A Genius is Behind Financial Euphoria

Let’s ask the right question before the fall

Photo by M. B. M. on Unsplash

“Speculative bubbles are inherent in the free market”, wrote John Kenneth Galbraith, a Harvard professor of Economics in his book. Its title caught a lot of attention among academia in 1994. The title is very simple; “A Short History of Financial Euphoria”. In the 17th century, captive dreamers in Holland ran after luring tulips with speculative deals. They made a purchase agreement with traders of beautiful tulips which did not even bloom yet. Gold rushers chased fortune and dig the mine in Louisiana for reckless risk-taking. It sounds like modern miners of Bit Coin, a first crypto currency yet to disrupt the central bank. Professor Galbraith presented the historical facts and his personal experience to support the argument. The major warning message is to remind us of our collective orientation that financial memory is “notoriously short”. It is indeed very short that at least two crashes in 2000 and 2008 reside in our memory since the publication. We gave the names such as the dot-com bubble and the Lehman Shock. The author describes the distinctive phenomenon that a genius is behind the new financial instrument before the fall. Even in my own business experience, there were junk bonds, derivatives, and sub prime mortgages. Once the sell-off started, it went very quickly to see the steep downhill. Since the read of the book, my preliminary attention focused on the next financial instrument and the signal of sell-offs. But probably the right question is, “What do we learn from the lesson before the next recession?” My answer is that we need to constantly remind ourselves of a lesson from Dr. Galbraith that there is no regulation to stop the recession.

The first shock came to the financial market on October 19th, 1989, better known as Black Monday. It was a Tuesday morning when I came to the office in the financial center of Tokyo where most eyes centered on the Tokyo Stock Exchange in Kabuki-cho. Dark and silent office in the morning was a rare look for me because usually traders of stock and bond sat before the terminal to start a deal at 9:00 am. That Tuesday was different. Only a few brokers came to the office and in almost empty office, I stood there for a while and saw the tossed chart of the stock market documents. Most people knew what happened to the financial market but there were a few people who actually had experience with it. Before the crash, even a week ago, securities traders boast new financial instruments such as junk bonds. The name of the product sounded a little irony that it is nothing but junk after the crash. No equity analysts talked about the sell-off during the analysts meeting to that day.

In 2000, the new crash brews the financial market again. People called it the dot-com bubbles because a lot of new IT-led companies such as Google, Amazon, and e-Bay drove the bull market with record initial public offering (IPO). Interesting enough that there were some people I knew intimately, who warned the fall of the stock market. One in particular was professor of Marketing at Georgia Institute of Technology, my business school. During the course in the winter quarter, he started his lecture with almost the same discussion, saying that the stock market hit the record high and would crash soon or later. A very few people in the classroom reacted to his statement but I still remember that professor alarmed his students with his solid theory. That was in 1992. The crash came in 8 years. Lehman Shock is another stage to see the shock. Wall Street was full of stories to tell us what was going on. Most people remember the new financial instruments of derivatives and sub prime mortgages.

There are some unnecessary questions to ask before the crash. Those questions sound interesting but most of the time valueless. The first question people ask is, “When does the next recession come?” Numerous reports and media have already warned us the there is a signal existent in the financial market to predict a fall. The historical figures suggest that the yield spread between short term bonds and long-term bonds reversed and then the fall comes. The three crashes were followed by the reversal yield spread. Therefore, the crash is about to happen in the near future. Economists can make a convincing argument to relate the statistical evidence to locate the pitfall of the financial market. The statistical analysis may suggest the timing of the fall with the accuracy of months or years. But this is not the right question. The crash will happen when it comes.

Some people may also wonder what will be the name of the crash. Which is the major driving force to trigger the fall in the financial market? This is not the right question, either. The memory of the Black Monday in 1987 is very vivid in my mind. There are some people I knew who were right in the middle of the crisis. The story is almost the same in the dot-com bubble and the Lehman Shock. In reference to this, the question of identifying the cause is also unnecessary for ordinary people to discuss. What is more important is that the recession has repeatedly come to us and what we should do consistently to prepare ourselves.

What do we need to ask then? Professor Galbraith mentions in his book that for a start, we need to understand the financial situation very clearly. The recession is inherent in the free market. The free market does not regulate any new financial instruments. As long as any forms of financial instruments exist or are born to aim at next speculative deal, the financial engineering is not the innovation such as product innovation. It is based on the speculative deal.

As long as financial market does not regulate the financial instruments to emerge, the only way to stop losing money lies on the responsibility of the individuals. The individuals must warn themselves that the business is cyclical, which cause the rise and fall of securities. At present time, the stock market sets the record high. If Dr. Galbraith is still alive, he would say that our memory in financial market is very short. Humans forget the past very quickly. A genus is behind the financial boom. The boom is a ghost, based on financial manipulation. Excessive involvement should not be done. With all cautions in mind, still some individuals lose on the market. Dr. Galbraith neatly describe with awe that it is only money we lose on the market. If we ask him about the recession, he would answer, “What people lose is just money. It is better than losing something more important. Read my book again.”

Taught marketing @ universities in Tokyo for a decade, ex-I-banker & mgmt consultant @ Kurt Salm (Accenture Technologies now), Georgia Tech educated