Monday, April 14, 2014

Zombie Alert

Dean Starkman had an interesting piece in the New Republic on the financial crisis. At least, it held my interest until I came across one one those things that annoy the hell out of me.
This attitude also has a literary pedigree. Cultural theorizing about our inherent weakness goes back to the Bible (see Genesis 2:4-3:24, Adam / Eve), but it was Scottish journalist Charles Mackay who most famously dissected the specific phenomenon of contagious folly in his 1841 classic, Extraordinary Popular Delusions and the Madness of Crowds. Mackay’s work chronicled episodes of mass hysteria—witch hunts, the crusades, alchemy. But most famously, Mackay gave us the parable of the Dutch tulip mania of 1636 to 1637, when flower bulbs briefly became one of the world’s most expensive commodities. A wry and witty stylist, Mackay mixes anecdotes—like one about a sailor who mistook a priceless tulip bulb for an onion to go with his herring breakfast—with mordant observations about human nature. “In reading the history of nations, we find that, like individuals, they have their whims and their peculiarities; their seasons of excitement and recklessness, when they care not what they do,” Mackay’s preface to the 1852 edition begins. “We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit.”

Mackay has attracted plenty of support from academics over the decades, particularly scholars of social psychology, and in the years since the crash, his work has been much cited as a master theory of what went wrong. People are greedy. What can you do?

There’s just one problem: The accounts that undergird Mackay’s thesis might be wrong. As Andrew Odlyzko, a University of Minnesota mathematician who studies financial panics, puts it, Madness “enjoys extraordinarily high renown in the financial industry and among the press and the public. It also has an extraordinarily low reputation among historians.” Peter Garber, a Brown economist, found in a 1990 paper that the most intense speculation in the Dutch tulip market of the era involved only the rarest bulbs, which had been infected by a certain virus that produced particularly intricate patterns in the flower. After that, the market behaved pretty much the way the market for rare bulbs always behaves. Prices for newly cultivated bulbs were high, then fell over time. In fact, the average decline in prices for the rarest bulbs in the five years after the tulip market crashed was, at most, 32 percent. “Large, but hardly the stuff that legends are made of,” Garber writes.
There is at least major one problem with Starkman's "just one problem." The accounts that undergird Mackay’s thesis about market bubbles are only tangentially related to tulipmania. Extraordinary Popular Delusions does discuss a couple of market bubbles in some detail, but those are both land bubbles. The first concerned France's Mississippi Company; the second focused on the South Sea Company in Britain . After spending about seventy pages on these crises, Mackay closes with a brief and relatively light seven pages on the market for tulip bulbs.

Not only does tulipmania play a relatively trivial role in Mackay's discussion of markets;  speculative bubbles play a secondary role in his short discussion of  the tulip market. The main focus here is on collector psychology and the tendency to highly value the rare and fragile simply because it's rare and fragile. Here's the opening of the chapter:
The tulip,--so named, it is said, from a Turkish word, signifying a turban,--was introduced into western Europe about the middle of the sixteenth century. Conrad Gesner, who claims the merit of having brought it into repute,--little dreaming of the commotion it was shortly afterwards to make in the world,--says that he first saw it in the year 1559, in a garden at Augsburg, belonging to the learned Counsellor Herwart, a man very famous in his day for his collection of rare exotics.

The bulbs were sent to this gentleman by a friend at Constantinople, where the flower had long been a favourite. In the course of ten or eleven years after this period, tulips were much sought after by the wealthy, especially in Holland and Germany. Rich people at Amsterdam sent for the bulbs direct to Constantinople, and paid the most extravagant prices for them. The first roots planted in England were brought from Vienna in 1600. Until the year 1634 the tulip annually increased in reputation, until it was deemed a proof of bad taste in any man of fortune to be without a collection of them. Many learned men, including Pompeius de Angelis and the celebrated Lipsius of Leyden, the author of the treatise "De Constantia," were passionately fond of tulips. The rage for possessing them soon caught the middle classes of society, and merchants and shopkeepers, even of moderate means, began to vie with each other in the rarity of these flowers and the preposterous prices they paid for them. A trader at Harlaem was known to pay one-half of his fortune for a single root, not with the design of selling it again at a profit, but to keep in his own conservatory for the admiration of his acquaintance.

One would suppose that there must have been some great virtue in this flower to have made it so valuable in the eyes of so prudent a people as the Dutch; but it has neither the beauty nor the perfume of the rose--hardly the beauty of the "sweet, sweet-pea;" neither is it as enduring as either. Cowley, it is true, is loud in its praise. He says--

   "The tulip next appeared, all over gay,
    But wanton, full of pride, and full of play;
    The world can't shew a dye but here has place;
    Nay, by new mixtures, she can change her face;
    Purple and gold are both beneath her care,
    The richest needlework she loves to wear;
    Her only study is to please the eye,
    And to outshine the rest in finery."

This, though not very poetical, is the description of a poet. Beckmann, in his _History of Inventions_, paints it with more fidelity, and in prose more pleasing than Cowley's poetry. He says, "There are few plants which acquire, through accident, weakness, or disease, so many variegations as the tulip. When uncultivated, and in its natural state, it is almost of one colour, has large leaves, and an extraordinarily long stem. When it has been weakened by cultivation, it becomes more agreeable in the eyes of the florist. The petals are then paler, smaller, and more diversified in hue; and the leaves acquire a softer green colour. Thus this masterpiece of culture, the more beautiful it turns, grows so much the weaker, so that, with the greatest skill and most careful attention, it can scarcely be transplanted, or even kept alive."

Many persons grow insensibly attached to that which gives them a great deal of trouble, as a mother often loves her sick and ever-ailing child better than her more healthy offspring. Upon the same principle we must account for the unmerited encomia lavished upon these fragile blossoms.

This is followed by a discussion of the extreme run-up of prices usually referred to as tulipmania in which speculation plays a prominent but perhaps not central part (it's worth noting that even Garber says that there was at least a brief period intense speculation that extended to common bulb prices), but Mackay keeps coming back to the desire to possess these flowers rather than to resell them for a profit. To drive home the point, Mackay closes with a paragraph on the continued high prices bulbs can fetch. "In England, in our day, strange as it may appear, a tulip will produce more money than an oak. If one could be found, _rara in terris_, and black as the black swan of Juvenal, its price would equal that of a dozen acres of standing corn."

Starkman seems to feel that Mackay's moralizing about bubbles is a form of blaming the victim. Perhaps he's right, but in order to argue the point he'd have to talk about Mackay's accounts of the Mississippi Scheme or the South Sea Bubble. Instead, we get the almost obligatory tulip reference. It was bad enough when writers were overusing this trivial and not particularly relevant case as an example of a speculative bubble; it's even worse when they use it to deny bubbles' existence.

Tulipmania is another one of those rhetorical zombies we need to kill off for good.

P.S. Though not directly related to the main point of the post, it's worth noting that, while Starkman seems to be accusing Mackay of seeing bubbles that aren't there, one of the two scholars he quotes, Andrew Odlyzko, was actually accusing Mackay of choosing not to see bubbles that were there.
Charles Mackay's book "Extraordinary Popular Delusions and the Madness of Crowds" enjoys extraordinarily high renown in the financial industry and among the press and the public. It also has an extraordinarily low reputation among historians.

This paper argues that Mackay's sins of commission were dwarfed by his sins of omission. He lived through several giant investment manias in Britain, yet he did not discuss them in his books. An investigation of Mackay's newspaper writings shows that he was one of the most ardent cheerleaders for the Railway Mania, the greatest and most destructive of these episodes of extreme investor exuberance.

Mackay's story provides another example of a renowned expert on bubbles who decides that "this time is different." His moves through a sequence of delusions help explain the length and damage of the Railway Mania. He was a free market and technology enthusiast, and faced many issues that are important today, such as government ownership or regulation, interconnection, standardization, structural separation, and analogs to net neutrality. A crushing national debt and high unemployment in an economy pulling out of a deep depression (and in perceived danger of falling into another one) were very important in shaping attitudes towards railway expansion. The analogies and contrasts between Mackay's time and ours are instructive.

1 comment:

  1. "He lived through several giant investment manias in Britain, yet he did not discuss them in his books."

    I actually have a lot of sympathy for this approach. Sometimes things that are more recent get associated with issues like partisan affiliation and the guilt of specific actors -- in the course of showing a general principle these elements could add more confusion than clarity.