"We appear to be in the midst of a raging bitcoin bubble. The stock market, or at least its lunatic fringe of meme stocks and crypto-related firms, is not far behind. How can we understand the origins of speculative mania?"
-Acadian Asset Mgt
Author:Owen Lamont, for Acadian Asset management
We appear to be in the midst of a raging bitcoin bubble. The stock market, or at least its lunatic fringe of meme stocks and crypto-related firms, is not far behind. How can we understand the origins of speculative mania? Here are seven phrases of timeless relevance:
- THERE ARE IDIOTS. Look around.
- Everybody ought to be rich.
- Nobody knows anything.
- A fanatic is someone who can't change his mind and won't change the subject.
- The more confusion, the better.
- Number go up.
- This time is different.
1. "THERE ARE IDIOTS. Look around."
Bubbles typically involve irrational optimists. While it's theoretically possible to have a bubble without irrationality, in practice bubbles are powered by a wave of credulous newcomers who are ignorant, innumerate, and looking to get rich quick.
"THERE ARE IDIOTS. Look around." These are the first two sentences of a legendary but unpublished paper by Larry Summers. Arguably the most memorable opening since "Call me Ishmael," the first sentence gives the hypothesis (undeniable) and the second sentence gives the evidence (irrefutable), all in five words.
I myself have never seen a copy of this paper (I think you need to be a Seventh Level Thetan to gaze upon the wondrous scroll) but it's described in Thaler (2015).
Now, it's uncontroversial that "there are idiots" in financial markets. The controversy is whether these idiots have any impact on market prices. There are three views:
The efficient market view: Yes, there are idiots, but they don't matter because they cancel each other out, or because their impact is immediately offset by the actions of non-idiots.
The Grossman-Stiglitz view: The idiots are a necessary ingredient for a partly efficient market where rational traders gather information and make money by trading with idiots, who systematically lose money. I've previously explained this view: idiots (or more politely, "uninformed traders," "gamblers," or "noise-traders") are the lubrication that allows information to get into prices.
The behavioral finance view: Idiots push prices around, sometimes creating market-wide bubbles or obvious relative mispricings, which can last for years.
For me, the behavioral finance view seems more relevant every day.
2. "Everyone ought to be rich."
That's the title of John J. Raskob's spectacularly ill-timed article, urging Americans to buy equities, in the August 1929 Ladies Home Journal.
Now, there's nothing wrong with buying equities in general, but there was something wrong with buying equities in 1929, especially buying overpriced leveraged closed-end funds. Maybe everyone ought to be rich, but in the 1930s everyone got poor, especially those owning equities.
Bubbles often involve glorious visions of a utopian future of unlimited prosperity. Raskob is part of a long tradition of "democratizing finance," which in practice sometimes means selling overpriced assets to suckers.
3. "Nobody knows anything."
Here's Goldman (2012) discussing Hollywood: "Nobody knows anything... Not one person in the entire motion picture field knows for a certainty what's going to work. Every time out it's a guess and, if you're lucky, an educated one." This goes double for Wall Street; nobody knows which asset prices will go up.
Indeed, we have theories which say asset prices are completely unpredictable.
The corollary to "nobody knows anything" is that anyone claiming certain knowledge of future events is a charlatan. Charlatans come in many shapes and sizes: hyperbolic sell-side analysts, social media chatterers, and megalomaniac CEOs. A recent development is the rise of crypto charlatans, an invasive species currently slithering into equity markets.
Here's Galbraith (1994):
When will come the next great speculative episode? And in what venue will it occur...? To these there are no answers. No one knows; anyone who presumes to answer does not know he doesn't know.
Galbraith is describing charlatans of the Dunning-Kruger variety: too ignorant to realize that financial market outcomes are inherently unpredictable, see Dunning (2011).
Why does anyone listen to charlatans? Consider these different answers to the question "Will bitcoin go up next year?"
Answer from me: "I don't know."
Answer from charlatan: "Bitcoin will rise 50% as more companies maximize their inverse revenue with encrypted hypercompute. Bitcoin is safer than cash."
Who sounds confident? Who gives actionable insights? Not me. Although nobody really knows anything, it's not hard to find charlatans who claim to know everything.
4. "A fanatic is someone who can't change his mind and won't change the subject."
This definition, often attributed to Churchill or Truman, describes the bitcoin maximalists at the core of the current bitcoin bubble. These zealots will happily spend hours explaining why bitcoin is the answer to the world's problems.
In Pedersen (2022), fanatical optimists play an important role in generating mispricing. They continually transmit their bullish message, operating as "influencers" or "thought leaders" whose ideas spread through the information ecosystem.
Bitcoin, along with all of crypto, seemed near death in 2022. But not for bitcoin maximalists. Since they can't change their minds, and won't change the subject, they continued to spread their pro-bitcoin message, like Typhoid Mary spreading infection through the populace.
5. "The more confusion, the better."
Why is crypto good? What's the use case for bitcoin? These are simple questions, but they do not have simple answers, and the answers provided seem to change every year.
The mathematical mystique of bitcoin is a feature, not a bug. If no one understands bitcoin's purpose, how can anyone prove that it has no purpose? Ponzi schemes often involve deliberate obfuscation and complexity. According to Chancellor (2000), the mastermind of the South Sea Bubble in 1720 allegedly said:
"The more confusion the better; People must not know what they do, which will make them the more eager to come into our measures."
Consider the following from Jack Dreyfus in 1960:[1]
"Take a nice little company that's been making shoe laces for 40 years and sells at a respectable six times earnings ratio. Change the name from Shoelaces, Inc. to Electronics & Silicon Furth-burners.
In today's market, the words 'electronics' and 'silicon' are worth 15 times earnings. However, the real play in this stock comes from the word 'furth-burners,' which no one understands. A word that no one understands entitles you to double your entire score."
Bitcoin is today's furth-burner. No one understands it, and that's why they love it.
6. "Number go up."
You don't need me to tell you that "number go up" captures a central dynamic in financial markets. You can call it extrapolation, FOMO, or as I've previously suggested, The Iron Law of Return-Chasing Flows: Money chases trailing returns.
Number Go Up is the title of Zeke Faux's excellent book on the rise and fall of crypto through 2023. Unfortunately, he must now write a sequel, Number Go Up Again.
7. "This time is different."
Here's the full quotation from Sir John Templeton:
"The investor who says, 'This time is different,' when in fact it's virtually a repeat of an earlier situation, has uttered among the four most costly words in the annals of investing."
Of course, it's true that the market today actually is different; every market is at least partly different from prior history. Wisdom comes from perceiving the underlying general pattern as distinct from the unimportant differences.
Charles Mackay wrote the lurid bestseller Extraordinary Popular Delusions and the Madness of Crowds, which discussed many historical bubbles. Despite publishing his book in 1841 decrying bubbles, in 1845 Mackay himself was caught up in the British railway bubble and advocated buying shares.
Here's Mackay, at the peak, denying that the bubble was a bubble, as described in Harford (2023):
"We think that those who sound the alarm of an approaching railway crisis have somewhat exaggerated the danger ... It may appear wise to the careless or to the ignorant to trace resemblances... Those, however, who look more deeply into the matter and think for themselves cannot discover sufficient resemblance of cause to anticipate a similarity of effect."
Translation: This time is different.
Source: Acadian Asset management
Comment: Everything he said rings true We don't agree with them to the point of owning no Bitcoin. This essay, while spot on in the risks, smacks of ideological thinking and not quantitative portfolio management observations which Acadian Asset Management is known for.
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