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Financial Lessons from the Eruption of Mt. Tambora
Bubbles, Herds, and Climate Change
The latest issue of Investing in Financial History is a teaser for an article that will appear in the Summer 2023 issue of the Museum of American Finance’s Financial History magazine. The article, which is co-written by one of my former clients, Elliot Chambers, details the Panic of 1819 and explains several lessons that remain relevant today — especially those relating to pressures on the banking system. This newsletter covers a few different lessons that are just as relevant.
America’s First Real Estate Bubble
“The demand for lands since the 1st July seems as great as ever; all payments are made in the Mississippi Stock — which is sold at 25 percent discount…the demand for lands is so great I have not time within office hours to attend to my returns or books.”
Nicholas Gray, Land Office Clerk (1816)
On April 10, 1815, Mount Tambora, a volcano located in the islands of Indonesia, exploded in what was later determined to be the largest volcanic eruption in recorded history. The volcano ejected an estimated 31 cubic miles of rock and ash, claiming at least 70,000 lives. But the impact on the climate was far more deadly and disruptive. The volcano injected an enormous cloud of sulfur dioxide into the upper atmosphere, which repelled sunlight and temporarily cooled the earth by an estimated one degree Fahrenheit (~0.5 degrees Celsius). The maximum impact hit in the Summer of 1816, which was dubbed the “Year without a Summer.” Crop yields collapsed throughout the world, creating a shortage of agricultural commodities and sharp rise in prices – especially for wheat and cotton.
European farmers were hit especially hard, and they relied heavily on imports to feed their citizens. In comparison to Europe, the U.S. experience was less catastrophic, but it was still painful. New England was especially hard hit due to the harsher effects of cold weather in the northern latitudes. Thousands of farmers responded by selling their land and heading west. The attraction was two-fold. First, they could purchase larger tracts of farmland. Second, crop prices, especially wheat, had risen by nearly 25% by the end of 1816, and more than 50% by the end of 1817. The combination of larger fields and higher prices seemed like the ultimate win-win situation. Figure 1 shows the massive increase in land sales using Washington County in the state of Mississippi as a sample.
America’s First Great Depression
“The bank bubbles are breaking . . . the merchants are crumbling to ruin, the manufacturers perishing . . . there seems to be no remedy but time and patience, and the changes of events which time affects.”
President John Quincy Adams
Global cooling caused by the Mount Tambora eruption was intense but short-lived. Unlike carbon dioxide, sulfur dioxide naturally dissipates from the atmosphere within a few years. By 1818, sulfur dioxide levels returned to pre-eruption levels and global temperatures normalized. Owners of Midwestern farmland suddenly found themselves in a dreadful situation. Many had taken on massive loans to purchase land at prices that could only be justified if crops sold at elevated prices for many more years. Instead, the combination of strong harvests and massive expansion of farmland created an enormous global oversupply, which caused prices to plummet. By 1820, wheat prices declined by approximately 60% relative to 1817 prices.
The decline of agricultural commodity prices triggered a collapse in U.S. land values as farmers and speculators adjusted their revenue forecasts. At the same time, the Second Bank of the United States, which began operations in 1817, reversed many of its lending policies to stem the erosion of its dwindling reserves. This caused a sharp reduction in the money supply, which intensified the economic contraction. The combination of commodity price declines, collapsing land values, tight monetary conditions, and highly indebted landowners was too much for the nation to bear. There was no single moment that marked the beginning of the Panic of 1819, but the financial misery that followed rivaled anything that the nation had experienced before. This is why the early 1820s are best described as America’s first Great Depression.
Lessons from the Eruption of Mt. Tambora
The eruption of Mt. Tambora occurred more than 200 years ago, but many lessons remain just as applicable today. Several lessons will be detailed in the Summer 2023 issue of Financial History magazine, but a few that are not covered are provided below.
Lesson #1: The Danger of Herd Behavior
“That’s the dilemma we face. Over the next 15 years, instead of having these beautiful fields and orchards [alternative assets] to ourselves, there’s going to be a lot more money and a lot more competition. One has to predict that it’s going to be much tougher for endowed institutions to preserve their performance advantage.”
Laurie Hoagland, CIO of the Hewlett Foundation
Humans exhibit a strong herd instinct. This bias was hard-wired into our brains over the course of hundreds of thousands of years because it was critical to our survival. When tribes identified an attractive resource, neighboring tribes benefited by following their lead. For most of history, the human population was sufficiently small to allow followers to benefit as much as early arrivers. But the herd instinct does not work in the investing world. In fact, it produces the opposite result because when followers flock to new investments, the price increases and quickly exceeds its intrinsic value. Early adopters may benefit from undiscovered investment opportunities, but followers are virtually guaranteed to come up short.
The herd behavior of farmers and speculators in the 1810s differed little from the herd behavior of investors in the 2000s. Dot-com stocks, residential real estate, cryptocurrencies, NFTs, and now AI stocks are all examples of the same phenomenon. For institutional investors, it is also the cause of massive increases in alternative asset allocations that have, in aggregate, produced disappointing results. In 2008, Laurie Hoagland all but predicted this outcome.
Lesson #2: The Danger of Dueling with Time
“Their delusion lies in the conception of time. The great stock market bull seeks to condense the future into a few days, to discount the long march of history, and capture the value of all future riches. It is his strident demand for everything now — to own the future in money right now — that cannot tolerate event the notion of futurity — that dissolves the speculator into the psychopath.”
James Buchan, Author of the Meaning of Money
The above quote was used to describe the behavior of participants in the Mississippi Bubble. This epic catastrophe occurred in France from 1717 to 1720, and it is often regarded as the greatest asset bubble in all of history. Many catastrophic financial errors can be attributed to investors’ attempts to cheat the unforgiving flow of time. In fact, one of the most distinguishing attributes of history’s best investors — the Hetty Greens and Warren Buffetts — is their ability to align their investment behavior with the flow of time. In other words, they are patient. They understand that successful investing is more like watching paint dry than hitting the jackpot on a slot machine. In contrast, participants in asset bubbles often suffer from a desire to compress the time required to turn a little money into a lot. Speculators in Midwestern real estate in the 1810s differed little from speculators in whatever the latest investment fads are in the 2020s. This is why there will likely be many more losers than winners in the latest fads, such as cryptocurrency and AI stocks.
Lesson #3: Buying Time with Sulphur Dioxide Emissions
“Solar radiation modification (SRM) is a potential complement to other tools available to address climate change: mitigation of greenhouse gas emissions, removal of carbon dioxide (CO2) from the atmosphere, and adaptation to existing and expected changes to climate. SRM offers the possibility of cooling the planet significantly on a timescale of a few years.”
Congressionally Mandated Research Plan and an Initial Research Governance Framework Related to Solar Radiation Modification (June 2023)
The last lesson comes with a huge caveat because is based on a rather extreme and undesirable proposal. While it may have merits, it is also accompanied by a lot of uncertainty and is by no means an ideal solution. Nevertheless, it is worth mentioning because it could be used to buy humanity time as the world reduces carbon emissions.
Most Americans now acknowledge that the world is rapidly warming and that CO2 levels are the most important driver. Thus far, however, countries are not moving fast enough to reduce CO2 emissions. Over the next several decades the race between the forces of nature and human ingenuity will determine how much the world warms and at what level it will plateau.
The long-term solution to climate change must involve sharp reductions in fossil fuel emissions (or innovations to remove it from the atmosphere). But given the slow pace of progress, the world may need to consider alternative tactics to buy time. In June 2023, the White House released a congressionally mandated report that explored the use of Solar Radiation Modification (SRM) to slow climate change. One potential tactic is to replicate the effects of a major volcanic eruption by injecting large amounts of sulfur dioxide into the upper atmosphere. This may seem farfetched, but the impact of the Mount Tambora eruption demonstrated that it would likely work — and it would work fast. That said, scientists are far from determining whether it is logistically and financially feasible. And even if it is feasible, the side effects may be unbearable. For example, sulfur dioxide produces acid rain and could deplete the ozone layer. Uncertainties aside, the fact that the experience of the Mount Tambora explosion may contribute to a solution to one of the most pressing problems for humanity in the present reveals why it is important to retain the memories of human experiences far beyond our lifespans.
More Lessons to Come…
Elliot Chambers and I look forward to sharing the article that provides more detail and lessons from the Panic of 1819. The Summer Issue of Financial History will be available online in August 2023. Stay tuned!
Malcolm J. Rohrbrough, The Land Office Business: The Settlement and Administration of American Public Lands, 1789-1837 (London: Oxford University Press, 1968).
“This Day in History: Mount Tambora Explosively Erupts in 1815,” National Oceanic and Atmospheric Administration, April 10, 2020.
Malcolm J. Rohrbough, The Land Office Business: The Settlement and Administration of American Public Lands.
Andrew H. Browning, The Panic of 1819: The First Great Depression (Columbia, MO: University of Missouri Press, 2019).
Lawrence E. Kochard and Cathleen M. Rittereiser, Foundation and Endowment Investing. (New York: John Wiley & Sons, 2008), 73.
James Buchan, Frozen Desire: The Meaning of Money. (New York: Rain Publishers, 1997), 111
OSTP. (2023). Congressionally Mandated Research Plan and an Initial Research Governance Framework Related to Solar Radiation Modification. Office of Science and Technology Policy, Washington, DC, USA.