The Mania of Boom & Bust


The perception that we learn from our mistakes is just one in a long-list of cognitive and behavioural biases that exist in the human mind.

As WIRED reported in 2009, “Researchers from MIT have shown that the brain learns more after a success than a failure. This study indicates, contrary to previous research, that neurons in the brain are able to keep a memory of recent success and failures during learning and performed better after doing it right than after doing it wrong. The researchers found that after monkeys did something correctly, there were prolonged neural signals, which continued to fire until the next action, therefore affecting subsequent neural response. But after a wrong action there was less neural activity and no improvement in further attempts.

In essence, we are hard wired (understandably) to do more of what works, and less of what doesn’t… and the ‘memory‘ of the things that work move between generations through learning (hence why humanity exhibits gradual improvements in technology, language, capability and so forth) while the ‘memory‘ of what doesn’t can be forgotten.   It is this latter phenomenon, our  selective-memory (combined with our innate overconfidence) means that time and time again humanity repeats mistakes and behaviours causing (amongst other things) the repeated cycles of  economic boom, bubble and bust manifesting in market catastrophes such as Tulip Mania, The South Sea Bubble, The Panic of 1907The Wall St Crash of 1929 and the myriad of crises that have marred the world from the 1990’s to present day.

The impact of these events was severe enough within the ‘walled‘ economies of bygone times, but in the modern day connected and globalised world; economic crises and panics have far more severe consequences.

To learn more about the phenomenon of boom and bust within economies and to understand potential solutions and responses, we spoke with Dr. Bob Swarup, Founder of Camdor Global.

Bob is a respected international expert and commentator on financial markets, alternatives, asset–liability management, regulation and pensions. He was formerly a partner at Pension Corporation, a leading UK-based pension buyout firm with c. $10bn of assets under management, where he ran their investments in alternative assets, was the Chief Risk Officer and oversaw the Thought Leadership unit. In addition, Bob was a visiting fellow at the London School of Economics, setting up the Pensions Tomorrow research initiative; a member of the Advisory Board of Adveq, a leading European PE fund of funds with $6bn AUM; an Observer Member of the Board of CatCo, a $2bn reinsurance hedge fund that he helped seed in 2011; and a member of the CRO and Solvency II committees of the Association of British Insurers.

Bob is also the writer of the critically acclaimed 2014 book “Money Mania: Booms, Panics and Busts from Ancient Rome to the Great Meltdown.” (You can read the first chapter for free here).

Q: What have been some of the key financial bubbles and crises in history, and how have they impacted society?

[Bob Swarup] We always think of every crisis as being somehow different and unique to us. That is human myopia.  The reality is that the perennial pattern we see is universal and immemorial.

The first known sovereign default was in ancient Greece c.377 B.C when ten out of 13 Greek city states defaulted on their loans to the Temple of Apollo at Delos.  Fast forward two and a half thousand years, and you find modern Greece defaulting again in 2012!

On the face of it, every crisis is different – different eras, geographies, instruments, currencies, assets and so on. But this is only superficial. Underneath it all, they all involve people and a medium – money by any other name. The differences that do exist are about the story, with some being more memorable than others, because of the scale or idiocy of delusion in hindsight. The other difference that emerges is in their impact, with some being transient and great dinnertime anecdotes whilst others are far more scarring.

What crises actually do is expose the underlying fragility and structural flaws within an economy and society.  Some of this is endemic – financial markets are fragile because they are giant pools of sentiment and leverage at their heart. However, some of this is also self-inflicted and reflects poor planning and understanding on our part of the true complexity of an economy. If we don’t deal with these deeper issues (often born of our all too human myopia and ill thought incentives) and simply paper over the cracks, we can still get growth and a seemingly good life. But this is only for a while till the same problem comes back worse than ever.  Unfortunately, the latter is often what happens.

Throughout history, therefore, you see waves of crises building up to a crescendo, will a crisis of finance eventually becomes a crisis of society.  That is also usually when you have a debt crisis, rather than an equity crisis.

Boom and bust are different sides of the same natural phenomenon. They follow one another like night and day. If you take the example of the dotcom boom, there was enormous euphoria, which was built on entirely rational foundations. There was the notion circulating that you would have instant globalisation, hyper-growth, disruption to existing business models, enormous rises in the spending power of the consumer, and many other very good reasons that told you where growth was going to come from.  Everyone got seduced by the ease of making money and before you knew it, everyone had piled in… stock prices started soaring… and that became a bubble! However, as reality sank in that this was not going to happen all at once, that businesses still needed to compete and make money, that not every contender will succeed, and so on, valuations adjusted to a growing more humble reality. This was the bust and when that bubble burst, it was painful for investors. However, it wasn’t too bad for society.  In fact, society gained… We had amazing technological infrastructure, and the internet became a part of our lives.

Bubbles are driven by people piling into ideas now, that they think will make them lots and lots of money in the future.  The more people that pile in, the more quickly innovation can spread (that’s the good side). … But if the capital is misallocated? then when the money meets common sense, you get a bust.

It’s important to also note that when you get a big bust, it’s usually symptomatic of the fact that we have tried really hard to avoid it.  Boom and bust are part of natural business cycles. As humans, we have a natural volatility of emotion – we get happy and we get down. That ebb and flow of emotion is reflected in the markets and shows up in the ebb and flow of money and credit in an economy. This creates the business cycles we observe, the periods of growth, the recessions and so on.

There is nothing really so bad about a recession. A recession is very much an economy pausing for breath to re-evaluate where it stands and to assess where to go next.  You need downturns to allow an economy to reallocate capital, get rid of what is not working and move ahead.  That is creative destruction and it is a natural part of the capitalism we espouse. Of course, anyone who is in a bubble doesn’t want it to end.  We like to feel good, we like the idea of growth, progress is always an imperative… we keep trying to perpetuate the boom and the arguments become even more fantastical to justify our core primal biases.  But if we try to perpetuate markets for too long, the corrections can be far worse.

Q: What are your views on the spread of digital currency?

[Bob Swarup] Digital currency shows that anything can be money.  We have become accustomed to see money as paper or pieces of gold, but in truth it could also be stones, grain, wood, cigarettes or complex computer codes.  This is a pattern you see throughout history.  If you go back to medieval England, in 1100, King Henry I initiated a system of collecting taxes in the form of wooden sticks called ‘tallies’.  They took a stick, and cut notches into it- each representing a denomination (e.g. penny, shilling, pound, etc.) in a simple abacus-like methodology.  They then split the stick down the middle with the creditor keeping one half (the stock) and the debtor keeping the other half (the foil). The notches had to be aligned, making this an elegant way of avoiding fraud and allowing both parties to have a record. It was also an excellent example of human ingenuity, as there was an enormous lack of coin in medieval Britain at the time. Because Henry I decided he only wanted to accept sticks as payments for taxes, it soon became a widespread legitimate currency!  Before you knew it… people were running out to acquire tallies through barter, work and trade.  This system of wooden tallies lasted for seven centuries till the 1800s and became highly sophisticated. Once kings realised that tallies were widely accepted and that future taxes would be collected through them, they began to issue their own tallies in advance of these incoming revenues. This was a primitive form of government debt, where the tallies were sold at a discount to their face value – effectively a rudimentary form of interest.

The end of the story is also fascinating.  As the economy moved towards coins and paper over the centuries, tallies gradually fell out of favour and were removed from circulation in 1826.  All these ancient wooden tallies were stored in the Houses of Parliament- and it was eventually decided to burn them all because of the sheer volume built up over the centuries.  They stuffed the tallies into the furnaces in the basement of the Houses of Parliament. The next thing you knew, they had set fire to all of Parliament and reduced it to a smouldering wreck. It was not the first nor the last time that money had destroyed the system, though it’s unlikely that it had ever been so literal!

Digital currency is the latest incarnation of this phenomenon.  Money is a social construct.  The value you place on money is entirely down to the level of acceptance it has in society, and the level of sanction it has from institutions like the state and businesses.   Irrespective of how mathematical and perfect you make a currency- something that Bitcoin tried very hard to do- human emotions will overwhelm.  Once people have something to speculate with, and once people realise that they can make money, they will run in and exploit the countours of emotion they see about them.  We are always looking to gain status and get wealthier.

Money unites us as a society and gives us a common medium to transact with but it also divides us.  I can compare my pile of Bitcoins or Gold to YOUR pile of Bitcoins or Gold and I can immediately tell you if I’m richer or poorer than you…. and here we see the birth of the rat race and the social influence of money.

Q: Can we ever overcome the tension between stability and growth?

[Bob Swarup] The fundamental question people need to ask is what kind of growth they want and what stability they want.  People tend to want everything at once… they want to have their cake and eat it.

As a society, we chose capitalism as our preferred way of running an economy. We like capitalism, it allows everyone to have a chance to reach the top of the tree and seems almost meritocratic.  The thing is… you cannot have stability and growth to the N’th degree at the same time.  One of the things we’re seeing in Europe right now is the fact that we have people on one hand making banks hold more capital and undergo stress-tests, but also have people saying the banks need to lend more to individuals and small businesses.  You cannot have both.

Growth is a human imperative.  If we’re not moving forward, we’re unhappy.  If tomorrow I gave you a raise, and suddenly you were earning half a million dollars a year, guess what… a day or a month later you’ll begin to get despondent… This is now the status quo and you’ll want to earn more and progress.  This so called hedonic bias is immensely powerful and is a very strong motivator in an economy and throughout history.  This is why we have this obsession with GDP, if an economy is not growing, we get deeply unhappy.  We measure our response to every crisis by its impact on GDP but we never ask the fundamental question of what GDP really means and represents… and what we want from it!  Ultimately, it’s just a measure of spending.  I could go out in New York and have a great night out and blow a load of money on champagne and luxuries, or I could invest the same amount in a business… The two are not the same… you can spend the exact same amount of money on both- one is essentially a person having a great time and some trickle down to an economy, the other could have a significant multiplier effect and add value to the economy.  In GDP terms, however, they’re the same level of growth and so, we never look beyond the superficial to debate the quality of growth. I call this the fetish of GDP.

Looking at the 2007/9 crisis, people realised that you could use debt to fuel growth.  If you give people lots of debt, they will go out and buy more and more. That spending is great for GDP and growth. Eventually, however, you got a debt boom and bust.  This principle holds true for companies and governments- the fact is that our last major financial crisis began with housing debt.  Right now, we have debt bubbles in areas such as student loans in the USA and arguably sovereign debt.  This debt fuelled growth is easy and shows up fast in GDP. Organic growth is usually slower, more work to nurture and therefore, not as seductive.

Q: Are financial crises necessary?

[Bob Swarup] Schumpeter used to talk about creative destruction, he saw recessions and busts as a way of clearing out debris to enable new growth.  Another philosopher, Thomas Kuhn talked about the nature of revolutions in the same ilk.

Progress occurs in spasms, it doesn’t happen uniformly.  A good analogy is the phenomenon of forest fires.  The reason forest fires happen in nature is not always purely destructive… often it clears away old trees and dead wood, allowing young plants to get the sunlight and room to grow that they need…

Most progress is disruptive.  If you go back to the end of the 19th century, you had the bicycle boom.  The bicycle had just come out, it was the first mechanised transport that was getting popular and people predicted hyper-growth.  You were in a very chauvinistic world – the bicycle was also the first mechanical transport that a woman could ride… and so the market was twice as large.  People predicted a world with armies of bicycles and the end of the horse… the first roads in America were actually built to connect towns because they expected armies of bicycles travelling between them.  The car then came along and aborted the bicycle boom before it could live up to this fantasy. But it also literally paved the way for the car to succeed and I don’t think anyone would mourn the death of the horse and carriage industry…

You need to have periodical busts to shift vast quantities of misallocated capital into other areas of the economy.  If you have a bust, you force people to liquidate and put money elsewhere.

What does this mean?

Whether we like it or not, the phenomena of bubbles, booms, crises and busts are not just here to stay, but set to become more commonplace in our hyper-connected high-speed economy.

If we are to survive and defend our economic way of life, we have to embrace these as being what they are- circadian rhythms of human psychology, manifesting in groupthink and pack behaviour.

The bubble has burst, long live the bubble!

Thought Economics

About the Author

Vikas Shah MBE DL is an entrepreneur, investor & philanthropist. He is CEO of Swiscot Group alongside being a venture-investor in a number of businesses internationally. He is a Non-Executive Board Member of the UK Government’s Department for Business, Energy & Industrial Strategy and a Non-Executive Director of the Solicitors Regulation Authority. Vikas was awarded an MBE for Services to Business and the Economy in Her Majesty the Queen’s 2018 New Year’s Honours List and in 2021 became a Deputy Lieutenant of the Greater Manchester Lieutenancy. He is an Honorary Professor of Business at The Alliance Business School, University of Manchester and Visiting Professors at the MIT Sloan Lisbon MBA.