Philip M Halperin

Donkey carrying booksBookshelf     Galbraith-Short History-Cover

John Kenneth Galbraith, A Short History of Financial Euphoria, 1990

If you must read only one financial disaster book, this is probably the one to pick. A short (110 pp.) and fast read, it is an elegant summary of past financial manias, with a good analysis and summary of the underlying themes common to all. Unfortunately, it was written before the current (1998) fun and games, but as one reads the analyses of past third world debt euphoria and past stock market bubbles (recall the phrase "new paradigm" that was common in early 1998?), one cannot but marvel at the mindless and memoryless behaviour that has typified the recent financial era.

This book works on several levels. Most importantly, Galbraith describes the characteristics of the mass psychosis that typifies the period of financial euphoria that precedes the inevitable crash. In the first instance, the general paper profit-making becomes (temporarily) a self-fulfilling prophecy, that leads to self-sustaining and self-congratulatory behaviour, what Galbraith terms "a vested interest in error" on the part of the participants, who, as members of a crowd are willing to suspend disbelief: Galbraith quotes Walter Bagehot - "all people are most credulous when they are most happy". To this, the author adds an elegant statement of the power of the vested interests who condemn and criticise doubting voices in an almost tribal manner.

Galbraith does not spare sarcasm in his characterisation of the attitudinal follies that lead to and sustain these episodes. He is brutally succinct in describing the extreme shortness of financial memory and the ignorance of history which leads to the same mistakes being repeated under similar circumstances within a few short years. (Regrettably, he does not discuss the degree to which this is institutionalised, on the one hand by the ageist behaviour of the financial community in hiring traders and managers and laying off senior people who have seen this before, and on the other by the short time horizons mandated in current historical back-testing requirements). He also lambastes the specious attribution of mental acumen to financial success, "accordingly, possession [of money] must be associated with some special genius."
" In practice, the ... individuals at the top of these institutions are often there because, as happens regularly in great organizations, theirs was mentally the most predictable and, in consequence, bureaucratically the least inimical of the contending talent.
...they are then endowed with the authority that encourages acquiesence from their subordinates and applause from their acolytes and and that excludes adverse opinion or criticism. They are thus admirably protected in what may be a serious commitment to error.
Relatedly, he describes the special deference accorded to heads of large financial institutions and lenders in particular, which creates an aura close to infallibility in marked contrast to the actual ability and judgement of those individuals:

The second important insight of the book is the summary of common denominators in all such episodes, many of which are visible in the period we are currently experiencing. Among these (and probably inevitable given the shortness of financial memory) is the appearance of specious financial innovation. This is treated at length in the discussions of the South Sea Bubble, John Law, and Miliken (regrettably, the book antedated exotic options and submerging markets hedge funds). Galbraith argues that most of these seeming innovations were essentially variations on the theme of leverage. In some cases, there was not even the semblance of innovation, as in the 1920s. Finally, there are some interesting parallels to be drawn from the terrible outcomes of speculative enthusiasm in investment in developing-country infrastructure, such as the historic collapse of British investments in the United States in 1837:

" It [the collapse of 1837] introduced a distinctly modern attitude toward the loans that were outstanding: in the somber conditions following the crash, these were viewed with indignation and simply not repaid. Mississippi, Louisiana, Maryland, Pennsylvania, Indiana and Michigan all repudiated their debts...Anger was expressed that foreign banks and investors should now, in hard times, ask for payment of debts so foolishly granted and incurred. A point must be repeated: only the pathological weakness of the financial memory...allows us to believe that the modern experience of Third World in any way a new phenomenon. "

The Short History of Financial Euphoria is an elegant tour-de-force of financial folly, and should be read, and re-read, by all traders and risk managers.

Link to buy book in the UK
(Note: This link is to AlphabetStreet Booksellers)

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