By Edward Chancellor
(Macmillan pounds 25)
SOME STUDENTS of financial booms and busts are becoming nervous as the crashes in stock markets that we have been forecasting for a time - long in my case - fail to materialise. We took comfort in the remark of Alan Greenspan in December 1996 that he was concerned over "irrational exuberance" in Wall Street. When Internet stocks decline (though other equities continue their upward climb), we think "at last". We look back to the remark of the distinguished American economist, Irving Fisher, in 1929, ahead of the crash of October, that the American economy had reached a "New Era". But the band of worriers is declining who cannot understand price/earnings ratios of 30, 50, 80, even infinity (when the price is divided by zero earnings), or negative (when the anticipation of future earnings is accompanied by current losses).
It is a mistake to be right too early, as Roger Babson, a financial analyst, learnt in 1928 when he predicted the crash of 18 months later and lost his clients. Edward Chancellor's has better timing than those who have long been welcoming a crash still in prospect. It is brilliantly written, with a good understanding of finance derived from his days as a banker with Lazard Brothers, and a historian's felicitous prose style that carries the reader along.
The episodes in financial speculation are limited to 10, mostly English and American. But there are two items from further afield, the classic 250-year-old Tulip Bubble of the Dutch Republic, and the Japanese implosion of a decade ago, which resulted in a recession or depression that is only now beginning to show signs of recovery but still has distance to go. An epilogue adds from America the debacle of Long-Term Capital Management of September 1998.
Some of the cognoscenti might have wished for a few other old and new favourites such as the Mississippi Bubble, which burst in 1720 a few months ahead of the South Sea Bubble, the Mexican troubles of 1982 and 1994-95, the East Asian Tigers from 1997, and on-going Russian economic collapse that threatened world finance last summer. But one should rejoice in what Mr Chancellor has provided in such detail and depth, with more light and colour than one normally receives.
Of particular interest to me is Chapter 2 on the 1690s in England after the Glorious Revolution of 1688, and preceding the South Sea Bubble of 1713-20. In between came financial revolution, the establishment of the Bank of England, and the Nine Years' War. Mr Chancellor devotes attention to the complex character of Daniel Defoe, whom children read for that remarkable economic tract, Robinson Crusoe, and bankers enjoy for his novels where financial detail is interspersed among lurid characters such as Roxana, the Fortunate Mistress and Moll Flanders.
Defoe was also a journalist with strong interests in his debts, in morality and in Exchange Alley, where speculation ran riot and in his judgement was doomed. The times were tempestuous and complex. The Nine Years' War cut off imports of claret and port, leaving merchants who had sold off their stock with the money to subscribe to the shares of the Bank of England, which had been founded to reorganise government debt in what became the financial revolution.
Booms have had their start in various ways: the refunding of British debt from the Napoleonic wars at low rates of interest, stimulating those who lost income to seek higher returns in insurance shares and foreign bonds; in innovations such as canals and railroads, the shares of which were often bought with small down-payments leaving some investors unable to meet calls for later instalments; sharp declines in foreign lending because of changes in domestic conditions, such as when Berlin and Vienna in 1873 suddenly stopped lending to the financier Jay Cooke's need for capital to build the Northern Pacific railroad in the United States; or the hectic share trading on Wall Street in March 1928, which diverted capital away from long-term lending for Germany, Argentina, Australia and Uruguay.
Mr Chancellor's rhetoric adds to the sharp taste of the juicy details. My Roget's Thesaurus notes that the book's title goes back to the 17th century and Samuel Butler of Hudibras. Chapter headings - "Fool's Gold", "Cowboy Capitalism", "Kamikaze Capitalism" and "Rogue Economists" - convey the pejorative quality of the prose. But it is hard not to feel a certain amount of schadenfreude when markets believed by most economists to be efficient, reflecting accurately all available information - "fundamentals" - processed by rational, informed and honest traders, crash as a consequence of lemming-like mad crowds, seen in 1841 by Charles Mackay, who provided the first popular accounts of speculative mania, as subject to extraordinary delusions.
Jaw-boning to these crowds, "moral suasion," is historically futile. It is hard to fault Barton Biggs of Morgan Stanley Asset Management when he says this book should be "required reading for every investor."
Charles Kindleberger is the author of `Manias, Panics and Crashes', the classic work on speculation. These days he is Emeritus Professor of Economics at Massachusetts Institute of Technology