In the realm of the senseless In a classic,Extraordinary “ Popular Delusions and the Madness of Crowds & Confusión de Confusiones”, by Charles Mackay & Joseph Dela Vega, there is an incisive forward by Martin Fridson. “When an editor of the Financial Times recently chose the ten best investment books ever written, the first two titles on his list were Joseph de la Vega’s Confusion de Confusiones and Charles Mackay’s Extraordinary Popular Delusions and the Madness of Crowds. The editor’s decision to arrange his selections chronologically gave a decided edge to de la Vega (1688) and Mackay (1841). Even without such advantages, though, these two venerable works are fixtures on short lists of the most valuable books on the securities markets. One or both invariably show up in articles with titles such as “A < ?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Reading List for Investors,” “The Library Every Investor Needs,” and “Gifts That Make Financial Sense.” Investors continue to cherish de la Vega’s confusions and Mackay’s delusions because the market never ceases to befuddle and beguile. Onlookers reacted with bewilderment to the Dow Jones Industrial Average’s 508-point plunge on October 19, 1987, much as their ancestors did when the South-Sea Bubble burst in 1720. Similarly, investors cannot fathom how Japan‘s Nikkei 225 could have been valued 91% higher at the beginning of 1990 than it was just nine months later. Charles Mackay attributes such outlandish volatility to periodic outbreaks of mass hysteria. In contrast, Joseph de la Vega sees cunning behind the market’s convulsions. He depicts price fluctuations as the handiwork of scheming speculators. Both explanations are worth examining if you aspire to an understanding of the stock exchange’s frequently erratic behavior. From the classics of Mackay and de la Vega,Delusions and Confusions extract investment wisdom that has been judged invaluable by many of the market’s greatest authorities. For example, Extraordinary Popular Delusions and the Madness of Crowdswas the favorite book of Bernard Baruch. Much of its present reputation is traceable to the celebrated financier. Baruch encouraged the republication of the book in 1932 and contributed an introduction. John Templeton, one of today’s most successful investors, likewise holds Mackay’s opus in high esteem. If you follow the financial press avidly, you cannot avoid the praise routinely accordedExtraordinary Popular www.capitalideasonline.com Page - 1 In the realm of the senseless Delusions. In the pages of Forbes, various columnists have called it “the most important single book related to [the investment] business,” a work “that should be in the library of every investor,” “required reading for all who invest in the securities markets,” and a treatise that “smart financiers often cite as their favorite text.” Typical descriptions found in other publications include “the celebrated tome of economic folly,” recommended reading for “all those who think ‘this time is different,'” and “a book you’ll wish you’d read before the stock market belly flopped in October [1987].” Another commentator simply observes, “If one works on Wall Street for any length of time, ultimately he or she is directed to the book,Extraordinary Popular Delusions and the Madness of Crowds.” A century-and-a-half after first being published, Mackay’s account of speculative bubbles is automatically cited in connection with every new boom or bust. Among the topics of recent years that have prompted experts to invoke Extraordinary Popular Delusions are gold, Mexican stocks, food company shares, housing costs, Japanese land prices, junk bonds, and the collapse of Baring Securities. Mackay’s influence extends far beyond the confines of the financial markets. A survey of the media yields allusions to Extraordinary Popular Delusions and the Madness of Crowdsin connection with computer virus protection, the confirmation hearings of Supreme Court Justice Clarence Thomas, Halley’s comet, the proliferation of casino gambling, Teenage Mutant Ninja Turtles, and the Power Rangers. Commentators draw parallels between the episodes recounted by Mackay and such diverse occurrences as the improbable box office success of atrocious movies, campaigns to reduce violence, debates over damage to the ozone, a poisoned fruit scare, fears of abuse at child care centers, and efforts to upgrade sewage treatment. A 1992 book was entitled Ponzi Schemes, Invaders from Mars& More Extraordinary Popular Delusions and the Madness of Crowds. Perhaps the ultimate cultural homage to Mackay was an art exhibition of the same year,Popular Delusions and the Madness of Crowds,which explored “what happens when individuals cease to take responsibility for themselves.” It is not overstating the matter to say that Mackay’s book has by now passed into legend. theIn retelling, the story has been magnified, embellished, and, inevitably, garbled. Some sources correctly indicate that Extraordinary Popular Delusions and the Madness of Crowdsfirst appeared in 1841, while others say 1852, the year of the second edition. A 1991 article establishesExtraordinary Popular Delusionsas a cult classic, describing it as out-of-print since 1956. Other writers, however, mention editions in 1974, 1976, 1980, and 1985. (Books in Print currently lists publication dates of 1980, 1986, and 1991.) Compounding the confusion is the change of titles between Mackay’s first and second editions, Memoirsfrom of Extraordinary Popular www.capitalideasonline.com Page - 2 In the realm of the senseless Delusions to Memoirs of Extraordinary Popular Delusions and the Madness of Crowds. “Memoirs” was dropped in the 1932 edition. In 1929, by most accounts, Bernard Baruch preserved his immense wealth by heeding Mackay’s lessons. One periodical says, on the contrary, that Baruch ignored the sound advice he gave others and plunged back into the market before the crash. The truth is that Baruch emerged from the debacle with his for tune largely intact. According to a biographer, though, he found that being a prophet of doom was causing peopleto ignore his opinion. In response, Baruch switched to a more bullish line in his public pronouncements. A dual legend has consequently arisen. On the one hand, admirers say that Baruch foresaw the 1929 crash, partly by remembering the antecedents described in Extraordinary Popular Delusions. Liberal historians, in contrast, cite Baruch’s optimistic comments as evidence of precisely the sort of market mania that Mackay decried. Sources variously describe the author ofExtraordinary Popular Delusions as a nineteenth century barrister, an English chronicler, and a Scottish journalist. In reality, the Scottish-born Mackay appended “LL.D.” to his name after being awarded that degree by Glasgow University, but never practiced law. His renown as a poet and songwriter was at least as great as his journalistic reputation. So fleeting is fame, however, that one citation gives his name as Bernard Mackay. No run-of-the-mill investment book could inspire such a steady flow of misinformation.Extraordinary Popular Delusions is clearly in a special class, as indicated by the many investment managers who tell interviewers that they keep it forever close at hand. Not so obvious is the reason for the book’s enduring popularity. After all, Mackay lays out no trading rules or formulas for valuing securities. It’s curious that a work invariably found on investors’ reading lists is so unlike the typical investment manual. Certainly, the incidents that Mackay describes have intrinsic interest. Readers are bound to be amused by his colorful depictions of the Dutch tulip bulb craze, the Mississippi Scheme, and the South-Sea Bubble. But there’s considerably more to the story than pure entertainment. Mackay’s theme appeals to everyone ~o hopes to prosper by proving the majority in error. This is a group to which all speculators belong, along with purveyors of opinions on a wide array of nonfinancial issues. In Mackay’s book, they find affirmation that the consensus is fallible. The message of Extraordinary Popular Delusions goes beyond the mere notion that people en masse sometimes behave irrationally. By Mackay’s account, the crowd’s hysteria is easily detectable by individuals who rely on www.capitalideasonline.com Page - 3 In the realm of the senseless common sense. Immense profits are to be had if this assertion is correct and Mackay has little doubt that it is. He portrays collective misjudgments so gross that seemingly only a dullard could fail to perceive them. To be sure, life was much simpler for financial commentators in the middle of the nineteenth century. Mathematician Louis Bachelier hadn’t yet calculated that stock prices moved in a patternless “random walk.” This conclusion cast serious doubt on the feasibility of divining the market’s future course, even when it appeared to have overshot in one direction or the other. Furthermore, it was only long after Mackay’s death that economists began to question the reality of speculative bubbles. New theories suggested that even apparently absurd price swings could reflect bona fide changes in asset values. Later, in reaction to such thinking, a school of Inefficient Markets theorists reasserted the importance of fads and follies. By then, arcane mathematical methods had overshadowed attempts to dissect the mind of the market. This is not to say that Mackay’s specialty of historical narrative has lost its place in the discussion. Since his time, however, the level of debate has escalated. Analysts have developed a troublesome habit of checking the facts behind published accounts, rather than accepting them as authoritative sources for citation. In the course of this change, the nineteenth century’s more casual approach to research hasn’t stood Mackay in good stead. Analysis by Peter M. Garber of Brown University shows that Mackay sloppily assembled his history of the tulip bulb craze from secondhand sources. Abraham Munting’s “folio volume of one thousand pages upon the tulipomania” was in reality a botanical treatise with no more than six pages touching on the affair.