CINCINNATI BUSINESS COURIER
March 30  – April 5, 1987

INVESTMENTS
Charles D. Vaughan

CROWD PSYCHOLOGY 

“All economic movements by their very nature, are motivated by crowd psychology. Graphs and business ratios are, of course, indispensable in our groping efforts to find dependable rules to guide us in our present word of alarms. Yet I never see a brilliant economic thesis expounding, as though they were geometrical theorems, the mathematics of price movements, that I do not recall Schiller’s dictum: ‘Anyone taken as an individual, is tolerably sensible and reasonable  as a member of a crowd, he at once becomes a blockhead’.

“…I have always thought that if, in the lamentable era of the ‘New Economics,’ culminating in 1929, even in the very presence of dizzily spiraling prices, we had all continuously repeated, ‘two and two still make four,’ much of the evil might have been averted. Similarly, even In the general moment of gloom in which this foreword is written, when many begin to wonder If declines will never halt the appropriate abracadabra may be: ‘They always did.’ ”

This statement was made by the legendary stock trader Bernard M. Baruch and was dated October 1932. The occasion was a foreword to a republication of an economic classic, “Extraordinary Popular Delusions and the Madness of Crowds,” by Charles Mackay, originally published In London In 1841. Both the book (which Is still available) and ft comments of Bernie Baruch may have a message for us today.

For those who may not be familiar with Baruch, he was a classic Horatio Alger type. From relatively modest beginnings, he made a fortune through shoestring investing at the turn of the century, only to see it dissolve into personal bankruptcy. His comeback was awe Inspiring as he more than regained his fortune and came into international economic and political power. His autobiography, “My Own Story,” is a study in stock trading expertise. The Mackay volume was reprinted at his urging to awaken the world to the economic vagaries of mob psychology.

“Extraordinary Popular Delusions” details a number of financial fiascoes and other public delusions. Among these are the great Mississippi Scheme inflicted upon 18th century France by Scotsman John Law. In this venture, shares of the Mississippi Co. were sold to the public offering the exclusive privilege of trading to the East Indies, China and the South Seas. After a change to a more grand name, The Company of the Indies issued 50,000 more shares, which were oversubscribed sixfold.

“Every day the value of the old shares increased, and the fresh applications, induced by the golden dreams of the whole nation, became so numerous that it was deemed advisable to create no less than 300,000 new shares at (10 times the last issue price) in order that the regent might take advantage of the popular enthusiasm to pay off the national debt. …Such was the eagerness of the nation, that thrice the sum would have been subscribed if the government had authorized it.”

The bottom line is, of course, that the enterprise never made any money and the decline in the shares was precipitous. The economy of France, a shambles before the venture, was truly devastated, and the promoters of the scheme ended in disgrace. Along the way, many who had the foresight to step gingerly into the fray and pocket profits rose from rags to riches. Those who exposed the scheme suffered public humiliation and many plebeians saw an end to their fortunes, All in all a typical, if spectacular, crowd cycle.

Mackay’s volume tells a similar tale of the South Sea Bubble in England early in the 18th century wherein, “Everybody came to purchase stock. Every fool aspired to be a knave.”

Stock was being sold in every conceivable type of venture and was being snapped up with wild abandon. “But the most absurd and preposterous of all, and which showed, more completely than any other, the utter madness of the people, was one stated by an unknown adventurer, entitled, ‘A company for carrying on an undertaking of great advantage, but nobody to know what it is.’ ”

Other Interesting and Instructional stories are related in this book which are easy for us to dismiss as history. But, if we read the prospectuses of some of the new penny stock offerings for so called blind pools, we can see some parallels. No. I don’t thing it is time to hit the panic button or to turn bearish on the financial markets. I do think it is time to resist the temptation to follow the crowd into questionable ventures. The higher prices rise and the more people got excited, the more we need to remember, with Baruch, that, “Two and two still make four and nothing can change that.”