James d. Gwartney

Video:
How to Recognize Investment Fraud
For as long as money has existed, people have schemed to take it away from each other
by fraud. New products and fast-moving markets are tempting to investment fraudsters—for
example, there are many bitcoin frauds. In some cases they offer a free bitcoin giveaway for a
small registration fee. Other scams set up fake bitcoin exchanges, and offer very competitive
prices which lull investors into thinking they are getting a good deal.
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It is important to
educate yourself about how to spot fraudsters; Rule 3 above is a good starting point.
We have discussed fraud extensively, but even transactions that are legitimate in a legal
sense may be very bad investments. History is full of “bubbles” when irrational thinking that
the price of something that has gone up a lot is bound to continue to do so has had disastrous
results. In the early 1600s, speculators in Holland drove the price of a single tulip bulb to over
six times average annual incomes. A perhaps apocryphal story tells of the despair of a man
who came home and found that his cook, not familiar with the tulip, thought it was a new kind
of onion and put it in that evening’s soup. Few bubbles could match the technology stock
bubble of the 1990s. The introduction of the Internet triggered a massive wave of speculation
in “New Economy” businesses, and as a result, hundreds of dot-com companies achieved
multi-billion dollar valuations as soon as they went public. The United States NASDAQ
Composite, the exchange where most of these dot-com companies were traded, soared from a

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level of under 500 at the beginning of 1990 to a peak of over 5,000 in March 2000. The index
crashed shortly thereafter, plunging nearly 80% by October 2002 and triggering a United
States recession. Investments need to be based on an asset’s real useful value, not an
unjustified assumption about the future.

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