nice piece...
Remembering the lessons of financial crises
Date: 12-04-1999 :: Pg: 20 :: Col: c
The leading authority on world financial crises, Prof. Charles P. Kindleberger, feels that an attempt to reshape the international financial system all at once is doomed to failure. ''I think it would be a disaster to have a new Bretton Woods now, there isn't enough agreement on which way to go,'' he said in an interview with N. Ravi. On the other hand, the way to go about setting things right is to deal individually with specific problems and issues that may need solving immediately.
Dr. Kindleberger, who is Emeritus Professor of Economics at the Massachusetts Institute of Technology, has analysed financial crises beginning with the Seventeenth Century. Of his classic work, the Nobel Laureate, Prof. Paul Samuelson, said, ''Sometime in the next five years you may kick yourself for not reading and re-reading Kindleberger's Manias, Panics and Crashes." It has also been described as ''a template against which to measure the latest financial crisis - whatever and whenever that happens to be.''
The following are excerpts from the interview:
On the nature of the East Asian crisis
It is because of the herd behaviour. There was a great deal of attention in the markets, particularly in Europe, and also in the United States to East Asia - they noticed that they were growing at a rapid rate of 5, 6, 7 or 9 per cent, so they started to lend, that built up and got to be herd behaviour. Very few of them seemed to back off and say stop.
We know that there was a little boomlet in 1993-94 which was stopped by the interest rate - the Federal Reserve in those days raised interest rates three times in the spring. Last fall, they lowered it three times.
It seems funny, I guess it is symmetrical, they had a slight crash when a hedge fund collapsed in 1994 as well as when the Long Term Capital Management got into trouble in 1998.
I don't say it is always herd behaviour operating, but occasionally. And the herd behaviour is a response to a displacement of some kind - war, peace, higher interest rates, lower interest rates. The quotation from John Stuart Mill, that John Bull can stand anything but he cannot stand 2 per cent is of some interest.
I have noticed that many times when governments tried to refund high interest debt after a war, that started booms. That is because investors had to keep their income up. If the British debt which was funded during the Napoleonic war was refunded to 3 per cent in 1822, that meant people started looking around for other things.
They lent to Latin America, you had a boom in Latin America which went too far and herds developed. Some economists have said policy switching was a displacement. That would be true, of course, when old bonds are refunded or when the government moved in and tried to slow down or speed up the economy.
On the limits of central bank intervention
I have one interest, which not many people pay attention to, which is that central banking has given up one weapon which was used to limit credit in a bull market. Keynes and the New York Federal Reserve Bank under Benjamin Strong and later the Japanese in 1990 worried about a situation in which commodity prices were stable but asset prices were going up, so they were wondering what they should do. They had only one weapon and two targets, they agonised, they had a dilemma. Now, we used to have a regulation in the United States which regulated margin requirements in the stock market but that got defused by derivatives.
Derivatives have a margin of 5 per cent or 4 per cent and even a 50 per cent margin on spot stock does not bother the arbitragers and speculation in the derivatives market spoils margin requirement as a tool.
That is why some people talk about the need to control the hedge funds, for example Long Term Capital Management had a leverage of over 40 or 50 times. We have lost control in monetary policy because of derivatives.
Let us go back to Timbergen - his Nobel prize was based upon the fact that he said in any economic policy you had to have as many weapons as you had targets. If your objective is price stability, you can do that with monetary policy which is the same as interest rate policy, let us say.
But if you have a divergence between asset prices and the GDP deflator, you need another tool. And talking will not do. We know that when Paul Warburg said in 1929 that the stock market was too high, it laughed at him.
When Mr. Greenspan said in December 1996 that the market is guilty of irrational exuberance, the Dow Jones was only close to 7000, then it went beyond 9500.
So that kind of body English does not seem to work at all. By the way, I have reduced the Timbergen economic policy to a well known aphorism: you cannot kill two birds with one stone, you need another stone.
On capital controls
A great many people are saying that we have to change the international system, they want to go back to an autarkic system with controls and so on. There are times when you might want to impose controls as the second best. But on the whole, I would say the first best is no controls and stability. On the other hand, when things become unstable, you might need controls.
I have found that capital controls work well in some countries but not in others because some countries do not mind evading them. The proof is when the British still had one exchange rate for the current account and one for the capital account, these exchange rates diverged with no arbitrage between them.
When the Belgians tried that, they could not get them to diverge at all as they were arbitraging between them all the time. In the United States, we tried capital controls on direct investment and they worked very badly.
On markets and the government
Markets work well most of the time but not always. The government ought to run a watching brief. Certainly we find this is true when it comes to cartels and monopolies. I don't understand computers or want to, but the Microsoft anti-trust case is of some interest.
When it started in oil, for example, we had just two big companies in the world, Standard Oil and Shell dominating and controlling it. After a while, competition grew more and more, the duopoly became the seven sisters, then you had 20 companies and now you have 50.
After a while, you don't need to worry if competition works. It is important for the European Union to have a group on cartels. The Germans love cartels and the United States in principle opposes them but in practice it is slow sometimes to respond.
On the power shifts in the world economy
My book, World Economic Primacy - which, by the way, does not take care of China, it is a book before the period - suggests that primacy moved from the Italian city states to Spain, Brugge, Antwerp, Amsterdam, London and New York.
It has been challenged by Japan, by France and by Germany unsuccessfully on the whole, I would think. The question is whether the Unites States is beginning to lose its leadership and will Europe take over? We had for a long time a contest between the United States and the Soviet Union, but that broke up. The question now is will the European Union pull itself together? It is an enormously educated group, a lot of people, smart people and some people like the French anxious for glory.
On leadership in the world economy
In dealing with the world economy, a hierarchical organisation is inevitable with some country providing leadership. I prefer to think of leadership not as hegemony but as responsibility.
There are five economic functions that need to be filled: maintaining a market for distress goods, providing counter cyclical or at least stable, long term lending, policing a relatively stable system of exchange rates, ensuring the coordination of national macro-economic policies and service as a lender of last resort abroad as well as at home.
I have pointed out in my book on the world depression that the depression was so wide, so deep and so long because Britain had lost its primacy and the Unites States was unwilling to pick it up. The Unites States did pick up responsibility and leadership after World War II but now it is beginning to lose it, at least I think so though it is a debatable point.
In the political sphere, Europe has been unwilling to take on responsibility in Yugoslavia, for example. In the Middle East, countries like France have backed Iraq and so on. There is a contest within the United Nations, with countries struggling to see who is going to be on top.
That is why the UN Security Council has trouble because the Russians and the Chinese do not agree. I am not suggesting that I applaud Blair for the way he follows Clinton, that is not very attractive somehow. But responsibility is a word I prefer to command or dominance.
On the role of the IMF as the lender of last resort
Walter Bagehot said the lender of last resort should lend freely at a penalty rate. The International Monetary Fund has trouble about lending freely, particularly because they started off in Mexico in 1994 with $50 billion - this was not all theirs, of course, there was some from the U.S. Treasury, some from Japan and some from the rest.
But they could not create any international money. The central bank inside a country with the government putting up treasury bills, exchequer bills, can create a large amount, an infinite amount. In an international crisis, unless you have a world central bank, there is nothing that can be done, the IMF is limited.
The sum of $50 billion worked very well in Mexico, they didn't use it all. But that meant that when they came to Thailand, they already had a precedent of a huge amount. So Thailand was $27 billion, then came in Indonesia with $47 billion, then South Korea with another $50 billion or so.
Then the IMF ran out of money. The United States tried to get the Congress to vote more and all other countries waited for the U.S. to vote first because the U.S. was the leader in this matter still. The U.S. Congress politicised the issue.
The lender of last resort issue should not be politicised, but it sometimes is. Sometimes the lender is accused of not lending to some people it did not like; in the Congress, the Republicans did not like to lend to countries that had birth control or abortion.
That is quite irrelevant to technical economic issues and I was unhappy about it. Finally, in the last minute they did pass the $18 billion and the other countries kicked in the rest of it.
On reshaping the international financial institutions through a new Bretton Woods conference
Some people say we need a new Bretton Woods, start all over again. Some would want a new body to supervise the IMF and the World Bank, there was a suggestion in an article that we need a new Keynes. I think the notion of trying to repair the system all at once is doomed to failure.
The model I look at in that regard is the world economic conference of 1933. The conference was premature. We had a depression, we needed to do something but we could not find what to do. Some people wanted to stabilise exchange rates, some people wanted to depreciate.
Till we have coherence of thought, it would be a mistake to try to solve everything. What I would suggest is sometimes called muddling through, tackling one area at a time as it comes up.
I have a vacuum theory of government, governments should move in to fill vacuums where they exist. This is different from having no government or having a dominant government.
An example that interests me is the way the United Nations was set up during the war, when political scientists created big tables of organisation and said you people do this, do this, they tried to set it all up at a time.
A lot of people worked up to the job, I thought. On the other hand, Myrdal, when it came to the Economic Commission for Europe, would hire people when he wanted them to do particular things, which it was important to do now.
Rather than try to plan for all kinds of emergencies and all kinds of problems, I would tackle problems as they arrive. I think it would be a disaster to have another Bretton Woods now, there isn't enough agreement on which way to go.
On public memory and the lessons from financial crises:
This raises the question of the moral hazard. Would you have thought that the Mexican crisis of 1994 was allowed to proceed so aggressively because the country was saved in 1992? I do not think so, I think the system has a limited memory, people remember some things and not others.
And sometimes, the memory is wrong. A classic example is the way the French built the Maginot line. The French thought the Maginot line was a cure for what happened in 1914 and it turned out to be not. On the other hand, the United States did remember what a mess it was with war debts, its failure to join the League of Nations, reparations and all that.
So we did not have the same thing after World War II as we had after World War I. Sometimes the memory works, sometimes it does not work. I have been impressed by the fact that in England in the nineteenth century you had a financial crisis every 10 years and then they seemed to behave as a new generation.
Between 1866 and 1890, the British had no problem, Germany had the crash of 1873 and France had a problem with the crash of 1881 and the Panama scandal in 1893. Who knows, people are funny, you cannot predict what exactly will happen. Sometimes memory is lost, sometimes it works.
On the state of economic research:
I find I cannot read the journals any more with all the mathematics and it seems to me that often trivial conclusions are decorated by fancy equations. To my mind, formal economics with mathematics often develops, after long and tortured proceedings, its own assumptions back again. If you have theory without empiricism, it is bad.
On the other hand, if you had empiricism with no theory, that would be awkward too. I have reported this before: I have heard a young man say," I have a new model, I hope you can find some use for it." I would like to talk about historical economics rather than economic history.
Historical economics is a look in history to see if you can find patterns that repeat themselves and changes. Generally, you have to use rationality in economics but you have to be prepared for the exceptions, for herd behaviour, for example. Economics may be the queen of social sciences but it can easily afford to take in a little politics, anthropology, sociology and so on.
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