The share-market gyrations this week were heartening indeed.
To see why, we should go back to a speech in the House of Commons by Robert Walpole on February 2, 1728.
“”The dangerous practice of stock-jobbing would divert the genius of the nation from trade and industry,” he said. “”It would hold out a dangerous lure to decoy the unwary to their ruin, by making them part with the earnings of their labour for a prospect of imaginary wealth.”
Nobody took any notice. The House of Commons permitted the South Sea Company to engage in an unsustainable scheme to take over public debt at a discount and issue stock which would pay a dividend to finance it.
Walpole again: “”The principle of the project was an evil of first-rate magnitude; it was to raise artificially the value of the stock by exciting and keeping up a general infatuation and by promising dividends out of funds which could never be adequate to the purpose.”
Despite the warning, the madness began. The stock rose from 130 to 300 in a day.
Other schemes, some fanciful and some seemingly sensible, were quickly floated. People bought and sold shares. The initial purchasers were not in the slightest way interested in the substance of the ventures — the manufacture or trade — but were only interested in talking up the share price to offload them to the really credulous who came in the second wave and third wave.
Eventually the South Sea bubble burst. Thousands lost fortunes, but many made them. Charles MacKay in his splendid 1841 book, “”Extraordinary Delusions and the Madness of Crowds,” summed it up: “”Knavery gathered a rich harvest from cupidity”.
Nothing much was learned. There was a further boom and bust in 1825. And in the 1840s the great railway expansion had its share of meritless schemes rumbustiously pushed to the credulous masses, who bought shares and got no dividends.
The 1880s bought property booms, especially in Australia, which inevitably turned to a bust in the 1890s.
And 40 years later the same thing happened. The share-market boomed through the late 1920s. In October 1929 the Dow Jones Industrial Average was 381. Three years later it was just 41.
Again in the 1960s we had the mining boom and the manic Poseidon and Tasminex booms when shares rocketed 20-fold only to collapse, taking fortunes with it. And a similar decline hit in 1974.
And in October 1987 overheated markets collapsed again.
So why am I heartened by this week’s events?
It is because I think the fundamentals are better. But I am not speaking Costellotalk here. The fundamentals are not inflation and the budget deficit. Rather they are fear and greed. I may be wrong, but this week’s events — in the grand scheme of things — show the balance between the fundamental economic forces of fear and greed is better than ever.
Most commentators are saying we will always have booms and busts. They say greedy people will panic to get in on the action and fearful people will ultimately cause a crash, and that greed or fear can sweep the whole financial community at once causing endless booms and busts.
I see it slightly differently and over a different time span. We have had about 280 years of capitalism since the Industrial Revolution. With it came the division labour, the separation of management and ownership, joint ownership by many through shares, and the ability to trade shares.
These things created abstract ownership and a distance between the owner and things owned. Before the industrial revolution a person laboured and consumed the things he produced. He could point to the things he owned and estimate their value. After the Industrial Revolution ownership was fragmented and abstracted.
The value of shares could not be easily assessed by reference to real assets. The only way they could be valued was by reference to what someone else would pay for it. In that climate fear and greed were more potent forces than sensible assessment, simply because the latter was barely possible.
But in the ensuing 280 years there have been trends towards assessment of the value of shares according to real worth against assets and away from assessing them according to what someone else might pay for them. As a result the breadth and depth of share-market crashes seem to be getting less serious.
Last week, for example, the bounce back and readjustment was very quick.
Many factors, both worldwide and those peculiar to Australia, seem to be having a smoothing effect. They all point to less reliance on rumour and the sentiment of the frenzied crowd.
Wider education is helping. Education breeds inquiring minds which are also questioning minds. There are still a lot of uneducated people to be duped and sharp unethical minds willing to dupe them, but it is a reducing proportion of the population. Greater education also means greater awareness of the true value of the assets behind the shares.
Mass communication helps. The more facts and comment are disseminated quickly through mass media, the more likely that people with silly black-and-white views of the world are disabused before their views take hold. More people have a better idea of what is going on in the wider economy. Also with more information, the quicker the bargain-hunters move back into the market.
Computerisation. This has enabled companies to maintain huge share registries of small holdings. It means more people are in the share market now and more of them have small holdings. They are more likely to keep and forget, rather than trade heavily.
We have far greater regulation than in the days of the South Sea Bubble or, indeed, the 1930s or 1960s. Insider trading is a crime. Prospectuses have to meet stringent requirements. Sure, not all investors read them, but they usually talk to someone who has. The Stock Exchange has improved its rules.
Tax changes in Australia have been very significant. We have swapped the tax emphasis from taxing dividends to taxing capital gains, so the incentive is not to sell thereby attracting tax. In the minor crash of 1997 the bulk of sales attracted capital gains tax and the bulk of dividends had very low levels of tax because they were franked. That results in greater incentive to stay in the market. In the 1980s and before it was the other way around. Most share sales did not attract capital gains tax and most dividends attracted full marginal-rate taxation. All the tax incentive was to sell as soon as prices started to fall; beyond that fear drove the price down further.
Also with many small holders getting attractive franked dividends, the incentive to sell is lower. Unlike big players, they have nowhere else to put their money without being hit with higher tax rates. Putting money in the bank is a joke for people on the top marginal rate.
The rise of superannuation funds has also stabilised the market.
Fewer people have borrowed to buy shares these days. Part of that it wariness following the lesson of 1987 (once again education and knowledge leads to greater stability). Also with present low inflation, the tax advantages of borrowing to buy shares are lower.
If you have borrowed to buy shares (as many more had in 1929 and 1987) and the market falls, your lender demands greater cash security. The only way to give it, of course, is to sell more shares, thereby further pushing the market down.
In all, fear and greed are being tempered by education and healthy scepticism and better tax and economic conditions, especially in Australia. In the US, it is less so, that is because the US is home to more new age drivel, credulism and fundamentalist religion than Australia. And note its share market has been more volatile than in Australia. The Dow has gone up 25 per cent a year for three years, but the mania is not there.
Markets will still fluctuate, but I think the tempering forces now are stronger than they have ever been in the history of capitalism. Sure, there is still plenty of lunacy and credulism about, but it is waning. Fewer people believe the earth is flat; that it was created in seven days or that huge fortunes can be made in a day on the back of some exaggerated venture.
Capitalism is maturing.