The Four Pillars of Investing by William J. Bernstein

Author:William J. Bernstein
Language: eng
Format: epub
Publisher: McGraw Hill LLC
Published: 2023-08-15T00:00:00+00:00

FIGURE 10.1 South Sea Company share price, 1719–1722

Source data: Neal, The Rise of Financial Capitalism

A tangle of ruined credit sprawled over the country like a vast, overgrown beanstalk, withering. The gentleman in Exchange Alley who said he had bilked his cabman “on account of having been bilked himself” stands for a universal picture of default. . . . The whole system of credit which had gradually grown up with the expanding economy since the middle of the previous century had suddenly collapsed.9

Previously abundant cash vanishes and becomes society’s most precious commodity: think Josephson’s “unimpaired capital” and Buffett’s stash of T-bills. Suddenly deprived of credit to purchase supplies and pay employees, businesses crumble in a chain reaction that spreads to suppliers and produces mass unemployment. Eventually banks collapse in a vicious cycle of self-reinforcing credit evaporation and commercial destruction.

As Carswell alludes, the situation in 1720 England was especially dire. Its sophisticated financial system, born after the 1689 Revolution Settlement and 1694 founding of the Bank of England, was just a generation old. Many worried about a permanent plunge back into the preceding medieval poverty and civil war. This fear’s most recent incarnation was the “new normal” meme that followed the 2007–2009 financial crisis.

Minsky’s criteria for bubbles, alas, work just as well in reverse. A generalized loss of faith in the once-fashionable new technologies to cure the system’s ills combines with a liquidity contraction to produce economic catastrophe. By that point, the knowledge that recoveries follow collapses has, like the memory of preceding bubbles, also fallen victim to amnesia. Finally, investors incapable of doing the math on the way up do not miraculously acquire the ability to recognize bargains on the way down.

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