Review: Manias, Panics, and Crashes: History of Financial Crises by Charles P. Kindleberger
Recently I spent time in America's outback with a friend with excellent credentials in economics in general and big-money investment in specific. We argued, as libertarians are wont to do, over fine points of theory. In particular I expounded Austrian economics. He doubted, and gave me this book, Manias, Panics, and Crashes, to read. A good thing too, since the flight into flyover territory is rather long.
Having finished it, I think it is a good book from the point of view of a sort of passive-voice history: a history of facts. So and so was here, and did this, said that. A battle was fought. Lives were lost. It is a history devoid of theory, almost, and therefore hard to understand. In this case, it's about financial history, but only the panics. A fraud was discovered. A panic started. Money was tight. Money moved. A lender of last resort appeared, or didn't. Missing from all that is the why: why do bubbles happen? What is speculative mania? Why do bubbles pop? Kindleberger does not explain these things; a sense of the economic structure is quite missing. In fact he willfully ignores most of them: the economic expansion period preceding a bubble he explicitly disattends.
It all reminds me of reading biological tracts written before the theory of evolution. Before then, it was quite evident that animals were designed, and designed pretty well. Much good work was done without evolution; but you could see ever so much more with that simple theory to guide you.
In the case of Manias, there is an abject ignorance of the theories of Austrian economics, in particular the theory of the business cycle. I doubt Kindleberger had heard our theories when he wrote the book. It's a revised edition I read, so there is all of one paragraph in the entire book where Kindleberger notes that there's this "new" theory about but dismisses it out of hand. (The fact that Kindleberger was completely ignorant of Austrian theory about the business cycle, which dates to Von Mises in the thirties, is a sad reflection on the damage Keynes inflicted and continues to inflict on economics.) In the Austrian view, trying to understand panics without understanding credit and money creation is like trying to understand for what purpose God put nipples onto men.
Kindleberger has no notion of where manias come from. To Kindleberger, they are just a given. Mania happens. People are irrational, and sometimes they just get nutty. End of story: now let's see how it unravels. That's not good enough for me. I'm an Austrian economist. The massive fraud of fractional reserve banking is what underlies the business cycle, including mania and crash if the swings are high/low enough.
To be specific, the source of mania is fractional reserve banking. In fractional reserve, demand deposits are lent out. The same money is supposedly available to the deposit any time he wants, even when it has been lent to somebody else. Banks are technically bankrupt at all times. There are real effects to this practice, even with all the moderating superstructure built by the modern state to try to prevent bank bankrupcies. In particular, when money happens to be flowing into banks (for whatever reason), it induces them to create and lend out large amounts of new money in an actuarially unsound structure. This falsifies the signalling that interest rates provides to entrepreneurs, and causes a boom. When money flows out of banks, the reverse must happen: they must reduce the money supply by a multiplied amount. But because the money is tied up in promises (which is what credit is, ultimately), it cannot be got easily. Thus the fundamental bankruptcy of the bank is exposed. Without state intervention, rational depositors, seeing that their bank is bankrupt, rush to extract their deposits. Panic ensues.
The state has, over time, evolved a number of ways to prevent the bankruptcy of banks. (Why, one might wonder. Is it for the good of the depositors, or the bankers?) With deposit insurance and the lender of last resort, there is no bank run. But there still must be the adjustment of the economic structure to reality. The structure was overbuilt due to false interest rate signals. Thus it must be partly liquidated. This process is recession.
Yes, a "lender of last resort" does help, in the sense that it can cut off a panic. But what is does not do is cut off the business cycle, nor the fundamental fraudulent nature of the system. Furthermore, the lender of last resort is itself, ultimately, just a big bank. Thus it, too, can be bankrupted if the crisis is large enough. What we have done, therefore, in tying all the US banks into one system is to guarantee that when failure happens it is absolutely catastrophic.
It is like playing double-or-nothing when one loses at blackjack. As long as the streak of losses is not too long, you stay ahead. But when you get unlucky enough - and it will happen - then you lose all. Meanwhile, though, you can be lulled into thinking that with your fancy betting strategy you have achieved something for nothing.
Perhaps an even better analogy would be in the way that the state has historically fought forest fires, without really understanding them. The more you fight fires, the more unburned stuff piles up in the forests; eventually a fire breaks out that you cannot contain. Modern foresting practice is to let fires burn and even set them; they happen yearly but no given fire is catastrophic.
What I did gain from the book was more of a sense of history, including some interesting panics. Most particularly, Kindleberger talks about a (fraud-based) mania/panic that happened in gold coins. In his mind that proves that mania and panic are not features of fiat money. In my mind, it is proof that monetary fraud underlies mania and panic.
I also deeply enjoyed the discussion of the connection of fraud with bubbles. Kindleberger can't really explain it; and I doubt he has a mind to. But I can, and do. The explanation is Austrian. Money is created in a fractional reserve system largely by banks, who must lend it out to stay competitive. This is what falsifies the interest rate. Bankers, naturally, want to invest in the soundest, safest investments they can. But the more money they have to invest, the further out they have to go on investment quality. But there is a smooth spectrum of quality connecting an outright fraud to a sound investment. For every sound investment, it is possible to find a slightly less sound one. If one man has a two year track record, another has only one. If one man is completely sure his idea will work, another is just pretty sure. If one man has $10000 in collateral, another has $9000. And so it goes, for every dimension you can imagine. Similarly for fraud: for every fraudulent scheme there is a slightly less fraudulent one. The spectrum meets in the middle. Thus, money creation via bank lending necessarily drives the society further out into the risk spectrum than it "should" be - that it would be without the fraud of fractional reserve. Some of those risks always turn out to be fraud; and thus, frauds inevitably accompany inflationary central bank policy in larger amounts than they would in an honest monetary system. Thus, it is almost always frauds being discovered that sets off a panic.