MANIAS AND CROWDS

The classic book on public manias is Extraordinary Poplar Delusions and the Ikdkss ofcrowds by Charles Mackay, originally pub- lished in 1841 and reprinted by Bonanza Books, New York (1980). There always seem to be one or more manias at large, but usually we can avoid individual harm by nonparticipation. Occasionally, however, a popular mania poses a risk even to nonparticipants.

Many manias involve animals. In 1890 it was short-homed cattle; thirty years ago, chinchillas; more recently, Suffolk sheep, then llamas, and now emus. A mania in Dorset sheep has also arisen.

From the famous tulip mania in Holland to the current United States stock market, these fads usually have one common characteristic - the prices being paid for the objects of the mania become discon- nected from the fundamental intrinsic values of the objects. In fact, sometimes the mania itself will actually reduce those intrinsic values.

The special Dorset sheep now selling for thousands of dollars each have been bred for a particular shape that is popular in the show ring. This shape includes a narrow body cavity that so reduces the food processing machinery of the ewes that they cannot raise their lambs successfully in a field of grass. They must be fed high-priced grain.

Stock market prices have now risen so high that the meager earn- ings and dividends of most of these investments no longer justify their prices. Popular opinion holds, however, that this does not matter, since capital gains from rising share prices provide a very handsome return. As long as there is a plentiful supply of greater fools who are willing to pay higher marginal prices, this investing for "capital gains" leads to profits. The capital gains are, unfortunately, artificial, since the earnings of most of the companies whose shares are being traded show that the intrinsic worth of their capital is far below current prices.

The price of a share of stock is set on the margin. Adjusted slightly by the mechanisms of the market, it is the price current buyers are willing to pay for the marginal shares of stock that sellers are willing to sell. Even in a rising market, there are not enough buyers at the marginal price to purchase all of the i.ssued shares. The more shares offered for sale, the lower the marginal price.

While tens of millions of investors regularly compute the value of their ' potiolios' by means of current prices, this value is an illusion. Only a very few of these investors could actually sell their shares for the current marginal price. Therefore, when the mania ends, most in- vestors will receive only a fraction of their calculated "worth." Those who have invested on margin - an increasing group as the mania continues - may receive nothing or even less than nothing and end in owing their broker additional money to close their accounts

A second common characteristic of manias is that, given the volatility and irrationality of crowds, it is almost impossible to predict how large the mania will grow. The higher it goes, the more traumatic and spectacular the fall when the mania ends. In an ordinary market, any decline is softened by the underlying intrinsic values. With these val- ues far below current prices, however, this softening effect is not effective until prices have fallen quite far.

Fear is a stronger emotion than greed, so markets tend to fall much more rapidly than they rise. We have no opinion on how high the stock market will go or how long this current mania will endure. As the ma- nia continues, however, the danger to everyone - investors and noninvestors - from its inevitable end is increasingly great.