Public RelationsV V: Galbraith on unfettered capitalism
“What experience and history teach us is this—that people and governments never have learnt anything from history, or acted on principles deduced from it.”
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Hegel: Introduction to Philosophy of History
Upmarket American journals like the New York Review of Books, Harper’s, Atlantic Monthly, American Scholar and others have all been taken up with the global financial crisis, apart from the numerous Op-Ed articles in the major newspapers. They have all talked of the enormous stock market bubbles, the credit collapse and its trillion dollar consequences and what should be done to get in place fundamental fixes for a collapsing system. And naturally books like Richard Posner’s A Failure of Capitalism: The Crisis of ‘08 and the Descent into Depression (Harvard University Press, $23.95) and several others have followed—successful publishers have an impeccable sense of timing—which have provided the peg for leading economists to put in their bit on how to save capitalism, and capitalists, from doom. But of all the books and critiques that are flying around it is John Kenneth Galbraith’s The Great Crash 1929 (first published in 1954, reprinted with a new introduction, Rs 399) that is on top of the charts because it tells, in a form so humorous and yet so carefully authenticated, how stock market bubbles end up in smoke with disastrous consequences for financial structures.
One of the reasons why readers are going back to Galbraith’s classic is that it describes common events that precede and accompany particular financial crises, events that are conveniently forgotten by politicians and regulators and their advisers when times are good. Galbraith, like Keynes before him, identified the instability of modern capitalism in its drive to accumulate excessive wealth because of the fragile nature of the financial system. As Galbraith put it, “all stock market bubbles exhibit seemingly imaginative, currently lucrative, and eventually disastrous innovation in financial structures.” He argued that an unfettered, competitive capitalist system, operating on free-market principles, was inherently cyclical and unstable, that requires robust regulation and active government intervention. What needs to be kept in mind is that the present crisis did not originate in the real sector of the economy; it was triggered by the excesses of the financial system.
What makes the book invaluable is that Galbraith places his argument squarely within a historical framework. He sweeps through a series of bubbles, beginning with the tulip bubble in the 1630s, the South Sea bubble of the early 1700s, the stock market crash of 1929 and then in 1987, the Nikkei bubble which began in 1991 and the Nasdaq bubble in 2000. All these bubbles share one thing in common: a perceived fundamental change in the economy induces a euphoria with heightened expectations of quick returns which leads to excess, fraud and collapse. Heightened expectations stimulate a credit boom with the banking system primed to cash in on the new situation. As Galbraith put it pithily, “the banks provided the money that financed the speculation that in each case preceded the crash.”
As Galbraith, and Keynes before him, warned, such speculation inevitably leads to euphoria or overtrading in which rising asset prices encourage further speculation. And it is particularly so when interest rates are low, which underpinned sub-prime borrowing in the US. Soon enough a vicious cycle is set up: as debt accumulates, it can only be serviced by the issue of new liabilities. As long as business is good, it is possible to sustain the business even with poor cash flows. But at some point, the cycle is bound to be broken. Soon enough organisations are forced to sell their assets to meet their liabilities. These “distress” sales cause asset prices to fall further, at which point financial markets and businesses that are exposed to the exigencies of the market collapse. Investors who try to get their money back from the market get nothing, because all their solid assets have melted into air. This is the essence of The Great Crash and describes the current crisis much better than the academic tomes that flood the market every day.
Who is to blame for the current crisis? As usually happens after a crash, the search for scapegoats has been intense, and many contenders have emerged: Wall Street swindlers, predatory lenders who sold loans people couldn’t afford; low interest rates for too long; ‘experts’ who gave wrong advice. All these explanations have some truth because all bubbles are more than just bad faith, or incompetence or rank stupidity; the interaction of human psychology with a market economy ensures that a whole lot of factors coalesce. Will we have learnt something from this crisis? As Galbraith might have put it, ‘we will learn an enormous amount in a very short time, quite a bit in the medium term, and absolutely nothing in the long term.’