We all have our favourite financial crises which fascinate us by their dramatic sequence of events. Professor Galbraith was fascinated by the 1929-1933 Great Crash, which I also find to be infinitely intriguing. However, the panic of 1907 seems to me to be equally interesting, and perhaps closer to the panic of 2008.
Usually the great American economist, Irving Fisher, is quoted because of his views on the 1929 Crash, in which, through optimism he lost a fortune. There is no rule that great economists have to be successful speculators. A rather similar speculation by Maynard Keynes in the currency market nearly bankrupted him; he had to be bailed out by his father, an older and more cautious economist of the classical school.
In November of 1907, Irving Fisher wrote an anonymous comment in the Yale Review, which is worth quoting: “The recent sensational events in Wall Street have been the occasion of a great deal of discussion as to the present soundness or unsoundness of the industrial and commercial world, and as to the causes which have precipitated so sharp and sudden a panic. Among the causes assigned have been the character of the speeches of President (Theodore) Roosevelt and of Gov. (Charles Evan) Hughes (of New York), the will of ‘fringed finance’, the organisation and promotion of trusts, with their undigested securities and their arbitrary effects on prices, and the particular characteristics of the individuals and firms who have failed.”
This sounds very like the first debate on the causes of the 2008 panic. Various politicians, bankers and regulators have been blamed for the crisis, and some very foolish mistakes have indeed been made – it should have been seen that the failure to rescue Lehman Brothers would spread the contagion of panic, and for that mistake the Secretary of Treasury, Henry Paulson – himself an old Wall Street hand – must take a share of the blame.
Yet we are already moving into a second, and more serious debate on the underlying causes of the pause of our own time. Karl Marx has even been resurrected as a plausible expositor of the contradictions of capitalism, and interesting articles have been written about the explanatory value of Keynesian theory. Again it is worth while to read Irving Fisher’s commentary piece.
“While undoubtedly some of these (personal) factors have had an influence on the result, they have been merely precipitating causes and are of far less importance than the causes which for years have been making ready for present conditions. We refer to the progressive rise in prices due undoubtedly to the increasing supplies of gold.”
In the period before 2008, it was not the increase in the supplies of gold which was distorting the money supply, but a huge increase in debt of all kinds, national, corporate, banking and personal. This did not lead to any particularly large increase in the prices of consumer goods, but it did lead to an increase in asset values, and particularly in housing prices, where the high prices were financed by collateralised mortgage instruments. Eventually it also resulted in an almost vertical increase in the price of oil, accompanied by a similar rise in the price of gas.
Irving Fisher believed that a period of rising prices was likely to be followed by excessive debt and by unsound investment – the 21st century phrase is “irrational exuberance”. He believed that there had always been a link between the supply of money and the level of prices, and even quotes from the Frogs of Aristophenes to show that the ancient Greeks were aware of it.
“For your old and standard pieces valued and approved and tried, Are registered and abandoned for the trash of yesterday, For a vile adulterate issue, drossy, counterfeit and base which the traffic of the City passes current in their place.”
Fisher points out, in his book on The Purchasing Power of Money that the quantity theory of money was stated by the Roman author, Julius Paulus in about 200 A.D. and that is was accepted by Locke, Hume, Adam Smith, Ricardo, Mill, Walker, Marshall Hadley, Kemmerer, “and most writers on the subject”.
In 2008, the panic has occurred on a world wide scale. As in 1907, the immediate and apparent events have been “merely precipitating causes”, to use Fisher’s phrase. Inside a very short period of time, starting in mid September, banks had to close or merge in centre after centre around the globe. For a global crisis we have to look for general rather than local causes.
Already, Governments have discussed the possibility of a new global conference to stabilise world commerce and banking. The trouble is that neither Governments nor public opinions have any clear view of the questions, let alone the answers to them. Nor are there economists with the intellectual authority of Keynes or Fisher, or Friedman, though the United States have produced some Nobel Prize Winners and there are some first class bankers, who have been able to steer their own banks through the storm.
There is one question which has not been asked, but would have to be discussed before the world convenes a second Bretton Woods. The first Bretton Woods, much influenced by Maynard Keynes, adopted a system of fixed rate convertibility into the dollar, with margins of flexibility, while the dollar was itself convertible into gold. Since President Nixon terminated gold convertibility in 1971, the world exchange register has consisted of unconvertible paper currencies, floating in terms of each other. The eurozone is the exception in which European currencies have been merged with each other.
The question is, therefore, one of convertibility or non-convertibility. Is a non-redeemable paper currency inherently unstable? Did it cause the 2008 panic? Should a second Bretton Woods try to create a new global convertibility? Or is the global free float the best we can hope for?
for Markets and Money