Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger

There is no better way to set the stage for this book than by providing you with one of my all time favorite quotes:

History doesn’t repeat itself, but it does rhyme.

– Mark Twain

One book that gives detailed proof of this statement is the classic Manias, Panics, and Crashes: A History of Financial Crises by Charles P. Kindleberger. As explained by the subheading, the book is a collection and review of all financial crises that this world has experienced. Moreover, the book provides a very good overview of the stages and the common threads of these crises but also the lessons that can been drawn from them.

Although I’m not a top-down investor, staying away from macroeconomic analysis and forecasting, I still consider Manias, Panics, and Crashes one of the most important books to read as an investor. This is especially true if you have little or no real life experience of being an investor during a crises. As many times before, my thoughts about this subject has been influenced by one of my favourite investors, Howard Marks. Therefore, in connection to reading this book I urge you to read his memo ‘You Can’t Predict. You Can Prepare.‘ and especially note the following two paragraphs:

In my opinion, the key to dealing with the future lies in knowing where you are, even if you can’t know precisely where you’re going. Knowing where you are in a cycle and what that implies for the future is very different from predicting the timing, extent and shape of the next cyclical move. And so we’d better understand all we can about cycles and their behavior.

So forecasts are unlikely to help us foresee the movements of the economic cycle. Nevertheless, we must be aware that it exists and repeats. The greatest mistakes with regard to the economic cycle result from a willingness to believe that it will not recur. But it always does – and those gullible enough to believe it won’t tend to lose money.

– Howard Marks

Please comment if you have read the book and what you thought of it. Also, if you have found a worldly wisdom in the book that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.

Worldly wisdom’s from the book

1.

“The thesis of this book is that the cycle of manias and panics results from the pro-cyclical changes in the supply of credit; the credit supply increases relatively rapidly in good times, and then when economic growth slackens, the rate of growth of credit has often declined sharply. A mania involves increases in the prices of real estate or stocks or a currency or a commodity in the present and near-future that are not consistent with the prices of the same real estate or stocks in the distant future. The forecasts that the price of oil would increase to $80 a barrel after the earlier increase from $2.50 a barrel at the beginning of the 1970s to $36 at the end of that decade was manic. During the economic expansions investors become increasingly optimistic and more eager to pursue profit opportunities that will pay off in the distant future while the lenders become less risk-averse. Rational exuberance morphs into irrational exuberance, economic euphoria develops and investment spending and consumption spending increase. There is a pervasive sense that it is ‘time to get on the train before it leaves the station’ and the exceptionally profitable opportunities disappear. Asset prices increase further. An increasingly large share of the purchases of these assets is undertaken in anticipation of short-term capital gains and an exceptionally large share of these purchases is financed with credit.”

(p. 12)

2.

“ Financial arrangements need a lender of last resort to prevent the escalation of the panics that are associated with crashes in asset prices. But the commitment that a lender is needed should be distinguished from the view that individual borrowers will be ‘bailed out’ if they become over-extended. For example, uncertainty about whether New York City would be helped, and by whom, may have proved just right in the long run, so long as help was finally provided, and so long as there was doubt right to the end as to whether it would be. This is a neat trick: always come to the rescue, in order to prevent needless deflation, but always leave it uncertain whether rescue will arrive in time or at all, so as to instill caution in other speculators, banks, cities, or countries. In Voltaire’s Candide, the head of a general was cut off ‘to encourage the others.’ A sleight of hand may be necessary to ‘encourage’ the others (without, of course, cutting off actual heads) to participate in the lender of last resort activities because the alternative is likely to have very expensive consequences for the economic system.”

(p. 23)

3.

“A follow-the-leader process develops as firms and households see that others are profiting from speculative purchases. ‘There is nothing as disturbing to one’s well-being and judgment as to see a friend get rich.’ Unless it is to see a nonfriend get rich. Similarly banks may increase their loans to various groups of borrowers because they are reluctant to lose market share to other lenders which are increasing their loans at a more rapid rate. More and more firms and households that previously had been aloof from these speculative ventures begin to participate in the scramble for high rates of return. Making money never seemed easier. Speculation for capital gains leads away from normal, rational behavior to what has been described as a ‘mania’ or a ‘bubble.’”

(p. 29)

4.

“Yet euphoric speculation with insiders and outsiders may also lead to manias and panics when the behavior of every participant seems rational in itself. Consider the fallacy of composition when the whole differs from the sum of its parts. The action of each individual is rational—or would be if many other individuals did not behave in the same way. If an investor is quick enough to get in and out ahead of the others, he may do well, as insiders generally do. Carswell quotes a rational participant on the South Sea Bubble:

“The additional rise above the true capital will only be imaginary; one added to one, by any stretch of vulgar arithmetic will never make three and a half, consequently all fictitious value must be a loss to some person or other first or last. The only way to prevent it to oneself must be to sell out betimes, and so let the Devil take the hindmost.”

‘Devil take the hindmost,’ ‘sauve qui pent,’ ‘die Letzen beissen die Runde,’ (‘dogs bite the laggards’), and the like are recipes for a panic. The analogy is someone yelling fire in a crowded theater. The chain letter is another analogy; because the chain cannot expand infinitely, only a few investors can sell before the prices start declining. It is rational for an individual to participate in the early stages of the chain and to believe that all others will think they are rational too.”

(p. 47-48)

5.

“Speculative manias gather speed through expansion of money and credit. Most expansions of money and credit do not lead to a mania; there are many more economic expansions than there are manias. But every mania has been associated with the expansion of credit.”

(p. 64)

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The Teachings of Don Juan: A Yaqui Way of Knowledge by Carlos Castaneda

The expression “take it with a grain of salt” is relevant for most of the content in the book
that I have collected todays worldly wisdoms from. ‘Mumbo Jumbo’ and pure fiction is how I would describe the book. However, this book also has a number of worldly wisdoms that in my opinion is truly fantastic and something you won’t find in your typical everyday book. The worldly wisdoms that I present today comes from the book The Teachings of Don Juan: A Yaqui Way of Knowledge that was published by the University of California Press in 1968 as a work of anthropology. It was written by Carlos Castaneda and submitted as his Master’s thesis in the school of Anthropology.

In short, the book is a collection of notes from events and conversations that took place during an apprenticeship with a self-proclaimed Yaqui Indian Sorcerer, Don Juan from Sonora, Mexico between 1960 and 1965. Whether these events and conversations actually took place or the book is pure fiction has continuously been debated. Nonetheless, when you read the worldly wisdoms I present below I think you will find them magnificent and applicable to both how you approach investing and your everyday life. At least I did.

Please comment if you have read the book and what you thought of it. Also, if you have found a worldly wisdom in the book that you think I should have included please comment on that as well. I’m very interested in what caught your eye while reading and why.

Worldly wisdoms from the book

1.

“There is nothing wrong with being afraid. When you fear, you see things in a different way.”

(p.18)

2.

“A man goes to knowledge as he goes to war, wide-awake, with fear, with respect, and with absolute assurance. Going to knowledge or going to war in any other manner is a mistake, and whoever makes it will live to regret his steps.”

(p. 19)

3.

The second worldly wisdom is a whole conversation, so bear with me, between the apprentice and Don Juan regarding ‘enemies’ of  a ‘man of knowledge’. 

“When a man starts to learn, he is never clear about his objectives. His purpose is faulty; his intent is vague. He hopes for rewards that will never materialize, for he knows nothing of the hardships of learning. He slowly begins to learn – bit by bit at first, then in big chunks. And his thoughts soon clash. What he learns is never what he pictured, or imagined, and so he begins to be afraid. Learning is never what one expects. Every step of learning is a new task, and the fear the man is experiencing begins to mount mercilessly, unyieldingly. His purpose becomes a battlefield. And thus he has tumbled upon the first of his natural enemies: Fear! A terrible enemy – treacherous, and difficult to overcome. It remains concealed at every turn of the way, prowling, waiting. And if the man, terrified in its presence, runs away, his enemy will have put an end to his quest.”

“What will happen to the man if he runs away in fear?”

“Nothing happens to him except that he will never learn. He will never become a man of knowledge. He will perhaps be a bully or a harmless, scared man; at any rate, he will be a defeated man. His first enemy will have put an end to his cravings.”

“And what can he do to overcome fear?”

“The answer is very simple. He must not run away. He must defy his fear, and in spite of it he must take the next step in learning, and the next, and the next. He must be fully afraid, and yet he must not stop. That is the rule! And a moment will come when his first enemy retreats. The man begins to feel sure of himself. His intent becomes stronger. Learning is no longer a terrifying task. When this joyful moment comes, the man can say without hesitation that he has defeated his first natural enemy.”

“Does it happen at once, don Juan, or little by little?”

“It happens little by little, and yet the fear is vanquished suddenly and fast.”

“But won’t the man be afraid again if something new happens to him?”

“No. Once a man has vanquished fear, he is free from it for the rest of his life because, instead of fear, he has acquired clarity – a clarity of mind which erases fear. By then a man knows his desires; he knows how to satisfy those desires. He can anticipate the new steps of learning, and a sharp clarity surrounds everything. The man feels that nothing is concealed. And thus he has encountered his second enemy: Clarity! That clarity of mind, which is so hard to obtain, dispels fear, but also blinds. It forces the man never to doubt himself. It gives him the assurance he can do anything he pleases, for he sees clearly into everything. And he is courageous because he is clear, and he stops at nothing because he is clear. But all that is a mistake; it is like something incomplete. If the man yields to this make-believe power, he has succumbed to his second enemy and will fumble with learning. He will rush when he should be patient, or he will be patient when he should rush. And he will fumble with learning until he winds up incapable of learning anything more.”

“What becomes of a man who is defeated in that way, don Juan? Does he die as a result?”

“No, he doesn’t die. His second enemy has just stopped him cold from trying to become a man of knowledge; instead, the man may turn into a buoyant warrior, or a clown. Yet the clarity for which he has paid so dearly will never change to darkness and fear again. He will be clear as long as he lives, but he will no longer learn, or yearn for anything.”

“But what does he have to do to avoid being defeated?”

“He must do what he did with fear: he must defy his clarity and use it only to see, and wait patiently and measure carefully before taking new steps; he must think, above all, that his clarity is almost a mistake. And a moment will come when he will understand that his clarity was only a point before his eyes. And thus he will have overcome his second enemy, and will arrive at a position where nothing can harm him any more. This will not be a mistake. It will not be only a point before his eyes. It will be true power. He will know at this point that the power he has been pursuing for so long is finally his. He can do with it whatever he pleases. His ally is at his command. His wish is the rule. He sees all that is around him. But he has also come across his third enemy: Power! Power is the strongest of all enemies. And naturally the easiest thing to do is to give in; after all, the man is truly invincible. He commands; he begins by taking calculated risks, and ends in making rules, because he is a master. A man at this stage hardly notices his third enemy closing in on him. And suddenly, without knowing, he will certainly have lost the battle. His enemy will have turned him into a cruel, capricious man.”

“Will he lose his power?”

“No, he will never lose his clarity or his power.”

“What then will distinguish him from a man of knowledge?”

“A man who is defeated by power dies without really knowing how to handle it. Power is only a burden upon his fate. Such a man has no command over himself, and cannot tell when or how to use his power.”

“Is the defeat by any of these enemies a final defeat?”

“Of course it is final. Once one of these enemies overpowers a man there is nothing he can do.”

“Is it possible, for instance, that the man who is defeated by power may see his error and mend his ways?”

“No. Once a man gives in he is through.”

“But what if he is temporarily blinded by power, and then refuses it?”

“That means his battle is still on. That means he is still trying to become a man of knowledge. A man is defeated only when he no longer tries, and abandons himself.”

“But then, don Juan, it is possible that a man may abandon himself to fear for years, but finally conquer it.”

“No, that is not true. If he gives in to fear he will never conquer it, because he will shy away from learning and never try again. But if he tries to learn for years in the midst of his fear, he will eventually conquer it because he will never have really abandoned himself to it.”

“How can he defeat his third enemy, don Juan?”

“He has to defy it, deliberately. He has to come to realize the power he has seemingly conquered is in reality never his. He must keep himself in line at all times, handling carefully and faithfully all that he has learned. If he can see that clarity and power, without his control over himself, are worse than mistakes, he will reach a point where everything is held in check. He will know then when and how to use his power. And thus he will have defeated his third enemy. The man will be, by then, at the end of his journey of learning, and almost without warning he will come upon the last of his enemies: Old age! This enemy is the cruelest of all, the one he won’t be able to defeat completely, but only fight away. This is the time when a man has no more fears, no more impatient clarity of mind – a time when all his power is in check, but also the time when he has an unyielding desire to rest. If he gives in totally to his desire to lie down and forget, if he soothes himself in tiredness, he will have lost his last round, and his enemy will cut him down into a feeble old creature. His desire to retreat will overrule all his clarity, his power, and his knowledge. But if the man sloughs off his tiredness, and lives his fate through, he can then be called a man of knowledge, if only for the brief moment when he succeeds in fighting off his last, invincible enemy. That moment of clarity, power, and knowledge is enough.”

(p. 35-37)

4.

Anything is one of a million paths. Therefore you must always keep in mind that a path is only a path; if you feel you should not follow it, you must not stay with it under any conditions. To have such clarity you must lead a disciplined life. Only then will you know that any path is only a path, and there is no affront, to oneself or to others, in dropping it if that is what your heart tells you to do. But your decision to keep on the path or to leave it must be free of fear or ambition. I warn you. Look at every path closely and deliberately. Try it as many times as you think necessary. Then ask yourself, and yourself alone, one question. This question is one that only a very old man asks. […] I will tell you what it is: Does this path have a heart? All paths are the same: they lead nowhere. They are paths going through the bush, or into the bush. In my own life I could say I have traversed long, long paths, but I am not anywhere. Does this path have a heart? If it does, the path is good; if it doesn’t, it is of no use. Both paths lead nowhere; but one has a heart, the other doesn’t. One makes for a joyful journey; as long as you follow it, you are one with it. The other will make you curse your life. One makes you strong; the other weakens you.

(p.46)

5.

The fourth worldly wisdom is a follow-up conversation between the apprentice and Don Juan regarding how to find a path with “heart”, presented in the third worldly wisdom.

“But how do you know when a path has no heart, don Juan?”

“Before you embark on it you ask the question: Does this path have a heart? If the answer is no, you will know it, and then you must choose another path.”

“But how will I know for sure whether a path has a heart or not?”

“Anybody would know that. The trouble is nobody asks the question; and when a man finally realizes that he has taken a path without a heart, the path is ready to kill him. At that point very few men can stop to deliberate, and leave the path.”

“How should I proceed to ask the question properly, don Juan?”

“Just ask it.”

“I mean, is there a proper method, so I would not lie to myself and believe the answer is yes when it really is no?”

“Why would you lie?”

“Perhaps because at the moment the path is pleasant and enjoyable.”

“That is nonsense. A path without a heart is never enjoyable. You have to work hard even to take it. On the other hand, a path with heart is easy; it does not make you work at liking it.”

(p. 71-72)