Charles Mackay’s 1841 classic “Extraordinary popular delusions and the madness of crowds” established the truth that crowds communicating with one another through the media can make “mad” decisions, in investment and other areas. Modern social media have immeasurably increased the amount and intensity of such communication; there are clear signs that it has also increased the irrationality of investment and other decisions.
The advent of the Internet intensified the flow of insanity-making information, but only moderately. The dot-com bubble of 1999-2000 bore considerable resemblance to several previous market bubbles. As in 1929, shoe-shine boys were touting the latest Internet stocks. As in 1929 and 1968, the valuations of market-favored stocks rose beyond any level justified by business prospects. A bizarre loss-making Internet retailer, that had never made a profit in any quarter of its existence, attained a market capitalization of $30 billion – how mad can the market get?
Of course, that was not the highest market capitalization of that bubble – JDS Uniphase reached a market capitalization of over $100 billion, around 1,000 times its earnings. Nemesis came rapidly, as you will remember – JDSU was trading down 98.7% from $153 to $2 within two years of the peak. On the other hand, that absurd $30 billion loss-maker was Amazon (NASDAQ:AMZN). So even we contrarian bears, level-headed and sensible though we may be, cannot be right all the time!
Since 2000, the flow of information to gullible investors has increased, in amount and more particularly in intensity. The triggering invention was that of the smartphone in 2007. Before the smartphone, people got their flow of information from computer screens, generally in ordinary amounts such as newspaper articles or their on-line equivalent. The smartphone not only increased the frequency and intensity of communication, it also dumbed down its content, so that instead of even poorly considered articles, people were soon getting information on 140-character “Tweets” – about the most information that could conveniently be read on a normal smartphone screen.
The software quickly adapted to meet the new hardware. Twitter and Facebook would not have had anywhere near their current ubiquity had it not been for the smartphone – there was no real technological advantage for Facebook over its predecessors Friendster and MySpace, but the medium on which Facebook pages was displayed was new, allowing people to browse Facebook during their inevitable periods of travel downtime, when an ordinary computer screen would not have been available. Similarly, Twitter was a great deal more addictive on the tiny cellphone screen than it would have been on an ordinary PC.
The combinations of cellphones and social media appears to have become unusually ubiquitous and unusually immersive – the manufacturers of these products attempt to make them psychologically addictive, and they seem to have succeeded. Furthermore, the universe of users has spread far beyond the traditional computer nerds to include almost the entire population (including the indigent, interestingly) apart from a few determined old fogeys like myself. (I can’t see the screens properly, and I always press the wrong keys on cellphones’ tiny keyboards – also, more important, I don’t like the damn things tracking me.)
Now consider the new technologies’ effect on markets. We know from Mackay that investors have a tendency to irrational enthusiasm, especially when as at present the monetary authorities have pursued a foolishly loose money policy. Asset prices soar skywards, and the most speculative assets soar the most. Before 1999, this effect was self-limiting – smart investors like Joseph P. Kennedy were savvy enough to know that if the shoe-shine boy is giving them stock tips, the market has probably got ahead of itself. Within a matter of months in 1929, the Joseph Kennedys with their greatly superior resources were able to place their bearish bets, and profit from the market’s collapse, or at least get out at the top (as did Sir Robert Walpole in 1720).
Now however with social media, the reinforcing effect of the shoe-shine boys may be sufficiently great as to overwhelm the Joseph Kennedys, for months and maybe for years. The success of the “bros” irrationally pushing up the price of Gamestop (NYSE:GME) until the major hedge fund that was shorting it as overvalued had to liquidate at a huge loss is an indication that the market’s normal checks and balances, preventing irrational exuberance from going too far, have ceased to work.
Another example of social media inflating the madness of crowds, the crowds being both larger and madder, is the entire existence of the crypto-currency market, in which entirely imaginary assets, riddled with fraud (look, for example, at the missing assets underlying Tether, supposedly a $1 “stablecoin”) can soar in value to be worth $2.1 trillion, as I write this. Without social media, crypto-currencies would have been a harmless diversion; with them, they are already approaching the market capitalization of the largest quoted companies. The ability of cryptos to survive for 12 years without the bubble bursting, or even being deflated more than temporarily, is a shining example of the market distortions wrought by social media.
There is a cost to bubbles and crashes; indeed there are two different types of cost. First, the deflation of the bubble causes bankruptcies among those who have invested in it, and the larger the bubble, the more widespread the bankruptcies and the greater their economic cost. The Great Depression was not solely caused by the 1929 crash – appalling government policies were to blame for at least 80% of the 10-year depression that followed in the United States – but the deflationary effect of the crash and its associated bankruptcies was itself highly economically damaging, causing the downturn until at least late 1931 when lousy policy took over.
The last major lurch downwards in 1932 and the failure to recover quickly in 1933-39 were due to lousy government policies, not the crash, but crashes provide excuses for lousy government policies. The 1929 crash caused the lousy government policies of Presidents Herbert Hoover and Franklin Roosevelt. More recently, the 2000 crash caused the lousy monetary policy instigated by Fed Chairman Alan Greenspan in his last years and was at least partly responsible for the appointment of the foolish Ben Bernanke to succeed him, against the strong advice of this column. Then the 2007-08 crash caused the blizzard of excessive regulation by the Obama administration, as well as the fatuous and damaging “QE” policies of the Fed during those years. Now the 2020 crash, or crashlet, has caused even worse monetary and fiscal policies to be adopted, and there is no sign whatever of any improvement, at least before 2025.
Social media causes bigger bubbles, and bigger bubbles cause larger bankruptcies and even worse policies to be adopted by subsequent governments (because the bubbles and their deflation discredit sensible free-market policies and embolden the leftist quacks pushing foolish destructive ones). Thus, there can surely be no question that social media is causing direct economic costs far in excess of its largely imaginary benefits. If consumers get a craving for a damaging product or service through marketing, the profits from providing that product or service may be enormous, but the true effect on economic welfare is sharply negative.
Banning social media directly is probably impossible; in any case, if the ubiquitous smartphones remained, the social media would re-emerge in another form. Fortunately, there is an alternative, generated by our desperate need for new revenue to balance the budget. The smartphones themselves should be subject to a really large monthly usage tax, perhaps around $250 per month (which might be partially offsetable against the Earned Income Tax Credit, so avoiding it falling unduly heavily on those of the impoverished who need their smartphones for business). Ordinary “dumb” cellphones without Internet access, like the brick I used to carry round in the 1990s, would be unaffected, so mobile communication would still be possible.
This would go a long way to balance the budget and would restrict smartphone usage to the rich and those for whom they are an essential business tool. As a result, only a small percentage of the population would be subjected to social media, its profitability would be decimated, and its ubiquity and addictiveness would disappear. Such a policy would be very unpopular, but unlike Prohibition it would be difficult to evade if implemented carefully.
The result would be less speculation, calmer stock, housing and other markets, and a richer and happier people.
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)