Devil Take the Hindmost: A History of Financial Speculationby Chancellor
Focusing on speculation as it developed in the world's leading stock markets, Edward Chancellor's story starts with the tulipomania in seventeenth-century Holland, then moves to Britain with accounts of speculative manias such as the South Sea Bubble and the Railway Mania. From
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A lively and authoritative look at speculation from early modern times to the present.
Focusing on speculation as it developed in the world's leading stock markets, Edward Chancellor's story starts with the tulipomania in seventeenth-century Holland, then moves to Britain with accounts of speculative manias such as the South Sea Bubble and the Railway Mania. From the mid-nineteenth century, the narrative turns to the United States, with chapters on the Gilded Age, the Roaring Twenties, and the revival of speculation since the early 1970s, then portrays the disastrous Bubble Economy of Japan in the 1980s. Chancellor shows that the impulses that have shaped speculative behavior are at odds with the orthodox theory of efficient markets. His comprehensive history is interspersed with trenchant commentary on speculation in the 1990s, including such current issues as emerging markets, Internet and foreign-currency speculation, rogue traders, the great U.S. bull market, and our current financial predicament.
"I daily hear such reports of advantages to be gaind by one project or other in the Stocks, that my Spirit is Up with double Zeal, in the desire of our trying to enrich ourselves."
Sound familiar? It should, given the zealous high spirits of those enriched by "the Stocks" of Wall Street over the past few years. But the author of the above sentiment was Alexander Pope, the British poet, and he was writing about a different bull market -- that of South Sea Company stock in 1720. As Edward Chancellor points out in his fascinating and frightening new book, Devil Take the Hindmost, all of London was caught up in the mania for South Sea stock, which was appreciating at a rate even early holders of Amazon.com would envy. Pope's contemporary Jonathan Swift probably described the era best: "I have enquired of some that have come from London, what is the religion there? they tell me it is South Sea stock."
Widespread market obsession, though, is only one of many ominous parallels Chancellor finds between the current boom and those of the past. After first tracing the history of financial speculation back as far as ancient Rome (unsavory operators sold shares on the Forum, near the Temple of Castor), he outlines the stunningly similar progress of various "speculative bubbles" throughout history -- the Tulip Mania of 1637, the South-Sea Bubble of 1720, the Railway Mania of 1845, the bull markets of the 1920s and the 1980s, and the Japanese Bubble Economy of the late 1980s. In each case, the signs of excess and imminent disaster should have been obvious to all but were lost in the euphoria of the quick and easy buck (or pound or yen). Why? Because each time the public allowed itself to believe what, according to Sir John Templeton, are the four most expensive words in the English language: This Time It's Different.
Arguing that speculative manias partake of a good bit of irrationality, Chancellor rebuts proponents of the so-called Efficient Market Hypothesis, who believe that stock prices by their very nature reflect intrinsic value (in other words, that stock in DutchTulip.com really is worth 4,000 times current earnings, because DutchTulip.com is the future). This faith in the surpassing wisdom of the markets, he contends, is what allows speculative bubbles to develop, aided by the ever more arcane and dangerous financial instruments that thrive in an era of laissez-faire economics.
Casting a critical eye on the current environment (where even George Soros complains that he doesn't understand how certain derivatives function), Chancellor implies that those who believe the current market to be rationally priced may be living in a dream world. "As an anarchic force, speculation invites government restrictions," he concludes, "yet it is only a matter of time before it slips its chains and runs amok."
One warning: Devil Take the Hindmost, while timely and enlightening, is not an easy read. Without an MBA and experience on Wall Street, you may find much of Chancellor's analysis heavy sledding. (If you do, try John Kenneth Galbraith's briefer, more accessible -- and delightfully condescending -- A Short History of Financial Euphoria.) But you don't have to know the difference between a hedge and a hedge fund to understand Chancellor's basic premise. And if you're like me, you'll have two overwhelming reactions: first, to marvel that the more things change, the more they stay the same; and second, to conclude that it may be time to redeem those mutual funds and stick the proceeds under a nice, safe mattress.
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"THIS BUBBLE WORLD":
THE ORIGINS OF FINANCIAL
* * *
And when dreams deceive our wandering eyes in the heavy slumber
of night, and under the spade the earth yields gold to the light of
day: our greedy hands finger the spoil and snatch at the treasure,
sweat too runs down our face, and a deep fear grips our heart that
maybe someone will shake out our laden bosom, where he knows the
gold is hid: soon, when these pleasures flee from the brain
they mocked, and the true shape of things comes back, our mind
is eager for what is lost, and moves with all its force among
the shadows of the past ...
Satyricon of Petronius Arbiter,
circa A.D. 50
The propensity to barter and exchange is an innate human characteristic. An inclination to divine the future is another deeply ingrained trait. Together they comprise the act of financial speculation. "All life is speculation," declared the celebrated nineteenth-century American trader James R. Keene, "the spirit of speculation is born with men." For the earliest known historical cases of speculation we must turn to ancient Rome during the Republic of the second century B.C. By this date, the Roman financial system had developed many of the characteristics of modern capitalism: markets flourished because Roman law allowed the free transfer of property, money was lent out at interest, money changers dealt in foreign currencies, and payments across the Roman territories could be made by bankers'draft. Capital concentrated in Rome, as it later did in Amsterdam, London, and New York. The idea of credit had also developed, along with a primitive form of insurance for ships and other forms of property. The people of Rome exhibited a passion for the accumulation of wealth, matched by an extravagance in its display and consumption. Gaming was common.
In Latin, the word speculator describes a sentry whose job it was to "look out" (speculare) for trouble. The financial speculator in ancient Rome, however, was called quaestor, which means a seeker. Collectively, speculators were sometimes referred to as Graeci or Greeks. Their meeting place was the Forum, near the Temple of Castor, where "crowds of men bought and sold shares and bonds of tax-farming companies, various goods for cash and on credit, farms and estates in Italy and in the provinces, houses and shops in Rome and elsewhere, ships and storehouses, slaves and cattle." The Roman comic playwright Plautus describes the Forum as peopled with whores, shopkeepers, moneylenders, and wealthy men. He identifies specifically two unsavoury groups; the first lot he describes as "mere puffers" and the second as "impudent, talkative, and malevolent fellows, who boldly, without reason, utter calumnies about one another." In this description, we find the originals of the bulls and bears of later stock markets.
The Roman state contracted out many of its functions, from tax collecting to temple building, to societies of capitalists, known as publicani. Like modern joint-stock companies, the publicani were legal bodies independent of their members whose ownership was divided into partes, or shares. They had executive managements, produced public accounts (tabulae), and held occasional meetings of shareholders. Many were considerable concerns, employing tens of thousands of slaves. Shares came in two sorts: larger executive shareholdings of the great capitalists, known as socii, and smaller shares, called particulae. The manner of dealing in unregistered particulae shares was informal, resembling the modern over-the-counter stock markets. The publicani maintained a system of couriers throughout the Roman territories in order to gather information, enabling them to calculate how much to bid for contracts at auction and how much shares in going concerns were worth.
No evidence remains of the prices for which partes sold, and there are no descriptions of stock market behaviour. We do know, however, that shares fluctuated in value. When the Roman consul Vatinius was accused of corruption he was asked: "Did you extort shares, which were at their dearest at the time ... ?" Cicero referred to partes carissimas (most expensive shares) and claimed that buying shares in public companies was seen as a gamble which conservative men avoided. Shares in the publicani did not attract only politicians and large capitalists. Polybius, the Greek chronicler, describes a widespread popular interest in share ownership: "All over Italy," he writes, "an immense number of contracts, far too numerous to specify, are awarded by the censors for the construction and repair of public buildings, and besides for the collection of revenues from navigable rivers, harbours, gardens, mines, landsin a word every transaction which comes under the control of the Roman government is farmed out to contractors. All these activities are carried on by the people, and there is scarcely a soul, one might say, who does not have some interest in these contracts and the profits which are derived from them" (my italics). Describing the last years of the Republic, Petronius Arbiter wrote that "filthy usury and the handling of money had caught the common people in a double whirlpool, and destroyed them ... the madness spread through their limbs, and trouble bayed and hounded them down like some disease sown in the dumb flesh." Perhaps these are descriptions of the first speculative "mania," although the evidence is too weak to prove the case.
The Roman publicani withered under the Empire, but speculation in property, commodities, and currencies continued. After fiduciary moneyi.e., money created by government decree which has no intrinsic value but depends on public confidencewas introduced in the third century A.D., currency crises became common. The city council of Mylasa in Caria (in modern-day Turkey) complained that as a result of the speculative hoarding of specie, "the very security of the city is shaken by the malice and villainy of a few people, who assail and rob the community. Through them speculation in exchange has entered our marketplace and prevents the city from securing a supply of the necessities of life, so that many of the citizens and indeed the community as a whole, suffer from scarcity." It is a very modern lament.
FINANCIAL SPECULATION IN THE
EARLY MODERN PERIOD
The culture of medieval Europe was inimical to financial speculation for both practical and ideological reasons. The feudal system dispensed with many financial transactions of the Roman world, replacing cash dealings with payments in kind. Medieval schoolmen revived the Aristotelian notion of a "just price," following the teaching of St. Thomas Aquinas, who declared that it was unjust and unlawful to "sell dearer or buy cheaper than a thing is worth." Usury was also condemned. The pursuit of profit was viewed as both morally corrupting and dangerous to the commonwealth. St. Augustine considered the unlimited lust for gain, appetitus divitarum infinitus, as one of the three principal sins, alongside the craving for power and sexual lasciviousness. In his City of God, there was no place for the speculator. When famine threatened, the medieval state intervened to supply food, and speculative hoarding was made illegal. These strictures against profiteering and speculation continue to resonate down the ages. When contemporary politicians rise to condemn the pernicious actions of speculators, they perpetuate unconsciously the Scholastic prejudices of medieval monks.
In the later Middle Ages, several Italian city-states began issuing marketable government securities. In Venice, government securities were traded from the middle of the thirteenth century at the Rialto. Speculation seems to have taken its normal course: In 1351, a law was introduced against rumours intended to sink the price of government funds; in 1390, 1404, and 1410, there were repeated attempts to prevent the sale of government obligations on deferred terms (i.e., bond futures); the Doge and members of the Ducal Council also tried to outlaw "insider trading." State loans also were traded at Florence, Pisa, Verona, and Genoa in the fourteenth century. The Italian city-states farmed out the collection of taxes to monti, companies whose capital was divided into tradable shares (luoghi). These early joint-stock companies appear strikingly similar to the Roman publicani.
The great fairs of Northern Europe, which had their origins in the fora and Bacchanalia of ancient Rome, enjoyed exemption from many of the medieval restrictions on trade and finance. They became, in effect, prototype stock markets. At the Leipzig fairs, shares in German mines changed hands in the fifteenth century; at the St.-Germain fairs near Paris, which opened after Lent, municipal bonds, bills of exchange, and lottery tickets were traded. Antwerp, with its two lengthy annual fairs in spring and autumn and yearlong permission of free trade, was described as a "continuous fair." In the middle of the sixteenth century, the city gave a home to the first settled bourse, so named after a gathering of merchants at the Hôtel des Bourses in neighbouring Bruges.
From the middle of the sixteenth century, there is more detailed evidence of speculative market conditions. The financial markets had developed a collective notion of credit (the so-called ditta di borsa) and bond prices reflected an anticipation of future events such as defaults. Market manipulation appeared in the 1530s, when a syndicate organised by the Florentine Gaspar Ducci led an attempt to suppress prices in the Lyons market (what we would now call a "bear raid"). In the middle of the 1550s there suddenly appeared in the markets of Antwerp and Lyons a speculative enthusiasm for royal loans, which came to an abrupt end when King Henry II of France suspended payments on his debts in 1557.
On an individual level, we find an Antwerp commodity trader, Christoph Kurz, puzzling at the periodic tightness and ease (strettezza and largezza) of money in the market. He believed that future prices were divinely ordained and discoverable through astrological observation. People bought when prices were at their highest, because "the upper influences so blind the natural reason with affections or desires." Like a modern technical analyst, Kurz rose early in the morning, surrounded "with work as a man in the ocean with water, for our astrologers aforetime have written much, but with little reason; wherefore I trust not their doctrines but seek mine own rules, and when I have them I search in the histories whether it hath fallen out right or wrong ..." Later Kurz forsook the market and enjoyed great professional success as a political astrologer, forecasting among other things the imminent extinction of the papacy.
The development of the capital markets in France and Flanders was interrupted in the second half of the sixteenth century by the Wars of Religion and the Revolt of the Netherlands and a succession of state bankruptcies. After 1557, Lyons went into decay as a financial centre. The sack of Antwerp by Spanish troops in 1585 led to the permanent decline of its bourse. Amsterdam benefited at the expense of Antwerp, as thousands of Protestant and Jewish refugees fled the Spanish, bringing capital and trading skills to the Netherlands. The stimulus provided by these immigrants has led historians to refer to the Dutch "economic miracle" of the 1590s. By the early seventeenth century, the Dutch Republic was the most advanced and thriving economy in Europe. Its merchants encircled the globe, buying wood in Norway, sugar in the West Indies, tobacco in Maryland, investing in forges in Wales or estates in Sweden, farming the Russian Tsar's export monopolies, and supplying Spanish America with slaves.
Although the Dutch did not invent the institutions and practices of financial capitalism such as banking, double-entry bookkeeping, joint-stock companies, bills of exchange, and stock markets, they brought together and established them on a secure basis in a mercantile economy organised around a highly evolved profit motive. In 1602, the United East India Company, the first joint-stock company to receive an official government charter, was established with a monopoly on Eastern trade. Nineteen years later, the Dutch West India Company was founded to exploit commercial opportunities in the Americas. Europe's first central bank, the Amsterdam Wisselbank, an institution derived from the Casa San Giorgio in Genoa, was established in 1609. Highly conservative in its operations, the Wisselbank paid no interest on deposits, issued notes only against its gold holdings, and made no loans. Yet its existence allowed Dutch merchants across the globe to settle their accounts bills in a universally accepted currency. The Dutch city authorities raised funds through bond issues and lotteries which attracted great popular interest. By the early seventeenth century, capital from across Europe was invested in a variety of Dutch financial assets, from property to annuities, municipal bonds, bills of exchange, and medium-term loans. Amsterdam was not simply a great entrepôt, it was the financial capital of the world.
All manner of financial products and services were traded on the Amsterdam Exchange (a New Exchange was founded in 1610): "commodities, current exchange, shareholdings, maritime insurance ... [it was] a money market, a finance market, [and] a stock market." Naturally, the Exchange became a crucible for speculative activities. Futures contractsagreements to deliver or take delivery of a commodity at a fixed price some date in the futurewere common. Since the previous century, futures had been traded in a variety of commodities, including grain, herring, spices, whale oil, sugar, copper, saltpetre, and Italian silks. In the early seventeenth century, they became available in the actions (shares) of the East India Company. Speculators could also take out loans on shares at up to four-fifths of their market value (what Americans later called "margin loans"). Stock optionswhich gave the buyer the right, but unlike the futures contract not the obligation, to buy or sell shares at a fixed price during the contract periodwere also traded on the Exchange. Later in the century, ducaton shares in the East India Company were introduced; valued at a tenth of the highly priced ordinary shares, they enabled less wealthy speculators to play the market. Futures, options, and ducaton shares are all examples of what we call derivatives, namely financial contracts which derive their value from an underlying asset, such as a share. Together with stock loans, they created the opportunity for financial leverage, so that small rises in share prices brought larger percentage gains to speculators (with small price declines producing the opposite effect).
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Meet the Author
Edward Chancellor studied history at both Cambridge and Oxford. In the early 1990s he worked for the investment bank Lazard Frères. He is a freelance contributor to the Financial Times and The Economist. This is his first book.
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