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There’s an interesting new preface to Charles Kindleberger’s The
World in Depression, 1929-1939 by U.C. Berkely
Economics Professors Brad DeLong and Barry Eichengreen
over at vox. It argues we’re making many of the same
mistakes today as were made 80 years ago and they note three key lessons as
detailed below.
First, panic. Kindleberger
argued that panic, defined as sudden overwhelming fear giving rise to extreme
behaviour on the part of the affected, is intrinsic
in the operation of financial markets. In The World in Depression he
gave the best ever “explain-and-illustrate-with-examples” answer
to the question of how and why panic occurs and financial markets fall apart.
Kindleberger was an early apostate from the
efficient-markets school of thought that markets not just get it right but
also that they are intrinsically stable. His rival in attempting to explain
the Great Depression, Milton Friedman, had famously argued that speculation
in financial markets can’t be destabilising
because if destabilising speculators drive asset
values away from justified, or equilibrium, levels, such speculators will
lose money and eventually be driven out of the market. Kindleberger
pushed back by observing that markets can continue to get it wrong for a
very, very long time. He girded his position by elaborating and applying the
work of Minsky, who argued that markets pass
through cycles characterised by self-reinforcing
boom, next by crash, then panic, and finally by revulsion and depression. Kindleberger documented the ability of what is now
sometimes referred to as the Minsky-Kindleberger
framework to explain the behaviour of markets in
the late 1920s and early 1930s – behaviour
about which economists otherwise might have arguably had little of relevance
or value to say. The Minsky paradigm emphasising the possibility of self-reinforcing booms and
busts is the organising framework of The World in Depression. It
then comes to the fore in all its explicit glory in Kindleberger’s
subsequent book and summary statement of the approach, Mania, Panics and Crashes.
Kindleberger’s
second key lesson, closely related, is the power of contagion. At
the centre of The World in Depression is the 1931
financial crisis, arguably the event that turned an already serious recession
into the most severe downturn and economic catastrophe of the 20th century.
The 1931 crisis began, as Kindleberger observes, in
a relatively minor European financial centre,
Vienna, but when left untreated leapfrogged first to Berlin and then, with
even graver consequences, to London and New York. This is the 20th
century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously. In 1931 they spread
through a number of different channels. German banks held deposits in Vienna.
Merchant banks in London had extended credits to German banks and firms to
help finance the country’s foreign trade. In addition to financial links,
there were psychological links: as soon as a big bank went down in Vienna,
investors, having no way to know for sure, began to fear that similar
problems might be lurking in the banking systems of other European countries
and the US. In the same way that problems in a small country, Greece, could
threaten the entire European System in 2012, problems in a small country,
Austria, could constitute a lethal threat to the entire global financial
system in 1931 in the absence of effective action to prevent them from
spreading.
This brings us to Kindleberger’s third lesson, which has to do with
the importance of hegemony, defined as a preponderance of
influence and power over others, in this case over other nation states. Kindleberger argued that at the root of Europe’s
and the world’s problems in the 1920s and 1930s was the absence of a
benevolent hegemon: a dominant economic power able and willing to take the
interests of smaller powers and the operation of the larger international
system into account by stabilising the flow of
spending through the global or at least the North Atlantic economy, and doing
so by acting as a lender and consumer of last resort. Great Britain, now but
a middle power in relative economic decline, no longer possessed the
resources commensurate with the job. The rising power, the US, did not yet realise that the maintenance of economic stability
required it to assume this role. In contrast to the period before 1914, when
Britain acted as hegemon, or after 1945, when the US did so, there was no one
to stabilise the unstable economy. Europe, the
world economy’s chokepoint, was rendered rudderless, unstable, and
crisis- and depression-prone. That is Kindleberger’s
World in Depression
in a nutshell. As he put it in 1973:
“The 1929 depression was so wide, so deep and
so long because the international system was rendered unstable by British
inability and United States unwillingness to assume responsibility for stabilising it in three particulars: (a) maintaining an
open market for distress goods; (b) providing counter-cyclical long-term
lending; and (c) discounting in crisis…. The world economic system was
unstable unless some country stabilised it, as
Britain had done in the nineteenth century and up to 1913. In 1929, the
British couldn’t and the United States wouldn’t. When every
country turned to protect its national private interest, the world public
interest went down the drain, and with it the
private interests of all…”
Though I enjoyed and highly recommend Mania,
Panics and Crashes: A History of Financial Crises, I’ve not read
this account of The Great Depression that, according to DeLong and Eichengreen is told mostly from a European point of view.
That oversight is now being corrected via Amazon’s One-Click ordering.
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