The Frenzy of the Crowd — The Trap Called a Bubble

Until now, we have followed the deceptions of individuals: those who feigned false oracles, the alchemists who promised to make gold. There was always a single ‘one’ who did the deceiving. But the fraud we are about to examine has no clear ringleader. The line between deceiver and deceived blurs, and the crowd itself grows feverish — this is a bubble. In seventeenth-century Holland for a flower bulb, in eighteenth-century Britain for a single share certificate, people paid impossible prices. Then, one day, all at once, they came to their senses, and everything crumbled. In this chapter, through two cases of groundless surge and collapse, we examine the structure of the trap known as crowd psychology.

A House for a Single Flower — Tulip Mania

Seventeenth-century Holland was one of the wealthiest commercial nations in the world. The East India Company brought riches, and surplus funds began to accumulate among its citizens. There, a single flower carried in from the direction of Turkey became an unexpected object of speculation. The tulip.

Especially prized were varieties whose petals were streaked with flame-like patterns. Among them, the finest bulb, called ‘Semper Augustus,’ the eternal emperor, was reportedly traded in Amsterdam for enough to buy a small house. Records of the time note cases in which a single bulb fetched many times an artisan’s annual income. Not to admire the flower, but in the belief that it could be sold tomorrow for more, people scrambled to buy bulbs.

Here appears the first characteristic of a bubble. The price becomes detached from the thing’s intrinsic worth. The tulip itself remained, as ever, merely a flower. Yet the expectation alone — ‘everyone wants it,’ ‘tomorrow it will rise higher’ — drove the price upward. Precisely because no one wished to take a loss, they kept buying. A game of musical chairs from which no one could step down swept across the entire country.

Then, in February 1637, the end arrived abruptly. In the trade at Haarlem, it is said, one day there were suddenly no buyers. When one person sells, the next grows anxious and sells too. The moment ‘everyone’s expectation’ — the very thing propping up the price — collapsed, prices crashed within just weeks. The bulb that yesterday was worth a whole house had returned to being merely a flower.

A Frenzy That Engulfed a Nation — The South Sea Bubble

Whereas the tulip mania was a frenzy over a flower, the ‘South Sea Bubble’ that struck Britain some eighty years later involved a far larger contrivance. The stage was the nation’s finances themselves.

The South Sea Company was established in 1711. Its ostensible purpose was a monopoly on trade with the direction of South America. But the company’s true role lay in assuming Britain’s swollen national debt. In exchange for taking on the government’s borrowing, the company gained privileges and the expectation of future profit. Before long, people grew intoxicated by the story that holding this company’s shares would bring immense wealth.

In 1720, the share price rose in a fever. According to the records, the price, which at the start of the year had been in the range of a hundred pounds per share, is said to have leaped to a level exceeding a thousand pounds by summer. Everyone rushed in, unwilling to be left behind, and speculators who had seen the South Sea Company’s success launched one flimsy new company after another to raise funds. Among them, records note, were even ventures with no substance at all, soliciting investment while refusing to disclose what their business actually was.

Here too, the structure was the same as the tulip mania. Few coolly examined how much profit the company’s actual business might generate. What people bought was not the business but the story of ‘forever rising.’ And the moment that story ceased to be believed, the share price that had exceeded a thousand pounds collapsed by year’s end to the range of a hundred pounds. Many investors lost their fortunes, and it became a great affair in which Parliament launched an inquiry.

Why Do People Buy What Everyone Else Buys?

Setting the two affairs side by side, it becomes clear that a bubble is not a matter of individual foolishness. The person who bought tulips and the person who bought South Sea shares may, by the standards of their time, have been behaving rationally. ‘Everyone is buying. The price keeps rising. If I do not get on board now, I will lose out’ — that judgment, taken in isolation at that one moment, was by no means absurd.

Here lies the heart of the trap of crowd psychology. People are creatures who, rather than judging value alone, take the behavior of those around them as a guide. The mere fact that many people are buying itself breeds the illusion of ‘safety.’ It must be sound, since everyone believes in it. Yet the foundation of that reassurance was a hollow consensus, one in which others were likewise thinking only that ‘everyone believes in it.’ When everyone takes others as their grounds, there is no true ground anywhere.

And as we will see in the chapters ahead, such a frenzy of the crowd transforms into more deliberate fraud. The tulip and the South Sea Company had, at least, a real flower and a real enterprise. But if people buy only the story of ‘forever rising’ — then, so long as that story can be prepared, might one not gather people even without any substance? Pay dividends to those who entered earlier with the money of those who entered later, and perform an act of prosperity. To that perilous notion, in the twentieth century, one man would give an unmistakable name. If the bubble was a natural frenzy of the crowd, what comes next is the story of one who sought to design that frenzy on purpose.