long-run roots of generic financial crises erik s. reinert the other canon foundation & tallinn...
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Long-run Roots of Generic Financial Crises
Erik S. ReinertThe 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 Starting point Peak Death
Physiocracy Quesnay 1758 1760s 1789(’Rule of Nature’)
Classical Ricardo 1817 1840s 1848
Economics
Neoclassical Samuelson 1948 1990s NOW
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 + neo-liberalism
The Circular Flow of Economics
”Black Box”
Production of goods
and services
Money/capital
The real economy“Güterwelt”
Financial economy“Rechenpfennige”
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.
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.
Three basic and complementary mechanisms behind the conflicts Three basic and complementary mechanisms behind the conflicts between the real economy and the financial economybetween the real economy and the financial economy
(financial crises):(financial crises):
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=
Major technology bubbles are part of CREATIVE DESTRUCTION in market economies
Credit-pumped bubbles leave destruction and recession in their wake
ICT and finance as percent of total IPOs in US stock markets 1970-2007
0%
10%
20%
30%
40%
50%
60%
70%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Per
cen
t o
f to
tal I
PO
s
ICT as % of total IPOs Finance as % of total IPOs
Major Technology Bubble
Common financialBubble
ICT and finance IPOs as percent of total in US stock markets 1993-2007
Per
cen
t o
f to
tal i
nit
ial p
ub
lic
off
erin
gs
Finance IPOS
Information andcommunicationstechnology IPOs
ICT and finance as percent of total IPOs in US stock markets 1970-2007
0%
10%
20%
30%
40%
50%
60%
70%
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Per
cen
t o
f to
tal I
PO
s
ICT as % of total IPOs Finance as % of total IPOs
Major Technology Bubble
Common financialBubble
ICT and finance IPOs as percent of total in US stock markets 1993-2007
Per
cen
t o
f to
tal i
nit
ial p
ub
lic
off
erin
gs
Finance IPOS
Information andcommunicationstechnology IPOs
Source: Piketty and Saez
The major technology bubbles change the trends in income distributionstrongly in favor of the few at the top
…and in this surge the trends have changed on a global scale
Percentage of income earned by the top 1% in the USA 1913-2007
Installation 4th
RecessionRecession
0%
5%
10%
15%
20%
25%
30%19
13
191
8
192
3
192
8
193
3
193
8
194
3
194
8
195
3
195
8
196
3
196
8
197
3
197
8
198
3
198
8
199
3
199
8
200
3
Sh
are
of
tota
l in
com
e
Turning Turning Point 4thPoint 4th
Deployment 4th
Installation 5th
The 1920s bubble
The Post WWII boom The 1990s bubble
The 2000s bubble
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.