Book summary of "Extraordinary Popular Delusions and the Madness of Crowds"

Book Summary

Extraordinary Popular Delusions and the Madness of Crowds

February 18, 2018

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  • This 176 year old book outlines some bizarre cases of crowd psychology that have caused men to toss out rationality and sense, but instead surrender themselves to persuading stories of easy riches.
  • The Mississippi Scheme is one such case where the French people were swept away by an exiled excessive gambler’s promises that Company of the Indies would forever appreciate in ‘value’. At it’s peak, the company’s market value reached 2,600 million livres, more than twice the amount of all the coins in the country. Eventually, people realized it was hyped like you wouldn’t believe, and it tumbled to practically nothing.
  • Tulipmania, the well-known story of how fortunes – enormous sums! – were exchanged for a few tulip bulbs, or simply futures contracts on them! Again, people realized it was worthless and the nation’s nobles were financially ruined.
  • “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

In 1841, Charles Mackay published this humongous book on crowd psychology. It covers a wide range of areas, from fortune-telling to believing in haunted houses and witchcraft. Though these tales are instrumental in illustrating the bizarre stories humans can be persuaded to believe, I’ll focus my efforts on two of the three chapters on economic bubbles.

The Mississippi Scheme
When Louis XIV died in 1715, the Duke of Orleans took the reins of the French government. A government, which was massively indebted. The country owed 3,000 millions of livres, and only brought in 3 millions annually (145 millions in revenues, and 142 million in expenses). The Duke was not equipped to handle the situation. Entering John Law, an excessive gambler who had been exiled from various cities. He advised the Duke to grant him authorization to establish a bank that managed royal revenues and issued notes.

Due to John Law’s success in this endeavor, the Duke granted him permission to establish a company with exclusive trading privileges to Mississippi and Louisiana in 1717. 200,000 shares of Company of the Indies were issued at 500 livres each. Due to John’s perceived success with Banque Générale, the promises he voiced on behalf of the Mississippi ventures were readily believed, e.g. his promise of a 200 livres annual dividend that accompanied the issuance of 50,000 new shares in 1719. “The public enthusiasm […] could not resist a vision so splendid” (p. 14), as evident in the 300,000 applicants received for the new shares. Soon thereafter, 300,000 additional shares were issued – now at 5,000 livres each. The issuance of shares was all in the regent’s quest to pay off its national debts with the money from the offerings.

The stock often rose 10-20% in a matter of hours. Charles portrays one story where a large shareholder sent his servant to the then French Wall Street, Jardin de Soissons, to sell 250 shares at the quoted value of 8,000 livres. When he arrived soon thereafter, the quote was 10,000; a 500,000 livres difference when possessing 250 shares – a difference, which the servant pocketed and rode towards the sunset. Indeed, “the highest and the lowest classes were alike filled with a vision of boundless wealth” (p. 15).

Fast forward, the share price of Company of the Indies has shot up in such a degree that more money needed to be printed for the public to buy them. But, when the usual “it can’t continue forever”-whispers began surfacing, people wanted to take their profits. The public, however, wanted their profits in coins, not paper. The issue was this: At it’s peak, the company’s market value reached 2,600 million livres, more than twice the amount of all the coins in the country. The government thus decided to 1) stop the printing of money, 2) and cutting the company’s value in half in 1720. This ‘controlled’ attempt to diminish the value of the company failed miserably, and the stock price quickly tumbled 95% before the huge debt burden was taken over by the government who had to raise taxes in order to meet these obligations.

Around the year 1600, tulips became a symbol of status in the wealthy households of Germany and Holland. The prestige of having tulips in your home increased each year “until it was deemed a proof of bad taste in any man of fortune to be without a collection of them” (p. 89) by 1634. The middle class, keen to bath in the prestige and status symbols of the rich, began admiring this exotic flower. The prices soared to 100,000 florins for forty roots by 1635, at which point Holland’s ordinary industries stood idle, since everyone embarked in the tulip trade. In lack of such amounts, one offered twelve acres of building-ground for one Harlaem tulip (a rare kind of bulb, we’re told). Charles describes the frenzy as such: “People of all grades converted their property into cash, and invested it in flowers. Houses and lands were offered for sale at ruinously low prices, or assigned in payment of bargains made at the tulip-mart.” (p. 94)

How did it all come to an end? The same way as is always the case with such bubbles: “At last, however, the more prudent began to see that this folly could not last for ever. […] It was seen that somebody must lose fearfully in the end. As this conviction spread, prices fell, and never rose again. Confidence was destroyed, and a universal panic seized upon the dealers. […] The cry of distress resounded every where, […] and many representative of a noble line saw the fortunes of his house ruined beyond redemption” (p. 95)

Lessons not learned
What can we learn from these centuries-old tales of mania? Plenty. What have we actually learned? Nothing, it seems. Mankind is easily persuaded, and we engage in bubbles somewhat frequently. The dot-com bubble is a brilliant example of how people drove prices of worthless assets to the moon. Interestingly, Bitcoin is the asset that has increased in value most rapidly ever (even more than Company of the Indies stock and tulip bulbs). Is it a bubble? According to the anatomy of bubbles (read Irrational Exuberance and Manias, Panics, and Crashes), it surely possesses all of the characteristics. But is it truly a bubble? Time will tell, but if it turns out to be, we surely haven’t learned much.

Let me end this summary with Charles’ probably most quoted (and rightly so) phrase: “Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.”

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