The book was written in the early 90s at a time when the junk bond bubble had collapsed. The book is short, simple, and intelligent. The central arguments of the book are these: 1 The common and especially American tendency to associate intelligence with great wealth is often specious -- great wealth but not moderate wealth is probably more closely associated with luck and cheating. See authors such as Nassim Nicholas Taleb for more on this subject. When a financial innovation is new it usually means that a hype machine is forming and that a bubble is inflating.

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He had an illustrious career in government as a public official, economist. He authored a thousand articles and four-dozen books and served 50 years as a Harvard economics professor. He died in at age Galbraith contended that financial euphoria episodes have common attributes that have occurred over and over for hundreds of years and that those types of episodes manias will continue forever.

Investors would do well to understand the historical lessons Galbraith documented for us from the ever-recurring financial euphoria episodes. Common Aspects of the Nature of Financial Euphoria Episodes Free enterprise economies have always had recurring episodes of speculative behavior large swing boom-bust cycles with bubbles that collapse.

All of these episodes have recognizable common attributes, despite differences in the type of assets at the center of speculation. The common attributes of speculative behavior make future episodes a virtual certainty. Among the common attributes of financial euphoria are these factors: The price of the objects of speculation goes up. The objects can be anything…. The price of the objects tomorrow will be higher than the price today. The increased price attracts more buyers. More buyers exert more upward pressure on the price.

The speculation, building on itself, provides its own momentum. Speculation participants typically have one of two common attributes: 1 some believe the new price-enhancing mechanism will go on forever, or 2 others, who are more astute, know they are in a speculative game and believe they will know when to "cash out" at a profit before the inevitable collapse.

But without fail, the fall will always happen. When the fall occurs, it will be disastrous. A few participants sense doom, so they pull out rapidly at a profit. But rapid sales produce almost instant price drop, then collapse.

Some participants are programmed for sudden efforts to escape. But the resulting loss of asset value is catastrophic for many. Thus, every speculative episode ends…not with a whimper, but with a bang. This scenario has reoccurred repeatedly over at least four centuries as if it was a hard and fast fixed rule.

Mass psychology plays a key role in speculative episodes. First, individual self-interest in the lure of fast profits is very powerful. Those who understand these factors save themselves from disaster. But, as the episode builds, the number of those "saved" becomes smaller. While prices are on the way up, speculative participants believe they have superior intelligence and this appeals to their vanity.

Participants, who are euphoric and have a strong vested interest in the episode, condemn the doubters. Speculative episodes have common characteristics. A key characteristic is that financial memories are short. Lessons from previous episodes are soon forgotten. This happens even if the next episode occurs only a few short years later.

Galbraith contended that there are very few fields of human endeavor where history counts for so little than in the world of finance. Another key factor is that money is the measurement of capitalistic success. During speculative episodes, financial success appears obvious. That obviousness implies that there is a "financial genius" at work. The larger the capital assets and income flow controlled by an institution, the larger the perceived intelligence of its leaders. The authority bestowed on those leaders encourages acquiescence and excludes criticism from subordinates.

Thus, leaders may not be protected from making serious errors. Another factor is at work and frequently has an impact. We compulsively associate unusual intelligence with the leadership of the great financial institutions - large banks, investment banks, insurance companies, investment funds, private equity funds, brokerages, etc.

But those leaders are the very ones who frequently make the most grievous mistakes by taking excessive risks. Financial genius goes before the fall. Most financial innovation involves, in one form or another, the creation of debt secured in greater or lesser adequacy by real assets.

Leverage appears in many different forms. But leverage is leverage. What happens after the inevitable crash: vicious anger and recriminations against those who caused it, despite the fact that they were most admired for their financial imagination and acuity prior to the collapse. There is inadequate scrutiny of the much-praised and innovative financial instruments featured in the episode that facilitated and financed the speculation.

This includes absurdly high prices, junk bonds, derivatives, insider trading, falsely evaluated securities, poor risk assessment, etc. After collapse, there will be talk of reforms to prevent, or at least mitigate, a reoccurrence of the episode with new rules, regulations and laws.

What will not be discussed is the speculation itself, or the defective optimism that lay behind it. Participants are never blamed. There are two reasons for this. First, possibly thousands of people and many institutions may be involved.

But injured people seek an individual or single entity to blame. Second, speculative manias are exempted from blame. In general, the free-enterprise market is assumed neutral and not subject to inherent error. As always, participants are never blamed. To sum up, the common attributes create the following scenario: The price of the objects of speculation rises.

The objects of speculation can be almost anything. The price continues to rise, gathering momentum. More buyers exert even more upward price pressure. Some buyers become highly leveraged to achieve even more profits. Some believe they can exit or cash out before the mania ends. Then price collapse happens.

Devastation can be severe. Past Episodes… Classic Cases So what are examples of financial euphoria episodes in the past? As stated previously, the episodes go back at least four centuries. Tulipomania to The Tulipomania episode occurred during the 17th century Dutch Golden Age in Holland as Amsterdam hosted one of the early stock markets. Tulip bulbs became one of the first commodity-based speculative explosions in known history. The euphoria centered on a newly discovered flower with species that sprouted from a bulb called the Tulipa of the lily family Liciacaea.

The tulip grows wild in the eastern Mediterranean. The first bulbs in Europe arrived in Antwerp by cargo ship from Constantinople around In the next few years, the tulip became an enormous symbol of prestige as appreciation of its beautiful flowers and increasing value grew immensely. As the desirability of more esoteric versions of tulips grew, prices grew accordingly, causing an astronomical growth in perceived value.

By the mids, prices had found no upper limit as the rush to invest in seemingly certain profits engulfed the whole country and beyond. It seemed that no one wanted to be left behind. By , a bulb of little value a few years earlier might be acquired for "a carriage, two grey horses and a complete harness". By , some bulb prices ultimately exceeded 3, florins, the equivalent amount of 25, - 50, USD in Many sold or put up other assets, including houses, as collateral for tulip bulb investments, thereby dangerously leveraging themselves.

As the speculative fever grew, a single tulip bulb might change hands several times before placement in the ground. Obviously, each exchange occurred at a higher price. Everyone imagined that the insatiable demand and passion for tulips would last forever and prices would never collapse.

People "of all grades" converted their property into cash and invested in flowers at the tulip-mart. Money poured into Holland from all directions. Every upsurge in prices enticed more speculators to enter the frenzied action. The prices justified the hopes of those already participating. Large amounts of money were borrowed to fund purchases of the small bulbs in hopes of ever-greater profit rewards. But in , it all came to an end. A few wise speculators nervously sensed the upward trend could not possibly go on forever and began cashing out to avoid investment loss.

No one knows why, but others soon noticed the departure of the astute few and quickly began to place their holdings on the market. Per the inviolate laws of supply and demand, the massively inflated tulip bulb prices collapsed as if they had jumped off a cliff. Those who had purchased by pledging their property as collateral in highly leveraged arrangements lost everything overnight.

The fortunes of thousands of tulip investors, including many European royals, became worthless. They bitterly searched for scapegoats. Those who had contracted to purchase bulbs defaulted en masse, leaving extremely angry sellers "holding the bag". Severe recriminations resulted and those injured sought redress, but none was available, even by legal means. The price collapse caused widespread poverty and an economic depression.


A Short History Of Financial Euphoria

He had an illustrious career in government as a public official, economist. He authored a thousand articles and four-dozen books and served 50 years as a Harvard economics professor. He died in at age Galbraith contended that financial euphoria episodes have common attributes that have occurred over and over for hundreds of years and that those types of episodes manias will continue forever.


A Short History of Financial Euphoria

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