…at particular times a great many stupid people have a great deal of stupid money.
Walter Bagehot has come up with some wonderful lines in his day. That line, in particular, perfectly describes a recurring theme in financial history.
He wrote those words in 1856 about an event that happened in 1720 — The South Sea Bubble. He was describing human nature’s role in turning smart money into stupid money during manias and panics:
A great deal has been written and is being written on panics and manias — a great deal more than with the most outstretched intellect we are able to follow or conceive; but one thing seems certain, that at particular times a great many stupid people have a great deal of stupid money. Many saving people have only the faculty of saving; they accumulate ably, and contemplate their accumulations with approbation, but what to do with them they do not know… Several excellent economists have plans for preventing improvident speculation…but the only real way is, not to allow any man to have a hundred pounds who cannot prove to the satisfaction of Lord Chancellor that he knows what to do with a hundred pounds. The only want of this obvious and proper precaution allows the accumulation of wealth in the hands of rectors, sweepers, grandmothers, and other persons who have no knowledge of business, and no idea except that their money now produces nothing, and ought and must be forced immediately to produce something. “I wish,” said one of this class, “for the largest immediate income, and I am therefore naturally disposed to purchase an advowson.” Every now and then, from causes which are not to the present purpose, the money of people of this class — the blind capital…of the country — happen to be particularly large and craving; it seeks for some one to devour it, and there is “plethora” — it finds some one, and there is “speculation” — it is devoured, and there is “panic.”
The only point I take issue with is the idea that knowledge of business immunizes people from the problem.
Not knowing is just a total reliance on dumb luck for success. Knowing should add skill to the equation, but human nature is particularly triggered by the appearance of easy money and a desire to get rich quick. See Stanley Druckenmiller’s famous mistake diving back into Dotcom stocks at the top.
The numerous “Bubbles” are obvious examples of the excess of stupid money. Stocks that double or triple in a short time are enticing. It’s hard to sit on the sidelines without being tempted to join in. The South Sea Bubble burst exactly 300 years ago. A smaller one popped 30 years before that. And many more have followed it.
The less obvious example of stupid money arises in panics. Most talks around panics focus on fear and the mistake of selling low. But that’s only one part of it.
Whether it’s because of greed or a need to recover losses, seeing stocks down big can be just as enticing. It starts by imagining the windfall on a stock down 80% that then recovers to its previous highs. Hope, or is it desperation, breeds stupid money.
Of course, thinking a stock down 80% is sure to recover, ignores the possibility it gets cut in half or worse. Stocks down big have usually fallen for a reason. The business is in trouble. And if the business worsens, the stock falls some more. They’re called falling knives — they hurt when you try to catch the bottom.
Human nature doesn’t discriminate between manias or panics. When you treat stocks like lottery tickets, stupid money is bound to be lost.
- What Lessons Should Investors Learn from the Coronavirus Bear Market? – Behavioral Investment
- James Montier: Fear and Investment (podcast) – Masters in Business
- A Historic Opportunity in Small-Cap Stocks (pdf) – OSAM
- 10 Features of the Post-Virus Investment Landscape – Behind the Balance Sheet
- Why We Focus on Trivial Things: The Bikeshed Effect – Farnam Street
- It’s Time to Build – M. Andreessen
- What’s Different This Time – M. Housel
- The First Modern Pandemic – GatesNotes
- COVID-19 Business Impact Survey – Permanent Equity
- How the Game-Changing George Foreman Grill Made History – Men’s Health