely analyzed, according to the author of A Short History of Financial Euphoria, John Kenneth Galbraith. This book from 1990 offers perspectives on bubbles that are still useful today. By paying attention to the signs, "there is a chance - a slim chance, to be sure, given the sweeping power of financial euphoria - that otherwise vulnerable individuals will be warned."

This chapter describes the giant bubble that took place in the South Sea Company in 1710s. Once again, large leverage was employed, as the company was granted certain trading monopolies in return for taking on the government's public debt. The imagination of the public was captured, as people believed the company would earn huge profits from its trading activities.

At some point, the company's stock price was bid up to such an extraordinary level that eventually some holders began to sell. The stock proceeded to fall in price by 90%, ruining many, particularly those who had purchased with debt or who had lent to those who were buying.

Isaac Newton noted during the period that "I can calculate the movement of the stars, but not the madness of men." He is said to have lost 3 million of today's dollars in the scheme.

As can be expected, much blame was placed on the company's executives and directors. Very few accounts at the time blamed the madness of the crowd.

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