Galbraith Warns of Stock Speculation Bubble
John Kenneth Galbraith
Here are excerpts from a seminar conducted by John Kenneth Galbraith, Paul M. Warburg Professor of Economics Emeritus, at Harvard University, at the Nieman Foundation December 9, 1998
I was here as a very young instructor when the Nieman Fellows first arrived. The Milwaukee Journal gave the money, hoping or expecting that Harvard would have a school of journalism. But the Harvard reaction, well, it was mixed. First, they wanted the money; but, second, they didn't want a school of journalism. That was widely felt, at that time, that a school of journalism at Harvard would be deeply undignified. So the Nieman Foundation was created much in the form that still exists. The senior professors at Harvard paid no attention to it. Those of us who were much younger and not concerned with protecting Harvard's dignity showed up as part of the audience.
I still have a memory of [Erwin Canham], the head of The Christian Science Monitor telling about one of the great crises at The Monitor. The Monitor, in its early and in its deeply committed days, did not allow the word "death" to appear in the paper, because that was inconsistent with the Christian Science commitment to life. A terrible fuss developed in the First World War, when the Christian Science Monitor correspondent told of a great cavalry charge on the Western Front, which left the whole battlefield covered with the remains of passed-on horses. That created difficulty for readers [until] the wonderful discovery that The Monitor could use the word "death," as long as it wasn't for human beings. You see how deeply, in those days, we got into the intricate problems of journalism.
A Warning About the Stock Market
I shall not give you another Harvard length lecture tonight. I'll surrender to your particular interests and questions. But I might just say a word about the economic situation of our times. I have had a long-time interest in the whole question of economic fluctuation, called by the nicer members of my profession "the business cycle," the succession of periods of extreme optimism and periods of recession and depression. This has been, for hundreds of years, part of the history of what used to be called capitalism, and what now we more neatly refer to as the market system. We've severed our connection with that word, "capitalism," because that has a nasty connection with Marx and signifies that capital might have a dominant role in the system.
Be that as it may, this is a system which has a built-in instability, which in good times attracts participants who bid up values in a mood of optimism. That mood produces the increase in price for real estate, but particularly for securities, that justifies the expectation. The process then repeats itself. It's a simple fact of life, the speculative bubble, but it's something that, on the whole, economists ignore, the fact that the optimism that attracts people to real estate or securities markets shoves up the price, justifies the expectation, and then the process continues until you run out of optimism, you run out of the means to sustain it, something else intervenes, and you get the inevitable breaking of the bubble.
One of the great facts of our time is that there is still, in the investment structure, in the stock market, a commitment to what we should call, "the speculative bubble." The possibility that bubble will break is something that everybody should have in mind.
There's one thing that should warn everybody. If you forget everything else tonight, remember this, that when you hear someone say, "We have entered a new era of permanent prosperity," then you should immediately take cover, because that shows that financial idiocy has really taken hold and that history, all history, is being rejected.
I once spent some months of my life on the 1929 crash. And in a way, I'm grateful. That book, which I wrote, which was published in 1955, has been in print ever since, because every time it was about to go out of print we had another crack-up and the book was saved. I learned, I must say, a lot from writing that history. I did it up at Dartmouth, and it was such a marvelous introduction to mass insanity. I finished it, published it. It was, for a couple of weeks, on The Times bestseller list, which has an enormously adverse effect even on the best character--you never go by a bookstore again without looking in the window to see if it's there. It very rarely is.
In those days, I was often in New York. In the old LaGuardia terminal, there was a small bookstore. Going by that, I would stop and look in the window to see if the book was there, and it never was. One night I had quite a little time to spare, so I went into the bookshop and wandered around. The lady who was in charge finally said to me, "Are you looking for something?" I was ashamed of myself. Here is a Harvard scholar looking for his own book. But I was there, so I said, "Well, as a matter of fact, I am. I kind of forget the author's name." But then I decided I had to come in hard on the title. I said, "I remember the title. It was 'The Great Crash.'" She looked at me solemnly, wiped a tear from her eyes, and said, "Not a book you could sell in an airport."
This all comes to mind because we have been enjoying, we've been seeing, a period of strong stock market speculation, we have seen the rush into the more dubious, the more questionable, and sometimes the more insane, of the subsidiary investment opportunities in the stock market, including hedge funds, for example, run by two Nobel Prize winners. You can see it every day, some reference to "a new era of permanent prosperity." This is the commonplace of what is called the speculative, the financial mind. The "great financial mind" rarely survives the market.
In 1929, two or three did. Joe Kennedy, the father and the founder of the Kennedy family, was deeply in the market in the 1920's, and got out. That is the basis of the Kennedy fortune to this day. The other great figure of that time was Bernard Baruch, who also went on to manifest interest in political and government matters. Baruch got out in 1929, in that summer, with a nice heap of millions, in a day when a million dollars really counted for something.
This is the warning of the present time. We had a slight indication of that in August and September. It's a warning that everybody should have in the back of her or his head. The effect of the speculative collapse is something which economists have not yet, even to this day, fully appreciated, because it is not the collapse that causes the trouble, but the further effect on investment, and also the further effect on consumer spending.
A very large part of our present consumer spending is based on debt creation, credit cards, or the impression given by stock market gains or real estate gains. If and when the end comes, the economic effect will be the drying up, the slump, in consumer expenditure and, of course, the economic effects of that.
I don't make any firm predictions, because I've discovered over the years that my wrong predictions are wonderfully remembered and my right predictions are always forgotten. But as you leave these pleasant precincts here in Cambridge next year, do take with you one slight note of gloom growing out of the discussion tonight.
Q.& A.
The Asian Collapse
Q. -- There's a great debate sort of going back and forth on whether the Asian collapse and the problems in Brazil are affecting the markets here. How do you read all that?
A. -- The cause, the source, of the Asian collapse, well, there are two. The Japanese stagnation, which has perhaps the strongest effect, and has had a marked effect on Japanese imports from the West and also from Western Canada. It was the collapse of a speculative bubble, both in the Japanese stock markets and in the real estate market. At the peak of the bubble, the full value of real estate, the aggregate value of real estate in Tokyo alone, was greater than all the real estate values in the United States --an enormous speculative bubble. When that collapsed, there was one good effect in Japan, a cleansing effect as regards incompetent or speculative bankers and corporate management. Joseph Schumpeter, who for many years was a member of the Department of Economics faculty, a dominant figure when I arrived here in the 1930's, spoke, always very favorably, of this cleansing effect, which he called "creative destruction," the cleaning out of incompetence.
There's something to that. The South Asia situation was, as I understand it, somewhat different. In Thailand, Indonesia and Malaysia, and, in substantial measure, South Korea, it was the product of optimistic amateurs. The enthusiasm of a new country, newly arrived with the market system, for the speculative possibilities, coupled with the fact that they got some advice --wonderfully wrong advice --from the United States and from the West on deregulation, leaving things to the market, assuming that the market could do nothing wrong.
This was a seed bed for incompetent bankers, reckless bankers, incompetent and reckless corporate chiefs, and incompetent, in the case of Indonesia and elsewhere, and corrupt government. A situation on the whole quite different from the problem in Japan, again with natural effect on exports to that part of the world, although less spectacularly clear than in the case of Japan. The effect of Japan on Oregon, Washington, on lumber and paper, on into British Columbia, was much clearer.
World Capital Markets
Q. -- George Soros has argued that the deregulation of international capital markets is going to lead to greater and greater instability. Do you agree with that view? And if that is a problem, can we solve it multilaterally.
A. -- I would have some agreement with that. Deregulation certainly had a clearly adverse effect in South Asia. Also, there is a case for a better knowledge and possibly a better control of international capital movements. I have come reluctantly to what is called the Tobin Tax, by which you use the tax system to identify and, if necessary, control international capital flows, which can have a developmental aspect, but can also have a destabilizing effect. This is a long way from acceptance, however, because in the financial world there are a large number of people who would rather accept poverty than common sense.
Globalization
Q. -- You're talking about speculative bubbles, which I think fundamentally are about irrational consensus. And I'm wondering how, or whether, you relate that notion to the popular notion of globalization, as expressed in the media very often as something that we should just accept, because it's inevitable and it's good for us anyway, so please sit down and don't talk about it.
A. -- I'm not sure I got the question.
Q. -- Just wondering if you would talk about the notion of globalization, whether you relate it to the sort of irrational consensus that underlies a speculative bubble in the market?
A. -- Let me make two points. First, I would like, as a major effect of the year you spent at Harvard, that you would go home and not use the word "globalization." It's an adverse piece of junk in the English language. I've been, for many years, an advisor on English usage to the American Heritage Dictionary, and I've vetoed "globalization," its improper usage. But I accept the closer association on trade and finance between the industrial countries. That is basically a good thing. In my lifetime, the explosion of national sentiment by the righteous call of patriotism has been part of the source of the two great disasters of that lifetime, World War I and World War II. And the knitting together of countries by economic effect is one of the things that, in the last half of the century, has reduced that danger. It was very acute through World War I, for example, in the nationalist rivalry that was culminated by the steel companies in Germany and Japan. There was a little bit of that still surviving in World War II, but the development of international trade and international association and international finance, and, I would add, the United Nations, has limited, in some measure, that threat.
So, I'm prepared to accept the degree of economic uncertainty and some degree of international speculation as the unfortunate result of a larger good fortune. I don't know whether or not I answered your question or not, because I didn't understand the question.
Rich-Poor Gap--1
Q. -- The gap between the poorer countries of the world and the richer countries seems to be getting bigger. And I wondered if you could share with us your thoughts on what multilateral institutions like the IMF and World Bank should be doing, and what your opinion is of what they are doing to try and narrow that gap, or at least create development in those countries.
A. -- This is probably the most pressing matter of our time. The increasing difference, as between the poor countries and the countries of general economic well-being, the continuing of a persistent difference there, which has also its internal manifestation. The differences in income within the fortunate countries, and particularly in the United States. The darkest aspect of the American economy is the large number of people, particularly in the great cities, but some of them lost in the rural South and the Appalachian Plateau, who live at or below the poverty line. That's an inequality that is greater than in any other country and which, unfortunately, is getting worse.
The answer in the two situations is quite different. The problem between the poor countries and the rich countries requires a flow of capital and a flow of talent to the poor countries. This is something we recognize, but are not doing on a large enough scale. The sort of things which the World Bank is doing, which the Scandinavian and other European countries have been doing, needs to be much enhanced.
There's another step that is extremely important here, and which has far too little recognition. A very large part of the problem of poverty, particularly in Africa, is the result of bad government. Nothing is so important for economic development as stable, honest government. In the great period of decolonization, this was one of the things that didn't come about. If one went back to the last century in the United States or Canada, you would have encountered every day emphasis on the importance of stable government, on the importance of honest government, for its economic effect. This is something we've lost sight of in the new countries. I just did a paper for the UN on this, which I wondered for a time whether they would publish or not, saying that we must have an international mechanism which replaces sovereignty, righteous as that seems, when the effect of sovereignty is to protect cruel, incompetent, depressive government. We take for granted that a country can be sovereign even though it's destroying its own people. And this is something that the international community must increasingly recognize. I thought it would be nice to publish this in a UN publication, and they published it. Maybe they didn't read it. There are two other things. One I've mentioned --to maintain the kind of flow of resources the World Bank and the other countries have been putting in, including our own economic aid program. These are important and need always to be pressed and increased. The other thing concerns particularly the IMF. When a country is in trouble, as in South Asia, the IMF policies are admirably designed to increase poverty. It bails out the bankers, it bails out the corporations, it enforces tight restrictions on government expenditure, and the people that suffer, the unemployed and the people who are dependent on government for welfare, are the people that are hurt. For a poor country, there is no misfortune like having to pass into the hands of the IMF. I think we need the IMF, but I would like to see far more of its resources used, for example, for unemployment compensation. And if it's going to help the banks, it should help the banks by insuring depositors. Instead of that, the IMF helps the people who are the greatest cause of the thing that it is seeking to remedy.
China's Economy
Q. -- Do you have anything to say about China's economy?
A. -- Not beyond what everybody knows. We had two great Communist economies in the years after World War II, that of China and that of the Soviet Union. Both found that Communism, comprehensive socialism, was unworkable. The Russians, the Soviet Union, yielding to a certain amount of Western advice, assumed there was a magic in capitalism, and that this whole structure could be dismantled overnight, This most unfortunate error of economic terms --that there could be shock therapy and capitalism would assert its magic in a short time is one of the most disastrous concepts in the history of economics. The Chinese, similarly escaping from the strictures and compression of mass socialism, went at the process gradually, step by step, and have made a much greater success of it. A difference between day and night. I regret the extent to which the Chinese have kept control of free speech, kept control of public expression and political action. But on the other hand, I don't feel entirely pessimistic about that. I think we're seeing that one shouldn't be totally pessimistic. As the Chinese economy improves, which it is, as the improvement spreads, there will be the inevitable thing, which is the counterpart of economic development, namely the bringing into existence of more people in technical positions, advisory positions, in education, in management, and, above all, in journalism, of course, the bringing into existence of more people who, as a practical matter, cannot be kept silent, who command voice. There is, in other words, an association between economic development and economic well-being, and intellectual and vocal expression. This comes about, I repeat again, partly by the will of people, and the idea of free expression, but partly because, above a certain level of well-being, you simply have more people than you can keep quiet. I'm disposed to think that China, although I'm certainly not competent to be a spokesman on China --I've been there two or three times --I'm inclined to think that that process is under way in China. Maybe that is an unduly optimistic comment, but I very much hope that is the case.
Rich --Poor Gap-2
Q. -- I want to go back to the statement you made about the two economies in America. You've got the very rich, you've got a nation that's increasingly very rich and very poor. What is the long-term consequence of that? Is our increasing poverty going to negate economic growth or permanent stability?
A. -- I would hope the long-term effect of it would be a much sharper recognition of the fact. The two answers are each indispensable. One is something that could well be afforded, a basic income for all people, enough to keep all people out of poverty. We talk a great deal about freedom. Nothing so denies a person freedom as a total absence of money. This is one of the most repressive things that there is. And I am an advocate, and I've long been an advocate, of a basic income, which, as I say, we can well afford, and I would, needless to say, like to see it coupled with the associated public services, namely education, health care, and housing. Going along with that, we should have continued and strong use of the progressive income tax. Nothing so measures progress as a few screams of anguish from the very rich. One of the great developments of the last 100 years came from a Republican president, President Taft, namely the progressive income tax. I would like to see you all advocate, in your country or in the United States, the enormous effect of the progressive income tax on individual enterprise. Nothing stirs people to effort so much as the need to protect their after-tax income. Make that point editorially, constantly, consistently.
How Papandreos Was Saved
Q. -- I am from Greece and I would like to ask a Greek question, if you allow me. Could you a say a few words about Andreas Papandreos, who was trained at Harvard?
A. -- He was a great friend of mine. We were together here at Harvard and were in touch throughout his lifetime. I visited him in Greece on a couple of occasions, and got credit for saving his life. This is a personally self-serving story. Word came on the television one night --it was still a military government --that he was to be executed. Our telephone rang all that night with calls from academicians around the country. California, where he'd been chairman of the department of economics, Minnesota, where he'd been on the staff, and my colleagues at Harvard here, where he'd been a student, asking what could be done about it. I had access to Lyndon Johnson, but we had broken on the issue of Vietnam. About 10 or 11 o'clock at night I decided that I must try to break through this difficulty that LBJ and I were having. I called the White House and he was still up. He was just back from [Chancellor Konrad] Adenauer's funeral in Germany. I got a hold of somebody in the White House, who got the message to Johnson. I went to bed, thinking I had done everything possible, and the telephone then rang, and it was Nicholas Katzenbach, who had been attorney general and had just moved to the State Department. He read me the most wonderful and typical Lyndon Johnson memo I had ever heard. Literally, I remember it all. It was, "Call up Ken Galbraith and tell him that I have told those Greek bastards to lay off that son of a bitch, whoever he is." I got out of bed, put in calls to Andreas's old colleagues across the country, and somebody gave the story to Newsweek, and Newsweek published the story with the key words blanked out. Papandreos was in a jail outside of Athens, a motel that had been ringed with barbed wire, and he was allowed a visitor. The American visitor said, "I don't know whether you saw this week's Newsweek, I just got it, maybe you need something to read," and left the Newsweek. And he discovered that he wasn't going to be executed from that story in Newsweek.
Unequal Pay for Women
Q. -- Women currently earn 25 percent less, on average, than men do in this country, given the same level of experience and training and education. What do you think can be done to equalize pay between men and women in the U.S.?
A. -- Well, I must say that's an issue to which I've never given the attention I should. But I was an early supporter of the women's movement. Gloria Steinem is one of my life-long friends. She was here for my birthday party the other night. The obvious answer is aggressive assertion by organized women. That is the way progress has been made so far. It hasn't been goodwill. It's been progress based on respect and, in some measure, fear. This means that women must be strongly organized and strongly assertive. That is how these things are accomplished.
Q. -- That didn't happen on the economic front at all.
A. -- I just had a wonderful row with Gloria Steinem over a speech I gave to a women's group in New York, where I said there were some things on which the women's movement was wasting its energy. And then I invented some of the things that they were doing, held to be doing, reacting adversely to the word "Manhattan," "Manheim," and "Amman," and reacting favorably to "Damascus." Gloria was absolutely furious about it. I thought it was very funny. She thought that I had made fun of one of the main objects of the women's movement, and was quite unforgiving.
Rich-Poor Gap--3
Q. -- Two quick follow-ups, two things that you said. Firstly, you said that you have hope that we might finally establish some sort of a basic floor beneath which we would not let people fall. Do we not seem to be moving in just the other direction, less and less willing in this country on the part of both politicians and the general populace to extend welfare benefits or anything for the poor? And second, this question of whether we will continue with a progressive income tax, with Bill Bradley now admitting, finally, that he wants to be president, are we going to hear more and more about flat taxes? Is there any good case to be made by someone like Bradley, who says that he is, in fact, has these same concerns that we're talking about, for a flat tax?
A. -- I don't make my recommendations by their popularity. And I don't assume that, because I urge these two things, that they are on the downslide to adoption. On the contrary, there is a point here which I would urge everybody to have in mind. As the economy develops and well-being develops as it has in the United States or Canada, you move more people into the brackets where self-satisfaction is in some measure, normal, and where people are more and more inclined to the oldest tendency of the affluent, the oldest tendency of the rich, which is to say, "I made it, and so can anybody else," and to say that government and public health stand in the way of progress, to develop all sorts of theories which reward them and their well-being and, effectively, deny it to those who are still in need. In some ways, you are better off if you're poor in a poor country than if you're poor in a rich country, because the unquestioned tendency of the affluent is to justify their affluence and ignore the people who do not share it, or to attribute their failure to their own shortcomings. So, in asserting something like the need for a basic, secure income in a rich country, I am also saying something that is, in effect, denied by an increasing number of people who are rich. I don't have any great inner confidence, or any unlimited confidence, but we should not conceal what may be the only solution. We have this terrible fear that people who have such a basic income will not work, will resort to leisure. But here we are in a community where leisure is assumed to be absolutely necessary. Nothing is so needed by a Harvard professor as an adequate access to leisure. And we always have a certain number who, getting tenure, see that as an open door to leisure. That doesn't provoke criticism. But if somebody down below Central Square doesn't work, then it's serious.
Q. -- What about the Bill Bradley question?
A. -- Well, Bill Bradley isn't going anywhere. He's a nice fellow, I have a slight acquaintance with him, but Bill Bradley as a presidential possibility is very close to zero. He's been out of it too long.
More on Stock Market
Q. -- I'd like to get back to the gloom and doom you were talking about. How would a depression and stock market crash this time around be different than what we saw in 1929?
A. -- That's a good question. I'm not making a prediction, but when you have a speculative bulge in the market, as you do now, as you had these last months and years, it's something of which you must always be aware. There would be, on the whole, an agreeably milder effect than in 1928. Then, there was no bank deposit insurance, and the stock market precipitated a terrible run on the banks, and then bank failures. We wouldn't face that. After 1929, there was no unemployment count. People now losing their jobs have some continuing income. There was no Social Security then. We have built into the system a certain cushion of security that would be very much better than it was in the 1930's. I think there's no doubt about that. But we should not doubt that if we have a pricking of the stock market bubble, we will have an economically depressing effect.
Q. -- I assume, from what you say, that you oppose this effort to bail out these hedge funds?
A. -- Long-term Capital management, I certainly would. Even if there was some adverse economic effect, I still want them to suffer. The enjoyment of seeing somebody like that in trouble, I do not want to deny myself. |
