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Long-run Roots of Generic Financial Crises Erik S. Reinert The Other Canon Foundation & Tallinn University of Technology Chennai, January 24, 2012.

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Presentation on theme: "Long-run Roots of Generic Financial Crises Erik S. Reinert The Other Canon Foundation & Tallinn University of Technology Chennai, January 24, 2012."— Presentation transcript:

1 Long-run Roots of Generic Financial Crises Erik S. Reinert The Other Canon Foundation & Tallinn University of Technology Chennai, January 24, 2012.

2 The impact of financial crises on the publication of economics books.

3 Hayeks 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 Minskys destabilizing stability as a mechanism behind financial crises.

4 Three Times Rise and Fall of Physics-based Economics School Starting pointPeak Death PhysiocracyQuesnay s1789 (Rule of Nature) Classical Ricardo s1848 Economics Neoclassical Samuelson sNOW synthesis

5 Financial Crises: A theoretical axis independent of right and left Financial crises a natural part of capitalism: Marx Lenin Hilferding Hitlers men Schumpeter Keynes Minsky Fails to see financial crises: Quesnay Ricardo & followers Neo-classical economics + neo- liberalism

6 The Circular Flow of Economics Black Box Production of goods and services Money/capital The real economy Güterwelt Financial economy Rechenpfennige

7 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

8 THE HAMMURABI EFFECT (Babylonia ca – 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, ) Destabilizing stability and Ponzi schemes. Three basic and complementary mechanisms behind the conflicts between the real economy and the financial economy (financial crises):

9 THE HAMMURABI EFFECT A shilling put out at 6% compound interest at our Saviours 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 Saturns orbit. Richard Price, English Economist, 1769.

10 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.

11 Types of bubbles (Perez): Technology bubbles that in the end are useful (1990s technology boom) Useless bubbles based on easy credit (NOW!)


13 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.

14 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

15 Source: Piketty and Saez The major technology bubbles change the trends in income distribution strongly 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 Installation 4th Recession 0% 5% 10% 15% 20% 25% 30% Share of total income Turning Point 4th Deployment 4th Installation 5th The 1920s bubble The Post WWII boomThe 1990s bubble The 2000s bubble

16 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 )

17 Latvian Ministry of the Economy 1994:

18 Forces set in motion: De-industrialization De-agriculturalization De-population Examples; Southern Mexico, Moldova, Caribbean states

19 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.

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