The Great Reflation: How Investors Can Profit from the New World of Money

Chapter 6. Financial Manias and Bubbles

[O]ne thing is certain, that at particular times a great deal of stupid people have a great deal of stupid money. ... At intervals, the money of these people—the blind capital, as we call it, of a country, is particularly large and craving; it seeks for someone to devour it, and there is a "plethora"; it finds someone, and there is speculation; it is devoured, and there is "panic."

—Walter Bagehot, "Essay on Edward Gibbon," 1856

As the Great Reflation worked its way through 2009 and into 2010, it was evident that numerous asset prices had risen so sharply that many investors were wondering whether we were in the early stages of yet another financial mania. Financial manias are seductive because they hold out the prospect of fast money for the nimble. However, they are bubbles and don't last. When they burst, as we learned in 2008 and 2009, they destroy untold wealth and have the potential to bring down the entire financial system.

Financial manias and bubbles, as Professor Kindleberger stated in his famous Manias, Panics, and Crashes,^[40] are hardy perennials and there is every indication that they will continue to be. All investors, or would-be investors, would be negligent if they did not make a serious effort to understand them, to recognize them, and to be ready to take action when they see the signs that they are getting out of hand. While such signs are always evident in a full-fledged mania, it is fascinating to note that almost everyone ...