We’re still dancing: How bubbles grow

In THERE ARE IDIOTS: Seven pillars of market bubbles, I gave seven phrases of timeless relevance for the origins of bubbles. Here, I ask what happens after the bubble has started; what keeps bubbles bubbling? I discuss seven more phrases:

1. We’re still dancing.
2. There’s a sucker born every minute.
3. A happy opportunity for ingenious mendacity.
4. Man is always a teller of tales.
5. Have fun staying poor.
6. Don’t fight the tape.
7. Ride the whirlwind.

1. “We’re still dancing.”

To have a speculative bubble, you need two things: something to trade and somewhere to trade it. You can’t have a Beanie Baby bubble in 1997 without a firm that makes Beanie Babies (Ty Inc.) and a trading venue (Ebay, among others).

Bubbles need institutions. In the tech-stock bubble, the institutions were mainly investment banks (underwriting IPOs) and growth funds (buying IPOs). In the crypto bubble of 2021, the institutions were mainly offshore crypto exchanges. Today, we see major financial institutions embracing crypto. How will it end?

Here’s Citigroup[1] CEO Chuck Prince in July 2007, echoing a famous passage in The General Theory where Keynes compares the stock market to a game of musical chairs:[2]

When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Prince was discussing lending to private equity, but it’s a classic dilemma: should institutions enable market bubbles that will probably end badly for their clients? That is, do institutions really have to get up and dance when the music’s playing?

Benjamin Graham thought underwriters behaved badly. Graham and Dodd (1934) said the wave of issuance in 1929 was “a wholesale and disastrous relaxation of the standard of safety previously observed by the reputable houses of issue.” Graham (1973) said the wave in 1969 was an “unprecedented outpouring of issues of lowest quality, sold to the public at absurdly high offering prices and in many cases pushed much higher by heedless speculation...the familiar combination of greed, folly, and irresponsibility.”

Let’s compare the actions of two large institutions as of today. Blackrock launched a highly successful bitcoin ETF in January 2024. In contrast, Vanguard has so far refused to enter the crypto space and will not even allow its customers to buy crypto ETFs offered by others.

Is Vanguard engaged in heavy-handed paternalism? Isn’t the customer always right? Perhaps not. Consider Vanguard's actions in 1999, when it saw inflows into the Vanguard Growth Index Fund:[3]

The company grew so worried that its customers were buying the growth fund for the wrong reason that it temporarily accompanied its prospectuses with a warning letter. As Jack Bogle uneasily admitted, Vanguard’s anxiety about the fund’s shareholders was justified. By December 2001, the fund had not only shed its previous gains, but it was suffering net redemptions.

Perhaps the lesson here is that fools rush in where Vanguard fears to tread.

Right now, one thing’s for sure. Blackrock is dancing. Vanguard remains seated, arms crossed, glaring at the DJ.

2. “There’s a sucker born every minute.”

Bubbles typically involve a wave of credulous buyers, an influx of inexperienced investors that I call The Fourth Horseman of the bubble. As P.T. Barnum supposedly said, there’s a sucker born every minute.

One bitcoin advocate, Matthew Sigel of VanEck, went on CNBC in October 2024 and justified his price target of $3 million for bitcoin as follows:[4]

… new buyers come into the market. Every day there’s new buyers being born.

Now, he didn’t actually use the word “suckers,” but perhaps that’s implied by his $3 million price target.

We observe waves of new entrants in stock market bubbles as measured by the opening of new brokerage accounts, including two recent bubbles in China and the 2021 U.S. bubble involving Robinhood customers. Greenwood and Nagel (2009) found that the tech-stock bubble was partly driven by inexperienced mutual fund managers, and they mention other historical examples:

Kindleberger (1979) argues that bubbles bring in “segments of the population that are normally aloof from such ventures.” Recalling the 17th century tulip bubble, Mackay (1852) reports that “even chimney-sweeps and old clotheswomen dabbled in tulips.” Brooks’ (1973) depiction of the stock market boom of the late 1960s is that “Youth had taken over Wall Street.”

When you see chimneysweeps touting bitcoin on CNBC, it’s time to sell.

3. “A happy opportunity for ingenious mendacity.”

Bubbles typically involve fraud and lots of it. Here’s Bagehot (1873):

The good times too of high price almost always engender much fraud. All people are most credulous when they are most happy; and when much money has just been made, when some people are really making it, when most people think they are making it, there is a happy opportunity for ingenious mendacity. Almost everything will be believed for a little while …

Kedia and Philippon (2009) find that “periods of high stock market valuations are systematically followed by large increases in reported frauds” and show that the tech-stock bubble was accompanied by a wave of accounting fraud. Some of this fraud was committed by actors that have since left the scene, such as Enron and its CEO Ken Lay, while some was allegedly committed by actors who remain in the spotlight, such as MicroStrategy and its founder Michael Saylor.[5]

Will today’s high crypto prices produce ingenious mendacity? So far, I’m seeing a lot of mendacity but not much ingenuity.

4. “Man is always a teller of tales.”

Shiller (2017) discusses how bubbles are powered by contagious narratives spreading through the population, and quotes Sartre:

A man is always a teller of tales, he lives surrounded by his stories and the stories of others, he sees everything that happens to him through them; and he tries to live his life as if he were recounting it.

Today’s economy is not about factories and farms; it’s about narratives and attention. And crypto has the ultimate narrative. Here are the main story elements:

• A decadent empire, corrupt and cruel (fiat currency and traditional banks).
• A leader with mysterious origins (Satoshi Nakamoto).
• Rebels fighting the empire, aided by mystical forces beyond human understanding (cryptography).

Crypto basically has the same plot as Star Wars, Dune, and The Matrix.

Most narratives eventually lose box office appeal, but for now, we’re living in the Bitcoin Cinematic Universe.

5. “Have fun staying poor.”

Shiller (2005) defines a bubble as “a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increases, and bringing in a larger and larger class of investors who, despite doubts about the real value of an investment, are drawn to it partly by envy of others' successes and partly through a gamblers' excitement.”

Let’s discuss contagion and envy. We see both elements in the quip by Kindleberger (1979) that “there is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.”

“Have fun staying poor” is a dismissive put-down made by bulls to denigrate bears. The phrase spreads contagiously via social media, and it is designed to trigger anticipatory envy in those who fail to buy. It communicates contempt for those too stupid, too old, or too cowardly to join the movement; they deserve to be poor.

Avoiding shame and derision is an age-old motive for participating in bubbles. Here’s poet Alexander Pope during the South Sea Bubble:

Let but Fortune favor us, & the World will be sure to admire our Prudence. If we fail, let’s e’en keep the mishap to ourselves; But tis Ignominious (in this Age of Hope and Golden Mountains) not to Venture.

Have fun staying ignominious.

6. “Don’t fight the tape.”

You might think that if an asset becomes overpriced, rational short sellers would enter. That’s not what happens in bubbles. Instead, we see the opposite: prices get crazy high and short sellers flee. For example, Lamont and Stein (2004) show short selling decreased during the tech-stock bubble.

Why do short sellers capitulate? Why don’t they fight the tape? Because of risk. Here’s Shleifer and Summers (1990):

As long as the arbitrageur is thinking of liquidating his position in the future, he must bear the risk that at that time stocks will be even more overpriced than they are today. If future mispricing is more extreme than when the arbitrage trade is put on, the arbitrageur suffers a loss on his position. Again, fear of this loss limits the size of the arbitrageur's initial position, and so keeps him from driving the price all the way down to fundamentals.

Crazy optimists create crazy price volatility, which scares away rational arbitrageurs. This dynamic explains why bubbles often involve high price volatility, and why bitcoin is both incredibly volatile and prone to bubbles.

What happens when you fight the tape? Nothing good. For example, betting on value and against growth in 1999 was a recipe for disaster, and many funds did not survive. The following passage from Lamont (2003) has a characteristically witty quote from someone who did survive 1999 and later prospered:

…it is clear in hindsight that NASDAQ was too high at 3000 in 1999. But anyone shorting NASDAQ then would have suffered severe losses as NASDAQ went to 5000 in March 2000. As hedge fund manager Cliff Asness has commented about short sale constraints, "Our problem wasn't that we couldn't short NASDAQ in 1999, our problem was that we could and did.”

He fought the tape, and the tape won.

7. “Ride the whirlwind.”

Bubbles can be magnified by rational investors who “ride the bubble,” the smart money that front-runs the dumb money arriving later. That’s the strategy suggested by George Soros, as quoted in Pedersen (2019):

When I see a bubble forming, I rush in to buy, adding fuel to the fire. This is not irrational.

Brunnermeier and Nagel (2004) show that hedge funds rode the tech-stock bubble, buying technology stocks between 1998 and 2000.

There is, however, a non-rational reason that sophisticated investors might buy: they just can’t resist. Consider this first-person account from Stanley Druckenmiller:[6]

So, I’ll never forget it. January of 2000 I go into Soros’s office and I say I’m selling all the tech stocks, selling everything. This is crazy …

So like around March I could feel it coming. I just – I had to play. I couldn’t help myself. And three times during the same week I pick up a – don’t do it. Don’t do it. Anyway, I pick up the phone finally. I think I missed the top by an hour. I bought $6 billion worth of tech stocks, and in six weeks I had left Soros and I had lost $3 billion in that one play. … I was just an emotional basket case and couldn’t help myself. 

“Ride the bubble” does not really capture the emotional rollercoaster induced by extreme price volatility. I think “ride the whirlwind” is a more apt phrase, as in Dickens (1841):

In the midst of thunder, lightning, and storm, many tremendous deeds have been committed; men, self-possessed before, have given a sudden loose to passions they could no longer control. The demons of wrath and despair have striven to emulate those who ride the whirlwind and direct the storm …

The idea that bubbles involve actual insanity has a long history. Consider the first bubble endured by the United States, the “Scripomania” of 1791. Here’s an account from Benjamin Rush, signer of the Declaration of Independence and physician, from Rush (1799):

The city of Philadelphia between the 10th and 11th of August 1791, will long be remembered by contemplative men, for having furnished the most extraordinary proofs of the stimulus of the love of money upon the human body … It excited febrile diseases in three persons who became my patients. In one of them, the acquisition of twelve thousand dollars in a few minutes by a lucky sale, brought on madness which terminated in death in a few days. The whole city felt the impulse of this paroxysm of avarice.

There you have it, friends. Do not ride the whirlwind, for it brings only madness and death.

Endnotes

[1] References to this and other companies should not be interpreted as recommendations to buy or sell specific securities. Acadian and/or the author of this post may hold positions in one or more securities associated with these companies.

[2] “Citigroup chief stays bullish on buy-outs,” The Financial Times, July 9, 2007.

[3] Rekenthaler, John. "Vanguard's Other Index-Fund Invention," Morningstar, May 27, 2022.

[4] “This is a very bullish setup for bitcoin into the election, says VanEck's Matthew Sigel,” CNBC, October 28, 2024.

[5] Norris, Floyd. “MicroStrategy Chairman Accused of Fraud by S.E.C.,” The New York Times, December 15, 2000.

[6] “Stanley Druckenmiller: My Biggest Mistake And What I Learned From It,” The Acquirer’s Multiple, July 9, 2018.

References

Bagehot, Walter. Lombard Street. 1873.

Brunnermeier, Markus, and Stefan Nagel. "Hedge funds and the technology bubble.” The Journal of Finance 59, no. 5 (2004): 2013-2040.

Dickens, Charles. Barnaby Rudge. 1841.

Graham, Benjamin. The Intelligent Investor, 1973.

Graham, Benjamin, and David L. Dodd. Security analysis: principles and technique. 1934.

Greenwood, Robin, and Stefan Nagel. "Inexperienced investors and bubbles." Journal of Financial Economics 93, no. 2 (2009): 239-258.

Kedia, Simi, and Thomas Philippon. "The economics of fraudulent accounting." The Review of Financial Studies 22, no. 6 (2009): 2169-2199.

Kindleberger, Charles P., Panics Manias, and Crashes. (1979).

Lamont, Owen A. "Comment on Perspectives on Behavioral Finance: Does ‘Irrationality’ Disappear with Wealth? Evidence from Expectations and Action" NBER Macroeconomics Annual 18 (2003): 200-207.

Lamont, Owen A., and Jeremy C. Stein. "Aggregate short interest and market valuations." American Economic Review 94, no. 2 (2004): 29-32.

Pedersen, Lasse Heje. Efficiently inefficient: how smart money invests and market prices are determined. Princeton University Press, 2019.

Rush, Benjamin. Three lectures upon animal life. 1799.

Shiller, Robert J. Irrational exuberance. 2005

Shiller, Robert J. "Narrative economics." American Economic Review 107, no. 4 (2017): 967-1004.

Shleifer, Andrei, and Lawrence H. Summers. "The noise trader approach to finance." Journal of Economic Perspectives 4, no. 2 (1990): 19-33.