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PENGUIN BOOKSA SHORT HISTORY OF FINANCIAL EUPHORIAJohn Kenneth Galbraith is the Paul M. WarburgProfessor of Economics Emeritus at Harvard University and was the u.S. ambassador to India duringthe Kennedy administration. His works The GreatCrash 1929, The Affluent Society, The New Industrial State, and Economics and the Public Purposeare landmarks of political and economic analysis.
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PENGUIN BOOKSPublished by the Penguin GroupPenguin Group (USA) Inc., 375 Hudson Street, New York, New York 10014, U.S.A.Penguin Group (Canada), 90 Eglinton Avenue East, Suite 700, Toronto,Ontario, Canada M4P 2Y3 (a division of Pearson Penguin Canada Inc.)Penguin Books Ltd, 80 Strand, London WC2R ORL, EnglandPenguin Ireland, 25 St Stephen's Green, Dublin 2, Ireland (a division of Penguin Books Ltd)Penguin Group (Australia), 250 Camberwell Road, Camberwell,Victoria 3124, Australia '(a division of Pearson Australia Group Pty Ltd)Penguin Books India Pvt Ltd, 11 Community Centre, Panchsheel Park, New Delhi - 110017, IndiaPenguin Group (NZ), cnr Airborne and Rosedale Roads,Albany, Auckland 1310, New Zealand (a division of Pearson New Zealand Ltd)Penguin Books (South Africa) (Pty) Ltd, 24 Sturdee Avenue,Rosebank, Johannesburg 2196, South AfricaPenguin Books Ltd, Registered Offices: 80 Strand, London WC2R ORL, EnglandPublished in the United States of America byViking Penguin, a division of Penguin Books USA Inc., 1993Published in Penguin Books 199419 20 18Copyright John Kenneth Galbraith, 1990All rights reservedThis book was first published by Whittle Books as part of the Larger Agenda Series.Reprinted by arrangement with Whittle Communications L.P.Photographs: Paul M. Warburg, Brown Brothers, page 6; Roger Babson, Culver Pictures,page 8; railroad construction, courtesy of Union Pacific Museum Collection, page 65; JosephSchumpeter, the Bettmann Archive, page 67; J. P. Morgan, Culver Pictures, page 68; CharlesPonzi, Brown Brothers, page 73; Florida land boom, Florida State Archives, page 74; CharlesMitchell, Brown Brothers, page 76; Irving Fisher, Culver Pictures, page 79; 1929 crash, theBettmann Archive, page 82; Bernard Cornfeld, Michael Creccorrhe Picture Group, page90; Robert Vesco, APlWide World Photos, page 93; 1987 crash, Susan Meise1as/MagnumPhotos, page 96; Robert Campeau, the Bettmann Archive, page 103.Illustrations: Holland tulips, courtesy of W. Graham Arader III, Chicago, page 29; John Law,Culver Pictures, page 35; Robert Harley, Culver Pictures, page 44; South Sea Company territory map, courtesy of the Newberry Library, Chicago, page 46; Sir William Phips, CulverPictures, page 55.THE LIBRARY OF CONGRESS HAS CATALOGUED THE HARDCOVER AS FOLLOWS:Galbraith, John Kenneth.A short history of financial euphoria/John Kenneth Galbraith.p. em.Includes bibliographical references.ISBN 0-670-85028-4 (he.)ISBN 0 14 02.3856 5 (pbk.)1. Speculation-Case studies. I. Title.92-50765HG4528.G35 1993332.64'5-dc20Printed in the United States of AmericaSet in SabonDesigned by Kathryn PariseExcept in the United States of America, this book is sold subject to the condition that it shallnot, by way of trade or otherwise, be lent, re-sold, hired out, or otherwise circulated withoutthe publisher's prior consent in any form of binding or cover other than that in which it ispublished and without a similar condition including this condition being imposed on thesubsequent purchaser.
coNTEForeword to the 1993 EditionNsTVII11The Speculative Episode2The Common Denominators123The Classic Cases, I: TheTulipomania; John Lawand the Banque Royale26The Classic Cases, II:The Bubble435The American Tradition5361929707October Redux878Reprise105Notes on Sources1114v
FoTOTHERE1993woRDEDITIONIt is now three years since I did the main workon this small book. As I told in the Forewordto the earlier edition, it concerns matters thathave interested me for a third of a century andmore. I first dealt with them in The GreatCrash, 1929, published a little after the twenty-fifth anniversary of the 1929 debacle. Thatbook has been continuously available eversince. Whenever it was about to pass outof print, some new speculative episode ordisaster would bring it back to public attention. Over a lifetime I have been, in a modestway, a steady beneficiary of the speculativeaberration in its association with more thanoccasional insanity. Only a stalwart character keeps me from welcoming these eventsvii
dohnKennethGalbraithas proof of personal prescience and as asource of small financial reward.In the first Foreword to this volume, I told ofmy hope that business executives, the in-habitants of the financial world and the citizens of speculative mood, tendency ortemptation might be reminded of the way thatnot only fools but quite a lot of other peopleare recurrently separated from their money inthe moment of speculative euphoria. I am lesscertain than when I then wrote of the socialand personal value of such a warning.Recurrent speculative insanity and the associated financial deprivation and larger devastation are, I am persuaded, inherent in thesystem. Perhaps it is better that this be recognized and accepted.In the years since I wrote this short disquisi-tion, the main players in the most recentspeculative episode, that of the extravaganteighties, have met their all but inevitable fate,and the larger economic consequences havebeen made strongly and sadly evident. The listv II iof those who have descended abruptly from
AShortHistoryofFinancialEuphoriathe heights is long, and only a few need bementioned. Mr. Michael Milken, perhaps themost spectacular figure of the last boom andcertainly the best paid, is a recent resident in aminimum-security gaol, which, if not whollyuncomfortable, could not have seemed personally rewarding. One supposes that hemet each new day without enthusiasm. Mr.Donald Trump is said not to be broke; hewas, however, described in recent news accounts as having a negative net worth. Thesedistinctions are no doubt important in theworld of finance. The Reichman brothers,with Robert Campeau the Canadian gift to financial excess, are indubitably broke with depressive effect on the banks that werecaptured by their euphoric mood. Perhaps it isto their credit that, like Donald Trump, theyerected monuments that will long commemorate their adventure. In London, tourists going down the Thames to the Tower willextend their journey to encompass the CanaryWharf development, perhaps the most awesome recent example of speculative dementia.To a marked extent, the speculative orgy ofthe eighties was in real estate, including thatfinanced through the S & L's by the guaranteeing American taxpayer. Salomon Brothersi x
.IohnKennethOalbralthof Wall Street recently estimated that it will bean average of twelve years before presentlyempty commercial real estate will be absorbed. Alas for averages. They think it willbe an estimated twenty-six years in Boston,forty-six years in New York and fifty-sixyears down in San Antonio, Texas (the leader,so to speak), in this provision for the future.However, the effects of the splurge extendfar beyond real estate and range from the serious to the sad. New Yorkers can hardly escape a tear when they see the efforts of R. H.Macy, one of their great civic symbols, to stayalive and pay for the goods it sells and thepressing charges of those who supervise it inbankruptcy. The cause of the difficulties ofthis great institution are not in doubt: it wasthe heavy load of debt incurred in the effort toobtain and retain control during the years offinancial pillage and devastation. Across thecountry other enterprises were similarly afflicted and are similarly oppressed with the resulting debt. Oppressed with them are thebanks that sustained the real estate speculation and provided credit for the mergers andacquisitions, hostile takeovers and leveragedxbuyouts, and the other exercises in financialdevastation.
AShortHistoryofFinancialEuphoriaBut there is more. The recession that beganin the summer of 1990 and continued so obdurately in face of the weekly predictions ofrecovery was almost certainly caused and wascertainly deepened and prolonged by the speculative collapse. Public confidence was shaken, corporate investment was curtailed,troubled banks were forced to restrict lending,workers were discharged and corporate executives and bureaucrats shed. (One does notfire or sack higher-income personnel; in theinterest of greater efficiency, they are onlyshed.)The end is not yet. Had there been no speculative excess and collapse with their largereconomic effect, the political history of 1992would have been far different. It was theboom and collapse that ended the political career and presidency of George Bush. Withouta recession and with a good or even a moderately performing economy, his reelectionwould have been certain, a cinch. WithHerbert Hoover, Mr. Bush stands as one oftwo Presidents in this century who were destroyed by Wall Street. In politics, as in othermatters, one must beware of one's friends.Not all, it should be said for Bush, will bebad. John Law, who presided at a magisterialx I
dohnKennethGalbraithlevel over the great French boom of the earlyeighteenth century, went dismally into exile.So did some of those in government officewho suffered the South Sea Bubble. By contrast, Mr. Bush, as also Mr. Reagan out inCalifornia, will have a wholly civilized retirement. In small ways the history of the greatspeculative boom and its aftermath doeschange. Much, much more remains the same.x II
ASH0RTHISTORYOFFINANCIALEUPHORIA
cHApTER1THE SPECULATIVEEPISODEAnyone taken as an individual is tolerably sensible and reasonable-as a member of a crowd, heat once becomes a blockhead.-FRIEDRICH VON SCHILLER,AS QUOTED BY BERNARD BARUCHThat the free-enterprise economy is given torecurrent episodes of speculation will beagreed. These-great events and small, involving bank notes, securities, real estate, art,and other assets or objects-are, over theyears and centuries, part of history. Whathave not been sufficiently analyzed are thefeatures common to these episodes, the thingsthat signal their certain return and have thus,
.JohnKennethGalbraiththe considerable practical value of aiding understanding and prediction. Regulation andmore orthodox economic knowledge are notwhat protect the individual and the financialinstitution when euphoria returns, leading onas it does to wonder at the increase in valuesand wealth, to the rush to participate thatdrives up prices, and to the eventual crash andits sullen and painful aftermath. There is protection only in a clear perception of the characteristics common to these flights into whatmust conservatively be described as mass insanity. Only then is the investor warned andsaved.There are, however, few matters on whichsuch a warning is less welcomed. In the shortrun, it will be said to be an attack, motivatedby either deficient understanding or uncontrolled envy, on the wonderful process of enrichment. More durably, it will be thought todemonstrate a lack of faith in the inherentwisdom of the market itself.The more obvious features of the speculative episode are manifestly clear to anyoneopen to understanding. Some artifact or somedevelopment, seemingly new and desirabletulips in Holland, gold in Louisiana, real es2tate in Florida, the superb economic designs
AShortHistoryofFinancialEuphoriaof Ronald Reagan--eaptures the financialmind or perhaps, more accurately, what sopasses. The price of the object of speculationgoes up. Securities, land, objets d'art, andother property, when bought today, are worthmore tomorrow. This increase and the prospect attract new buyers; the new buyers assure a further increase. Yet more areattracted; yet more buy; the increase continues. The speculation building on itself provides its own momentum.This process, once it is recognized, is clearly evident, and especially so after the fact. Soalso, if more subjectively, are the basic attitudes of the participants. These take twoforms. There are those who are persuadedthat some new price-enhancing circumstanceis in control, and they expect the market tostay up and go up, perhaps indefinitely. It isadjusting to a new situation, a new world ofgreatly, even infinitely increasing returns andresulting values. Then there are those, superficially more astute and generally fewer in number, who perceive or believe themselves toperceive the speculative mood of the nJoment.They are in to ride the upward wave; theirparticular genius, they are convinced, will allow them to get out before the speculation3
.JohnKennethGalbraithruns its course. They will get the maximumreward from the increase as it continues; theywill be out before the eventual fall.For built into this situation is the eventualand inevitable fall. Built in also is the circumstance that it cannot come gently or gradually. When it comes, it bears the grim face ofdisaster. That is because both of the groups ofparticipants in the speculative situation areprogrammed for sudden efforts at escape.Something, it matters little what-although itwill always be much debated-triggers the ultimate reversal. Those who had been ridingthe upward wave decide now is the time to getout. Those who thought the increase wouldbe forever find their illusion destroyed abruptly, and they, also, respond to the newly revealed reality by selling or trying to sell. Thusthe collapse. And thus the rule, supported bythe experience of centuries: the speculativeepisode always ends not with a whimper but4with a bang. There will be occasion to see theoperation of this rule frequently repeated.So much, as I've said, is clear. Less understood is the mass psychology of the speculative mood. When it is fully comprehended, itallows those so favored to save themselvesfrom disaster. Given the pressure of this
AShortHistoryofFinancialEuphoriacrowd psychology, however, the saved will bethe exception to a very broad and bindingrule. They will be required to resist two compelling forces: one, the powerful personal interest that develops in the euphoric belief, andthe other, the pressure of public and seemingly superior financial opinion that is broughtto bear on behalf of such belief. Both stand asproof of Schiller's dictum that the crowd converts the individual from reasonably goodsense to the stupidity against which, as he alsosaid, "the very Gods Themselves contend invain."Although only a few observers have notedthe vested interest in error that accompaniesspeculative euphoria, it is, nonetheless, an extremely plausible phenomenon. Those involved with the speculation are experiencingan increase in wealth-getting rich or beingfurther enriched. No one wishes to believethat this is fortuitous or undeserved; all wishto think that it is the result of their own superior insight or intuition. The very increase invalues thus captures the thoughts and mindsof those being rewarded. Speculation buys up,in a very practical way, the intelligence ofthose involved.This is particularly true of the first group&
ohnKennethGalbr.lthnoted above-those who are convinced thatvalues are going up permanently and indefinitely. But the errors of vanity of those whothink they will beat the speculative game arealso thus reinforced. As long as they are in,they have a strong pecuniary commitment tobelief in the unique personal intelligence thattells them there will be yet more. In the lastcentury, one of the most astute observers ofthe euphoric episodes common tothose years was Walter Bagehot,financial writer and early editorof The Economist. To him we areindebted for the observation that"all people are most credulouswhen they are most happy."Fellow bank.,. and theinvestment houses in1929 assailed Paul M.Warburg, a banker andfounder of the Federal 8yBtem,for hiswarnings of a crash.Strongly reinforcing the vested interest in euphoria is thecondemnation that the reputablepublic and financial opinion. di- rects at those who express doubtor dissent. It is said that they are unable, because of defective imagination or other mentalinadequacy, to grasp the new and rewardingcircumstances that sustain and secure the increase in values. Or their motivation is deeply
AShortHistoryofFinancialEuphoriasuspect. In the winter of 1929, Paul M.Warburg, the most respected banker of histime and one of the founding parents of theFederal Reserve System, spoke critically of thethen-current orgy of "unrestrained speculation" and said that if it continued, therewould ultimately be a disastrous collapse, andthe country would face a serious depression.The reaction to his statement was bitter, evenvicious. He was held to be obsolete in hisviews; he was "sandbagging American prosperity"; quite possibly, he was himself shortin the market. There was more than a shadowof anti-Semitism in this response.Later, in September of that year, RogerBabson, a considerable figure of the time whowas diversely interested in statistics, marketforecasting, economics, theology, and the lawof gravity, specifically foresaw a crash andsaid, "it maybe terrific." There would be a60- to 80-point drop in the Dow, and, in consequence, "factories will shut down .menwill be thrown out of work.the vicious circlewill get in full swing and the result will be aserious business depression."Babson's forecast caused a sharp break inthe market, and the reaction to it was evenmore furious than that to Warburg's. Barron's7
.JohnKennethGalbraithsaid he should not be taken seriously by anyone acquainted withthe "notorious inaccuracy" of hispast statements. The great NewYork Stock Exchange house ofHornblower and Weeks told itscustomers, in a remarkably resoEconomist Roger Bab-nant sentence, that "we wouldsonls forecast of thenot be stampeded into sellingcrash of 1929 broughthim grave rebuke fromstocks because of a gratuitoustheforecast of a bad break in thegreatfinancialhouses of the time.market by a well-known statistician." Even Professor Irving Fisher of YaleUniversity, a pioneer in the construction of index numbers, and otherwise the most innovative economist of his day, spoke out sharplyagainst Babson. It was a lesson to all to keepquiet and give tacit support to those indulgingtheir euphoric vision.Without, I hope, risking too grave a chargeof self-gratification, I might here cite personalexperience. In the late winter of 1955,J.William Fulbright, then the chairman of theSenate Banking and Currency Committee,called hearings to consider a modest speculative buildup in the securities market. Aiongwith Bernard Baruch, the current head of the8New York Stock Exchange, and other author-
AShortHistoryofFinancialEuphoriaities real or alleged, I was invited to testify. Irefrained from predicting a crash, contentedmyself with reminding the committee at somelength as to what had happened a quarter of acentury earlier, and urged a substantial protective increase in margin requirementsdown payments on the purchases of stocks.While I was testifying, the market took a considerable tumble.The reaction in the next days was severe.The postman each morning staggered in witha load of letters condemning my comments,the most extreme threatening what the CIAwas later to call executive action, the mildestsaying that prayers were being offered for myrichly deserved demise. A few days later Ibroke my leg in a skiing accident, and newsmen, seeing me in a cast, reported the fact.Letters now came in from speculators sayingtheir prayers had been answered. In a smallway I had done something for religion. I posted the most compelling of the communications in a seminar room at Harvard as aninstruction to the young. Presently the marketrecovered, and my mail returned to normal.On a more immediately relevant occasion,in the autumn of 1986, my attention becamefocused on the speculative buildup t
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Department of Plant Biology, University of Newcastle upon Tyne, Newcastle upon Tyne, NEl 7RU, United Kingdom ABSTRACT: 200 taxa of algae were recovered from cultures of 24 "terres trial" and "hydro-terrestrialll soil and vegetation samples from Glerar dalur, northern Iceland. 22 of the samples were collected at heights of between 500 and 1300 m. The algae were divided between the classes .
