What you will learn from reading Devil Take the Hindmost:
– The role financial speculation plays in a free market economy.
– How financial mania hype begins and what to look out for to spot a mania.
– The Difference between speculating and investing.
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Devil Take The Hindmost Book Summary:
My motives for reading this book were to try and get my head around the ascendance of crypto currency as an investment in the COVID crisis of 2020. Not only did it hit the mainstream but it seemed like everyone was making a lot of money from it. My search for answers led me to Devil Take the Hindmost which is a book on the history of financial manias. It’s a fascinating book that reveals that often history does repeat itself and yet, we still don’t learn our lesson. Having read this book I feel like I have a much better understanding of why the crypto market has exploded and also come to appreciate the role speculation does play in technological advancements.
If you’re interested in financial folly and want to make sense of the recent surge in crypto prices. Then this is the book for you.
So, we start with a very valid question.
What’s the difference between speculation and investment:
The line separating speculation from investment is so thin that it has been said both that speculation is the name given to a failed investment and that investment is the name given to a successful speculation.
Speculation is conventionally defined as an attempt to profit from changes in market price. Thus, forgoing current income for a prospective capital gain is deemed speculative. Speculation is active while investment is generally passive. According to the Austrian economist J. A. Schumpeter, “the difference between a speculator and an investor can be defined by the presence or absence of the intention to ‘trade,’ i.e. realize profits from fluctuations in security prices.”
The two can be separated on the grounds that the first aim of investment was the preservation of capital while the primary aim of speculation was the enhancement of fortune. As Schwed put it: “Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money becoming a little.”
The Psychology of Speculation:
The psychologies of speculation and gambling are almost indistinguishable: both are dangerously addictive habits which involve an appeal to fortune, are often accompanied by delusional behaviour and are dependent for success on the control of emotions.
Speculation and Manias:
A fashionable style, like a speculative movement, is subject to a popular consensus and follows a trend until it reaches a point of extravagance from which it can only retreat.
Keynes argued that since the future could not be known with degree of certainty values in the stock market ultimately depended on a state of confidence, itself the outcome of the “mass psychology of a large number of ignorant individuals.
Essentially, instead of acting on sound information, speculators were driven by fantasy.
New Technology Speculation and Profiteers:
The Austrian economist J. A. Schumpeter observed that speculative manias commonly occur at the inception of a new industry or technology when people overestimate the potential gains and too much capital is attracted to new ventures. Perhaps the speculators of the 1630s, entranced by the novelty of the tulip, were anticipating the development of the Dutch flower industry, now the largest in the world. If so, as with many later speculators, their foresight was not to be rewarded financially.
Company promoters took advantage of investor “euphoria” to float new ventures, many of which were supposedly based on new technologies but in reality were little more than fraudulent undertakings, intended solely to profit the promoters and stock operators.
Charles Kindleberger, in his book Manias, Panics and Crashes, suggests that speculative manias typically commence with a displacement which excites speculative interest. The displacement may come either from an entirely new object of investment or from the increased profitability of established investments. It is followed by positive feedback as rising share prices induce inexperienced investors to enter the stock market, and results in euphoria-a sign that investors’ rationality is weakened.
How speculation begins:
Emerging market speculation tends to appear at a juncture in the economic cycle when declining yields on domestic bonds combine with an excess of capital to make foreign investments particularly attractive. This could be what we are seeing with the crypto markets.
The fact is, that the owners of savings not finding, in adequate quantities, their usual kind of investments, rush into anything that promises speciously, and when they find that these specious investments can be disposed of at a high profit, they rush into them more and more. The first taste is for high interest, but that taste soon becomes secondary. There is a second appetite for large gains to be made by selling the principal which is to yield the interest. So long as such sales can be effected the mania continues; when it ceases to be possible to effect them, ruin begins.
Busts create new booms:
According to John Stuart Mill, the seeds of each boom are sown during the preceding crisis, when the liquidation of credit causes asset prices to decline so severely that they become genuine bargains. Their subsequent sharp rise from a low level leads to a revival of speculation.
After each crisis, the financial markets invariably shrug off past follies and losses to confront the future with bright optimism and fresh credulity. Capital becomes “blind,” to use Bagehot’s term. Unable to remember the past, investors are condemned to repeat it.
During the upturn of the cycle, Bagehot argued, people become convinced the prosperity will last forever and mercantile houses engage in excessive speculations. At the same time, an increasing number of frauds are perpetrated on investors, which only come to light after a crisis: “All people are most credulous when they are most happy”
How Mania Hype Begins (Promotion between friends):
In January 1845, sixteen new railway schemes were projected. By April, with rail receipts continuing to grow rapidly, over fifty new companies had been registered. Advertisements for railway prospectuses, soliciting subscriptions from the public, flooded the newspapers.
The standard notice contained a list of provisional committeemen, a paragraph extolling the benefits of the proposed line, and in most cases the promise of a final dividend of at least 10 percent. If the subscription was successful, the committeemen retained a large allocation of stock for themselves and their friends and released only a few shares in the market, thus creating a scarcity which threatened to snare speculators who had sold shares short in anticipation of buying them back at a lower price.
The new railway company was then hyped by friends in the railway press and its stock bid up by agents in the stock market. Once the shares were trading at a premium, the promoters would off-load their retained shares at a vast profit. Some companies even employed special “share committees” to oversee the success of these operations.
As long as the mania continued, Beneficiaries of the mania become a hero to the people. They symbolise someone who literally had gone from “rags to riches,” became a living symbol of the get-rich-quick mentality that enthrals the nation.
The Paradox of Equality in America:
It may appear paradoxical that Americans love equality, having enshrined it as a founding principle in the Declaration of Independence, and yet they strive ceaselessly to create material inequality amongst themselves.
The link between speculation and fraud:
It is difficult to ascertain whether the prevalence of speculation actually lowered moral standards, or whether the moral decay of the era simply manifested itself through speculation. It is clear, however, that speculation and financial fraud were frequent bedfellows.
Expected earnings as ‘scientific’ speculation:
Old yardsticks of valuation, which priced stocks at roughly ten times earnings and expected dividend yields to be greater than bond yields, were replaced by the discounting of future earnings.
By this method, future receipts were reduced to their present value by applying a discount rate: so that $100 paid in one year’s time, discounted at 10 percent, is valued today at $90. The discount method of valuation is the most speculative method of valuing stocks since it relies entirely on estimates of future earnings which remain uncertain.
But the combination of precise formulas with highly imprecise assumptions can be used to establish, or rather to justify, practically any value one wishes, however high, for a really outstanding issue.
The more proven an investment theory is the less it is questioned:
It is an irony, not uncommon in the looking-glass world of the financial markets where “proven” investment theses tend to lose their validity when acted upon, that the great stock market boom of the 1920s was induced by the statistically reasoned proposition that stocks were neither speculative nor even particularly risky investments.
The growth of credit and speculation:
Capitalism, however, requires consumers as much as savers and demand was maintained by the massive expansion of consumer credit, then called “instalment purchases.” Radios, fridges, cars, and clothes could all be purchased on credit. By the end of the decade, when outstanding instalment debt had risen to $6 billion, it was estimated that around an eighth of all retail sales were made on credit. There was a decidedly speculative element in the growth of instalment credit: present consumption was being financed with anticipated earnings.
When speculation enters the popular culture:
As J. K. Galbraith observed, “the striking thing about the stock market speculation of 1929 was not the massiveness of the participation. Rather it was the way it became central to the culture.” The stock market lured the leading celebrities and entertainers of the age, including Groucho Marx, Irving Berlin, and Eddie Cantor, the Ziegfeld Follies comedian, who all speculated on margin and eventually lost fortunes.
In the stock market of the Roaring Twenties, Americans found a secular religion whose ludic qualities, cynicism, and materialism reflected the zeitgeist of the Jazz Age. F. Scott Fitzgerald’s The Great Gatsby (published in 1925), a tale of hope and disillusionment, is a parable for the era.
History repeats itself:
The 1990s American investor, just like his earlier counterpart, convinced himself that he was buying shares for the long term rather than speculating for quick profits. ” “Buy and hold,” observed James Grant, “have replaced ‘I love you’ as the most popular three words in the English Language.
In both periods, investors saw each market decline as an opportunity to “buy the dip.” As a result, every downturn was quickly reversed, supplying the bull market with an aura of invincibility.
The new paradigm ideology is simply a product of the bull market. As long as investors maintain their faith in a new era and ignore dissonant information, then stocks will continue to rise. In the short run, a rising market serves to cover up weaknesses in the economy. Consumers spend their stock market gains and ignore their rising debts, companies issue new shares or bonds to purchase other companies or finance capital expenditure, and governments enjoy rising tax receipts as the economy prospers. In this way the new era analysis becomes something of a self-fulfilling prophecy.
The cyber-marketplace of the late twentieth century, with its bashers (bears) and hypsters (bulls), closely resembles the coffeehouses of Exchange Alley three centuries earlier, with their bubblers, sharpers, and cullies. The people and their practices remain the same, only the language and technology are new.
Better communication and less volatile markets:
The speedier the communication, the faster the contagion spreads.
There is little historical evidence to suggest that improvements in communications create docile financial markets or better-informed investment behaviour. If anything, the opposite appears to be the case.
In the past, the wider availability of financial information and improvements in communications have tended to attract impulsive new players to the speculative game: the first generation of daily newspapers stimulated the South Sea Bubble, the new “money market” columns of the British newspapers contributed to the mining mania of 1825, railways facilitated railway speculations in the 1840s, just as the ticker tape assisted stock market gambling in the Gilded Age and radio programmes in the 1920s excited a later generation of speculators.
Because the Internet allows people to conceal their identity, the information revolution has generated an extraordinary amount of fraud, mostly of a low-level nature. Scattered across the worldwide web are literally hundreds of thousands of get-rich-quick investment scams. Behind a veil of anonymity, crooked promoters “pump and dump” stocks through on-line investment forums. Perhaps more worrying than the appearance of fraud is the unsettling effect the Internet has had on investors’ behaviour.
Capitalism and greed:
Friedman boldly asserted that all societies were structured on greed: “The problem of social organisation,” he claimed, “is how to set up an arrangement under which greed will do the least harm; capitalism is that kind of system.
Is Speculation good?
These arguments in favour of speculation are predicted on the assumptions that markets are inherently efficient and that actions of speculators are both rational in motivation and stabilising in effect.
As we have seen this so called random walk theory is incompatible with the notion of stock market bubbles, since during bubbles investors react to changes in share prices rather than new information relating to companies’ long terms prospects (fundamentals). Such behaviour is termed ‘trend following’ and there is ample evidence that is has been a key feature of the financial markets in the 1990s.