Charles Kindleberger: Why We Bring On Manias, Panics, and Crashes
The economist Charles Kindleberger observed what we often ignore: humans tend to get euphoric in good times and panic in bad.
The phrase, may you live in interesting times, is not intended as an expression of optimism. It is the Chinese curse, although there is no equivalent expression in Chinese. The phrase was made famous by an Englishman, Austin Chamberlain, the elder half-brother of Neville, the Prime Minister at the outbreak of the Second World War. The nearest the Chinese have that is translated as “better to be a dog in peacetime, then a human in a time of war.”
It is significant that a Chinese curse is used in America, yet has no equivalent that we can find in China. Perhaps our problems are imported, but their development into a full-blown crisis is homegrown.
Kindleberger was kind enough to provide us with the eight stages of mania to crash:
- Shock: a crisis begins with displacement as one sector outperforms all others.
- Correlation: as it heats up, self-directed agents (you, me) join the rush and drive up prices.
- Mania: euphoria turns into widespread speculation.
- Retreat: Smart money takes profits.
- Panic: As the market sees outflows, people crowd the exits.
- Failure: participants relying on leverage become insolvent
- Crash: prices fall precipitously
- Rebound: the smart money comes back.
Charles Kindleberger believed the kind of crisis we so often find ourselves in is the result of what he called, Manias, Panics, and Crashes, which first appeared in 1978. Unfortunately, the subject has turned out to be a bestseller. Fortunately for professor Kindleberger, fifty years later, it never lost its freshness and is more relevant than ever today.
The inspiration for Kindleberger was the work of Hyman Minsky, a proponent of the “financial instability hypothesis,” in shorthand, markets are unstable, inherently so. If this doesn’t make you want to buy gold and hide your cash under a mattress, then consider the chart below. A crash seems to occur every five or ten years, which isn’t long enough to create wealth or even a career.
What is ironic is that at one time, not long ago, markets were thought to be perfect reflections of reality so that any gains or losses in the market would be quickly captured by market forces (see Random Walk Theory). Minsky and Kindleberger knew better. They proposed that crashes follow financial booms, and while governmental intervention helped it did and would not eliminate them, that manias, or bubbles, typically occur in the markets following unexpected good news. “New opportunities for profit are seized and overdone.” When this eventually dawns on investors, the financial system experiences distress, and panic ensues.
The question we need to address is why crises are so frequent?
Minsky’s co-author, Aliber, characterizes the decades since the early 1980s as “…the most tumultuous in monetary history in terms of the number, scope, and severity of banking crises.” Kindleberger’s co-author, Robert Aliber, believes the problem is that crises are married to other disasters, and the result is a family of crisis. In “Manias, Panics, and Crashes,” Kindleberger argued that human irrationality seemed to lie at the heart of these events. He was a skeptic by nature. He considered clinging to rigid beliefs in the face of disconcerting evidence to be the most dangerous form of irrationality.
