Excessive borrowing amplifies the impact of financial euphoria from "summary" of A Short History of Financial Euphoria by John Kenneth Galbraith
The financial world is a place where emotions often run high. When people see others making money, they want to get in on the action themselves. This leads to a sense of euphoria, a feeling that the good times will never end. It is during these times of heightened emotion that people tend to take on more debt than they can handle. They borrow money to invest in assets that seem to be going nowhere but up. This excessive borrowing can amplify the impact of financial euphoria, making the highs even higher and the lows even lower. In the midst of a financial boom, investors often believe that the rules of risk and reward no longer apply to them. They convince themselves that they are smarter than everyone else, that they have found the secret to making money in the markets. This overconfidence leads them to take on more and more debt, thinking that they can always pay it back later with their newfound wealth. However, when the inevitable crash comes, these investors are left scrambling to cover their losses. The problem with excessive borrowing is that it can create a vicious cycle. As asset prices rise, investors borrow more money to buy even more assets, driving prices even higher. This creates a feedback loop where euphoria begets more borrowing, which in turn begets more euphoria. However, when the music stops and asset prices start to fall, the cycle goes into reverse. Investors are forced to sell their assets to cover their debts, leading to even lower prices and even more panic selling. In the end, excessive borrowing can turn a mild downturn into a full-blown crisis. When everyone is leveraged to the hilt, a small decline in asset prices can trigger a cascade of selling that can quickly spiral out of control. This is why it is crucial for investors to maintain a healthy balance between risk and reward, to avoid the temptation to borrow more than they can afford. Otherwise, they may find themselves caught in the grip of financial euphoria, with no way out but down.
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