It is an old tendency of human beings to delude themselves and think that impending dangers could be warded off. Thus they live undisturbed in a make-believe world. Jawaharlal Nehru, in one of his books, has written that when a foreign invader came to raid the famous Somnath temple in Gujarat and loot its treasures, the priests told the devotees to have faith in God and pray, not fight, so that the deity would himself appear and destroy the enemy and his army. Despite prayers for days, no deity appeared and the raider achieved his goal. This phenomenon has been once again underlined by the ongoing global financial crisis and the efforts of economists till the other day to deny its possible recurrence with ferocity in the future and lull them to sleep.
History testifies that we have been having frequent financial crises ever since the rise of modern capitalism and they have been gripping increasing number of people and larger and larger geographical areas. Niall Ferguson thus rightly says: “As long as there have been banks, bond markets, and stock markets, there have been financial crises. Banks went bust in the days of Medici. There were bond-market panics in the Venice of Shylock’s day. And the world’s first stock-market crash happened in 1720, when the Mississippi Company … blew up. According to … Carmen Reinhart and Kenneth Rogoff, the financial history of the past 800 years is a litany of debt defaults, banking crises, currency crises, and inflationary spikes. …financial crises seldom happen without inflicting pain on the wider economy … 148 crises since 1870 in which a country experienced a cumulative decline in GDP of at least 10%, implying a probability of financial disaster of around 3.6% per year.” (“Wall Street Lays Another Egg”, Vanity Fair, December 2008)
Ever since the Amsterdam Stock Exchange came into being and sale and purchase of shares began some 400 years ago, the same pattern of ups and downs has been visible and fortunes have been changing hands. Robert Shiller points out that it is “irrational exuberance” that leads people behave like a herd of sheep. Yet every time it has been asserted by someone or the other that a way out has been found that will make the economy immune from any such crisis in future. For example, when a decade ago, Asian crisis devastated the economies of Indonesia, Thailand, South Korea, Taiwan, Singapore, Malaysia, etc., it was asserted that now onwards financial crises would wreak havoc only on the countries on the periphery while the mainland of developed capitalism would remain immune. Thus crises were to afflict only the countries of Asia, Latin America and Africa. The Business Week (September 27, 1999) predicted that Dow Jones index was to reach 36,000 in the coming 3 to 5 years. The earning per share might be as high as 100 per cent!
In addition, it was asserted that revolutionary changes in the spheres of information and telecommunication had given birth to a “New Economy” whose dominance was fast increasing. This New Economy had inherent immunity from financial crisis, and its increasing dominance would keep the entire economy sturdy. By August 2000, the rising prices of the hares of the companies in the New Economy came to a halt and then began sliding down. A number of such companies collapsed and ceased their existence. This came to be known as Dot-Com Bubble. The Wall Street witnessed a 50 per cent decline. As many as five hundred companies listed by the Standard and Poor could make up their losses only by May 2007. As ill luck would have it, another financial crisis, the biggest since the Great Depression, came to afflict the economy. This time it was not born in stock market but in credit market.
Its impact is being felt all over the world while during the Great Depression the Soviet Union had remained unaffected. The most affected are the economies situated on the main land of capitalism. The economies in the periphery are less affected because they are, to a large extent, dependent on their domestic savings supplemented by foreign direct investment. Their dependence on foreign institutional investments is, by and large, much less. In addition, the proportion of exports in their GDP is not very substantial in many cases.
A number of eminent economists have been, from time to time, lending their might to strengthening the delusion that financial crisis has been banished for ever. But every time they have been proved wrong. It is deplorable that people forget it and again and again become mesmerized by so-called elegant theories and mathematical models. As early as autumn of 1929, Prof. Irving Fisher whose name is known to every student of economics, to quote Prof. J. K. Galbraith, gave “his immortal estimate” that “Stock prices have reached what looks like a permanently high plateau.” When the Great Crash was standing on the door, the Harvard Economic Association asserted in November: “a severe depression like that of 1920-21 is outside the range of probability. We are not facing protracted liquidation.”
In recent times, too, we find similar claims falsified by the realities. Let us cite just two instances. To begin with, let us refer to the statement by Robert Lucas Jr., a professor of economics at the University of Chicago, who was awarded Nobel Prize in 1995. As president of American Economic Association, he delivered a long address on January 10, 2003. It was entitled “Macroeconomic Priorities”. Rubbishing the Keynesian foundations of macroeconomic theory, he pontificated: “Macroeconomics was born as a distinct field in the 1940s, as a part of the intellectual response to the Great Depression. The term then referred to the body of knowledge and expertise that we hoped would prevent the recurrence of that economic disaster. My thesis in this lecture is that Macroeconomic in this original sense has succeeded: Its central problem of depression – prevention has been solved, for all practical purposes, and has in fact been solved for many decades.” One may like to ask this eminent economist: then why this ongoing depression?
Almost a decade before this pontification by Lucas, two Nobel Prize winning economists came out with elaborate mathematical analysis of the market variables and behavior and claimed that they could be correctly predicted and moves could be made accordingly. These mathematical “quants”, as they came to be popularly known, set up a hedge fund—Long Term Capital Management—in 1994. Unfortunately, their quantitative analysis went haywire and their company collapsed in just four years. The main problem lay with the assumption that all the players involved were fully rational and all-knowing and they easily digested all the essential information.
The leader of the Chicago School, the Nobel laureate Milton Friedman had claimed, time and again, that the Great Depression would have been prevented if the Federal Reserve had liberally increased the supply of liquidity. His precepts were followed by the Fed Reserve chairman Alan Greenspan who was brought in by Reagan in 1987. While he increased the liquidity, he forgot that the Fed had a regulatory role too. During his dispensation, the Glass-Steagall Act of 1933 was repealed, thus ending the separation of commercial banking and investment banking. It is said that vested interests had spent $300 million on lobbying to achieve this objective.
Obviously, the realities have shattered the delusion and woken up the people at large. One does not whether this awakening will endure.