Long-run Roots of Generic
Financial Crises
Erik S. Reinert
The Other Canon Foundation &
Tallinn University of Technology
Chennai, January 24, 2012.
The impact of financial crises on the
publication of economics books.
Hayek’s ’overshooting’ mechanism.
’Never will man penetrate deeper into error
than when he is continuing on a road which
has led him to great success’
Friedrich von Hayek, Austrian economist.
i.e. economic success leads to theoretical
oversimplification which leads to crisis.
Compare Hyman Minsky’s ’destabilizing
stability’ as a mechanism behind financial
crises.
Three Times Rise and Fall of
’Physics-based’ Economics
School
Physiocracy
Starting point
Quesnay 1758
Peak
1760s
Death
1789
1840s
1848
1990s
NOW
(’Rule of Nature’)
Classical
Economics
Ricardo 1817
Neoclassical Samuelson 1948
synthesis
Financial Crises: A theoretical axis
independent of right and left
Financial crises a
natural part of
capitalism:
• Marx
• Lenin
• Hilferding
• Hitler’s men
• Schumpeter
• Keynes
• Minsky
Fails to see financial
crises:
• Quesnay
• Ricardo & followers
• Neo-classical
economics + neoliberalism
The Circular Flow of Economics
The real economy
“Güterwelt”
”Black
Box”
Production
of goods
and services
Financial economy
“Rechenpfennige”
Money/capital
WHEN THE ’ACCOUNTING UNITS’
ATTACK ’THE REAL ECONOMY’
“In the years preceding the first world war there were in
common use among economists a number of metaphors ...
‘Money is a wrapper in which goods come’; ‘Money is the
garment draped round the body of economic life’; etc.
During the 1920s and 1930s ... money, the passive veil, took
on the appearance of an evil genius; the garment became a
Nessus shirt; the wrapper a thing liable to explode. Money,
in short, after being little or nothing, was now everything...
Then with the Second World War, the tune changed again.
Manpower, equipment and organization once more came into
their own. The role of money dwindled to insignificance..”
C. Pigou, The Veil of Money, 1949, pp.18-19.
Three basic and complementary mechanisms behind the conflicts
between the real economy and the financial economy
(financial crises):
THE HAMMURABI EFFECT (Babylonia ca. 1795 – 1750 BC)
The Effect of Compound Interest.
THE PEREZ EFFECT(Carlota Perez, Venezuelan economist)
Technological Revolutions Create Financial Bubbles.
THE MINSKY/KREGEL EFFECT (Hyman Minsky, 1919-1996)
Destabilizing stability and Ponzi schemes.
THE HAMMURABI EFFECT
‘A shilling put out at 6% compound interest
at our Saviour’s birth would . . . have
increased to a greater sum than the whole
solar system could hold, supposing it a sphere
equal in diameter to the diameter of Saturn’s
orbit.’
Richard Price, English Economist, 1769.
THE PEREZ EFFECT.
1. Financial markets – with some logic – have a
love affair with a new breakthrough technology
(US Steel, Microsoft).
2. Role of financial innovation: 1720 stocks, 1990s
hedge funds, that create illusion of ’gravity lost’.
3. Illogically the market wants to bid up all shares
as if they were hi-tech (US Leather).
4. Enters fraud: Parmalat & ENRON.
5. Gravity rediscovered: collapse.
Types of bubbles (Perez):
• Technology bubbles that in the
end are useful (1990s technology
boom)
• Useless bubbles based on easy
credit (NOW!)
DUBIOUS
PROJECTS
IN 1720
BUBBLE
THE MINSKY EFFECT
Types of financing:
Hedge financing, low risk.
Speculative financing involves future renegotiating of the debt
(rollover). A typical speculative position consists of financing long
term assets with short term liabilities.
Ponzi financing is when expected revenues can not afford even
interest payments, and agents are submitted to increasing
debt.
Ponzi schemes (such as subprime loans) cause financial
institutions to redefine the game – in this case not only causing a
financial crisis but also a permanent (?) shift in profitmaking
from the real economy to the financial economy in the West.
1990s NASDAQ Bubble
=
2000s easy-liquidity bubble
ICT finance
and finance IPOs
as percent
total IPOs in
stock in
m arkets
1970-2007
ICT and
as ofpercent
ofUStotal
US stock
markets 1993-2007
Common financial
Bubble
Major Technology
Bubble
60%
50%
Percent of total IPOs
Percent of total initial public offerings
70%
Finance IPOS
40%
30%
Information and
communications
technology IPOs
20%
10%
ICT as % of total IPOs
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
0%
Finance as % of total IPOs
Major technology bubbles
are part of CREATIVE DESTRUCTION in market economies
Credit-pumped bubbles leave destruction and recession in their wake
The major technology bubbles change the trends in income distribution
strongly in favor of the few at the top
Percentage of income earned by the top 1% in the USA 1913-2007
Turning
Point 4th
Share of total income
30%
Recession
Deployment
4th
25%
Installation
4th
20%
The 1920s
bubble
Installation
5th
The Post WWII boom
The 1990s
bubble
The 2000s
bubble
15%
10%
5%
2003
1998
1993
1988
1983
1978
1973
1968
1963
1958
1953
1948
1943
1938
1933
1928
1923
1918
1913
0%
…and in this surge the trends have changed on a global scale
Source: Piketty and Saez
Fragilities + Retrogression.
•
•
•
•
•
•
Financial fragility (Hyman Minsky)
Wage fragility
Pension fragilities
Livelihood fragility
Technological fragility
and so on, including ’reduced marriage fragility’
(number of US divorces down by 25 % in the
1930s).
Increased social tensions, increased migration
(’Grapes of Wrath’), neo-Medievalism, ’madmen
in authority’ (Keynes 1936)
Latvian Ministry of the Economy 1994:
Forces set in motion:
• De-industrialization
• De-agriculturalization
• De-population
Examples; Southern Mexico, Moldova,
Caribbean states
Destruction of real wages:
• In small Latin American countries from the
mid 1970s.
• Stagnating wages in the US from about the
same time.
• De-industrialization of The Second World
starting in 1990 (from Latvia to Mongolia).
• Argentina late 1990s (real wages down by 40
per cent from peak) + Asian crisis.
• Western Europe is being hit now.