Edward Chancellor -- Devil take the hindmost: a history of financial speculation ================================================================================== Edward Chancellor's account of a number of extreme speculative periods in history is both entertaining and educational, although I'll admit that the entertainment is enjoyable only if you can ignore the damage that these manic periods can do and can for get that we're likely due for another one soon. Here are some comments and notes about several of my favorite chapters from the book. The chapter titled "Kamikaze capitalism" gives a description of how Japan and the Japanese are different or believe they are different, and how that difference has led to a different style of economic system. Some of the characteristics of that different economic system are reduced individualism, increased control by government, and huge industry cartels (called keiretsu), which engage in extensive cross- shareholdings between them. Another Japanese "difference" is a sense of community and oneness, which, Chancellor claims, led to a huge wave of "trend following" investing and a herd like behavior among investors. First, the Japanese created asset bubbles in equities (corporate stock) and real estate. And, then the mania spread, but there was a vicious circularity: paper profits and a sense of wealth gained from one type of assets led to speculation in other assets. Increased availability of credit created a real estate bubble; the real estate bubble created a stock price bubble (company ownership of land was a rationalization for high stock prices); real estate and stock asset price spikes led to bubbles in fine art paintings and even golf club memberships and several other bizarre almost imaginary assets (even an AIDS cure). Almost anything that could be bet on *was* bet on. Market manipulation was rampant, much of it done for the benefit of insiders and for politicians, who had cosy, quid pro quo relationships with corporate executives. Chancellor describes bubbles in a variety of assets in addition to stocks and real estate, for example fine art (especially French impressionist paintings) and golf club memberships. In the cases of both fine art and golf club memberships there were prices indexes and brokers to facilitate monitoring and trading in these assets. The banks offered margin loans to fund purchases. And, the rising prices of these assets were used to enable purchases or "investments" in other assets. Government policies and practices at the big four brokerages favored insiders: the insiders and the rich gained while the outsiders and the middle class lost during this decade (1980's). During the market descent (1990) Ministry of Finance attempted to manipulate and prop up the stock market in part by decreasing margin account requirements, prohibiting sale of new shares, and loosening accounting requirements (e.g. by removing requirements to re- evaluate positions and to report losses). And then it all came down: the price of stocks and the price of real estate and the price of paintings and the price of golf club memberships and more. They were each used to justify loans to purchase (and drive up the price of) others, and they all came down. There are chapters on other manias, for example , but the chapter titled "Fool's Gold" which discusses Britain in the early 1800's seemed especially entertaining because the speculation and behavior it describes was so outlandish. Here are a few of the wild things that the Brits "invested" in during the early part of the nineteenth century: (1) Foreign bonds where supposedly a way to finance projects in South American countries, but really just another asset to "pump and dump", the funds often did not get to the purported creditor anyway. There were innovations such as sale of bonds with a requirement that the purchaser only pay a small initial payment, effectively giving investor/gamblers leverage by enabling them to buy bonds on margin. Before long, brokers were using current sales receipts to pay previous investors, turning it into a Ponzi scheme. (2) Gold mining company stock became the next mania. Outrageous claims were made in the prospectuses for stock offered in these companies included claims that gold was lying everywhere and that each mining company had huge amounts to be mined easily. (3) Then, since money was available and thirsting for something to invest in, innovation became extreme. Shares were offered for a company to pipe salt water to London for those who wished a saltwater swim but could not afford the trip to the sea and for a company to provide umbrella rental stations scattered in London for those who did not want to carry their umbrellas everywhere. There are several lessons that we might take away from this chapter: (1) If you have a wealth effect (people feel rich) and there is enough easy access to capital and credit, people will try to speculate on anything, no matter how bizarre. (2) Once a mania starts, it tends to perpetuate itself and to generate its own energy as asset prices increase and people begin to feel that they must not be left behind. In the last chapter, titled "Epilogue", Chancellor attempts to describe a distinction between good speculation and evil speculation. Good speculation calms markets, corrects evaluations (e.g. when executives lie to boost their company's stock price), disciplines governments, and has a negative feedback effect (it corrects wild swings). Bad speculation produces bubbles, price spikes, and wild price swings; it has a positive feedback effect, making mild swings bigger. Chancellor believes that the difference between the two kinds of speculation, bad and good, is that bad speculation is trend following, whereas good speculation is based on fundamentals and evaluation of an asset. He does, however, seem to doubt that we can have any regulation that effectively distinguishes between good and bad speculation, protecting us for the bad, allowing the good. Derivatives can be used for "good speculation", but often become a tool for an extreme form of the bad sort. This is especially true of derivative products for which there seems to be no possible use other than gambling. While reading the later sections of this book, I got the ominous sense that another boom and bust would soon be upon us, say around 2006 to 2008. Oh, wait, we already did that. We've already done this decade's boom and bust. And, you can see it all coming, yet again, when Chancellor talks about derivatives and how dangerous they are and about how those in positions to control them are saying that they do not need to be controlled and about how there is no imaginable use for some of the more innovative derivatives. It is positively frightening when Chancellor talks about a ten year cycle of boom and busts, about how the seeds of each boom are sown in the midst of the previous crises, and about how capital becomes "blind", i.e. investors are unable to remember even the recent past and are condemned to repeat it. The easy credit and the low asset prices created by the previous crisis provide the fuel for next one. 09/20/2011 .. vim:ft=rst:fo+=a: