Irrational Exuberance

I.INTRODUCTION:

Irrational exuberance means wishful thinking on the part of investors that blinds us to the truth of our situation (definition based on the book of Yale professor Robert Shiller) or can be simply understood as the overvalue/undervalue of the market because of irrational thoughts.

The word irrational and exuberance themselves are not new, but they are first combined and used by Mr. Alan Greenspan- former Federal Reserve Board Chairman in his comments on December 5th, 1996.

What interest me is that after Mr. Alan Greenspan's speech, the market did actually react according to what is called irrational exuberance. We can look at the table below to see the epidemic phenomenon in the market at that time:

Country Percentage decrease

Japan Nikkei index 3.2%

Hong Kong Hang Seng 2.9%

Germany DAX 4%

Britain FT-SE 100 4%

USA Dow

Jones Industrial Average 2.3%

These facts makes the words "irrational exuberance" quickly became Greenspan's most famous quote--a catch phrase for everyone who follows the market.

However, the situation in the market was not a downward trend as the table shows, actually the economy situation between 1994-1999 was very splendid, not to say wonderful.

- The Dow Jones Industrial Average stood at around 3,600 in 1994, by 1999, it had passed 11,000, more than tripling in five years.

- The stock market valuation in Germany, Italy, Spain and United Kingdom roughly doubled.

- Stock market in Asia (such as Hong Kong, Malaysia, Singapore, South Korea, Japan) also made spectacular gain.

Therefore, we have credence evidences to believe that sometimes, the whole market movement is just the surface of a more sophisticated problem, or say, that the movement is just fakely- created because of irrational decisions from a mass of investors.

As we all know economics is the study of allocating scare resources, forecasting market movement, and managing risk. However, to do all these functions, the economists need to understand the trend reaction of the majority of the market. That is why we need behavioral economics- a combination between psychology and economics.

In some situation, we cannot merely use mathematics functions, graph or curve to explain issues for example, these mentioned-above tool cannot explain neither why a student choose to go to university and waste a huge amount of money, instead of working right after graduating from high school (a matter of opportunity cost) nor can they explain why increasing welfare for the poor will reduce the productivity of the whole economy and can reduce the welfare in reality of the whole society, the same as why increase tax rate will reduce the tax revenue of the government and they even cannot give explanation to the failure of Hope Scholarship initiated by Bill Clinton in 1992 (the asymmetric information problem).

That is why I choose the topic Irrational Exuberance, I want to explain the economic events (especially the 1929 stock market crash) without much using calculators or the graphs, I want to explain them through psychological aspects. I want to look deeper into the underlying forces that make the market move around

II. THE STOCK MARKET CRASH:

1929 has gone into the history of USA and the world as the time of the most devasting crash in the history. It was also the beginning of The Great Depression on the whole world.

Anyone who bought stocks in mid-1929 and held onto them saw most of his or her adult life pass by before getting back to even.

Richard M. Salsman.

As we all know, at the end of World War I raise the curtain for new era of the USA. This was the era of freedom and abolishment of irrelevant moral. Woman can escape the small kitchen spaces and integrate with the fast-developed society outside. The rich confidently took money out of the bank and the mattresses to invest in the market- especially the stock market.

Below is the graph of the USA GDP through 1920-1940.

It shows the upward trending of gross domestic product between 1920-1929- and the peak was in 1929-above 800 billions of constant 1999- more than 9918 billions in today's value (with 1929 CPI: 17.1 and 2012 July CPI: 229.104). This was such a promising and splendid value for the future economy.

This record growth lured people to go to the stock exchange. Although stock market has had the reputation of riskiness, the exuberance in the community made people to believe that stock was safe assets and whatever happened they could get their return back.

More people rush to the stock market, and of course as demand increase the price will also increase. The first noticeable upward trend was in 1925. Stock prices then went up and down throughout 1925 and 1926, followed by a strong upward trend in 1927. The strong bull market enticed even more people to invest. And by 1928, a stock market boom had begun.

Stock market became a place for dream comes true. People believed that stocks could change their life and make them richer. And of course, the media also played an important role in propagating this exuberance. On Ladies Home Journal, people could found an article with a lucrative name "Everybody Ought to be Rich" by Samuel Crowther suggested that every American could become wealthy by investing $15 per month in common stocks (at a time when average American's weekly salary was between $17 to $22). The number of news about stock market increased day by day.

Year Number of article

1922-1924 29 articles

1925-1928 67 articles

1929-1932 182 articles

What was mentioned in the newspaper at that time: the story of a chauffeur, a teacher a famer became a millionaire in one night. Was it attractive? The history has given us an answer: Yes, it was. If your neighbor could earn more money by investing in the stock market why didn't you do so? If anyone asks me what is the most popular things in 1920s? I will not hesitate to reply that it was the stock tick. They are so pervasive.

That is where the problem begins. Everybody wanted to buy stocks but not all of them had enough money. The solution was "all margin". Meaning that the buyer would put