Sounds contemporary, doesn’t it? The sort of thing that might have been written about the failure of the Dutch bank Dexia a few years ago, or the Italian banking system right now. But it isn’t. It was actually written about the failure of the Ayr Bank in 1771, two years after the spectacular collapse of a credit bubble in East India Company stock.
Or here’s another good quote: “I lost everything in the market thanks to you and your rotten friends. You think you can crush the little man, destroy me and my family with your illegal operation.”
Once again it sounds fairly fresh – the sort of thing someone might have said to an executive of Lehman’s a few years ago perhaps - but once again it’s a lot older. It’s actually a message sent to the great speculator Jesse Livermore during the crash of 1929, when he shorted the market at the top and made a hundred million dollars.
So if you think the quotes sound fresh and recent, it’s with very good reason. It’s because all this has happened before, and will happen again. And what’s more you can’t stop it.
I’m fascinated by economic bubbles. They’re actually comparatively regular events. Bubbles emerge in equities or bonds or commodities or tulip bulbs or wherever people – particularly people with little or no market experience or knowledge – think there’s easy money to be made. They pile in, driving the price higher. Then as the price keeps going up with no sign of stopping, euphoria takes over. People start saying things like ‘new paradigm’ and ‘end of boom and bust’. They start borrowing to invest more and more. Then, as the price starts to falter and fall, panic ensues. People who have borrowed too much rush for the door to avoid getting wiped out. Many, trapped in a market with an overpriced commodity with no buyers, are wiped out.
A good example of this is the Dotcom/ Tech bubble of the late 1990s. A new technology excited people and they rush to get in, often borrowing to do so. As the market topped and turned, people who had bought at the top panicked and started to sell to minimise their losses. This in turn pushed the price lower, precipitating more selling. And so on. When it all had gone sour it’s estimated that something like US$1.75 trillion was lost. Not stolen or transferred, but just gone. Many people (including me, I’m not too proud to admit) lost a packet.
But it’s not really bubbles I want to talk about. They’re a part of where I’m going here, and they’re exciting and a lot of money is gambled and lost or won but they aren’t catastrophic. It’s the really bad ones which lead to debt and banking crises that I’m interested in. They're much rarer, but they are when the foundations of the economic system itself shake and there’s the danger that not only investors could be wiped out, but banking depositors – ordinary savers – might be wiped out too.
For starters, it’s important to remember that not every bubble leads to a banking crisis. Far from it. For example the stock market bubble of 1907 almost led to a run on the banks, but the day was saved by JP Morgan himself announcing that he was prepared to extend a credit line of ten million dollars to stabilise them. Panic subsided, people relaxed, and the world went on. By way of comparison, in the crash of 1929 the US government put US$25 million in and it didn’t help much at all. The scale was just that much bigger than your average, ordinary everyday bubble. (And looking at that $1.75trn lost when the dotcom balloon went up, it’s estimated that the losses in 2008 were at least ten times bigger. It really did shake the pillars. That’s why it is taking so long to climb back out of the hole).
So unlike your run of the mill market bubble, speculative credit bubbles leading to debt and banking crises are rare events happening perhaps every 30-60 years. Whilst they have happened throughout history, I propose to look at the most recent and to focus on the UK (with a bit of the US for detail, as you can’t really ignore them in matters financial) which would be the crises of 1769, 1848, 1873, 1929 and 1972 and their aftereffects. Because banking crises appear to have consistent and really, really interesting aftereffects. Aftereffects that we are living though the modern version of now, post 2008. And these aftereffects result in the political consensus shifting and realigning.
In other words, things fall apart.
What’s really interesting is that politically speaking things don’t change or fall apart immediately. It takes time, and the period of time seems linked to the usual business cycle.
The ‘business cycle’ is a phrase that gets used a lot, but basically means the period of time between peaks and troughs of growth and slowdown. For sake of argument the business cycle perhaps averages 7-8 years, but can be as short as four or five and as long as ten or twelve (in some cases even longer – the country which has gone longest without a recession is Australia, which is now 25 years and counting into a period of sustained growth thanks to their massive natural resources). If it were an exact science this would all be easy and we’d all be a lot richer than we are.
If the crisis marks the beginning of a substantial and sustained period of economic slowdown, then the political eruption happens not at the time, but at the time of the *next* trough at the end of the next business cycle.
The period after the crisis is marked by political anger, a growth in populist movements, and, above all, a search for someone to blame. Because yes, a lot of people rushed out during the golden years and borrowed money or invested their savings in to the bubble. A defining characteristic of a bubble is that euphoric feeling that you can’t lose. Just borrow and pay back your debt with your guaranteed profits because prices can only go up, up, up. And when that goes wrong, people – many of whom were new market entrants with no experience or idea of what to expect who’d been sold on the idea of easy profits – look for someone to blame.
At the same time people who didn’t get involved in the bubble but instead carefully saved and scrimped but also benefitted from the halo effect also had the horrid sensation of watching their savings be at risk, and the value of their house and stocks and shares and pensions tumble and they want to know who is to blame as well.
Now, greedy bankers or whoever are easy targets, but ultimately the finger of blame will alight upon the established political consensus. The cosy bubble divorced from the people they represent. You know the rhetoric. We’ve heard a heck of a lot of it lately.
Meanwhile, economically, the period post crash is marked by one of two reactions. Either a retrenchment, with a fall in taxation revenues and thus spending by the government, which is never popular, or a loosening of monetary policy to try and boost growth – or possibly a combination of both to a greater or lesser extent. Frankly, neither of these outcomes are great but in the wake of a crisis there are no perfect solutions. After a full business cycle of post-crash policy measures the anger and resentment of the people comes to a head with the next slowdown. We’ve gone through so much pain caused by [insert blame group here], is the cry. The government has done nothing to help [insert victim group here] and they aren’t listening to the people. Something must change. And it does. In this febrile atmosphere, demogogues and populist movements prosper as the established political consensus tries to save itself in the face of popular anger and blame.
I don’t think it’s a coincidence that the American Declaration of Independence was signed seven years after the crash of 1769. In the wake of the crash, the British government tried to bolster its economic position, in part, by increasing tax revenues from the colonies.
It’s often forgotten that the Boston tea party was occasioned by a reduction in tax. Taxation on tea was so high into the Americas that smuggling was rife and revenues from tax were nigh-on nothing. So the government dropped the taxation to a point where suddenly smuggling was uncompetitive against the risks of capture and this, coupled with a legitimised government monopoly on the trade granted to the East India company, was intended to generate revenues for the crown, and it did. It worked too well, in fact. Boston tea merchants were horrified by the loss of their profits from dealing in contraband. Populism in the colonies, unhappy at suddenly being treated as a tax farm, leaped in the wake of losses sustained from the fallout of 1769 (and a lot of colonists were shareholders in the East India Company who price had tanked, causing the crisis).
The arguments for nationalist movements are always the same. The government is distant and unresponsive. We want democracy. We’d be voting for the leaders we choose. Why should we give them our taxes when we could spend them on ourselves. It’s all about sovereignty. Once again, we’ve heard them a lot recently.
So, in 1776, one business cycle after the crash, boom.
Meanwhile in Britain protectionism was also rife. The crash of 1769 ushered in an political era of economic protectionism for British vested interests exemplified by the corn laws. A period which lasted until the next crisis, that of 1846 with the collapse of the railway bubble.
You probably can guess how that went. People piled into the exciting new technology of railways which would revolutionise their lives until, with a rise in interest rates in 1846, the bubble popped. Money flowed out and over-leveraged people panicked and started to sell at any price. Many were wiped out. This led to the banking crisis of 1847 and then to the great rally of the chartists – the occupy movement of their day, in 1848.
Prior to the crash the chartists had been a fringe movement of slightly wonkish obsessives, a bit like UKIP pre-2008. After it, they were huge, presenting a great charter with a million signatures on it (like Occupy, they had a touching faith in the efficacy of petitions) to parliament making the usual demands like more money and democracy. Ostensibly the movement failed, but in after the election of 1852 the ruling coalition of agrarian high Tories who had dominated British politics and maintained a protectionist consensus for decades collapsed, making way for the ascendancy of a new consensus – that of liberal, free trading Whigs, whose place in the sun lasted until (you guessed it) the next crisis. That of 1873-4.
The effects of the crisis of the early 1870s were particularly severe in Britain, leading to what is called the ‘long depression’ that lasted the better part of a decade. This period saw the established Liberal coalition tear itself apart and the emergence of new, socialist movements that would coalesce into the Labour party. The consensus, which lasted until the crisis that followed the 1929 crash, was one of Mercantilism best exemplified by the policy of ‘Imperial preference’.
The effects of the 1929 crash are probably the best documented of all, largely due to the second world war, but it’s worth noticing that populist movements also emerged in the UK and the US and they’ve been largely forgotten about in all the excitement that Hitler started. However, it’s well worth remembering that the 2000s is by no means the first time the UK has seen mass movements marching under banners saying “Stop the war” and demanding a referendum:
The consensus that emerged from this period – actually known in Britain as the Postwar Consensus - was one of planned economics and state ownership and it remained until, you guessed it, one business cycle after the secondary banking crisis of 1972, when Margaret Thatcher and Ronald Reagan disrupted the old consensus and established a new one of market liberalism and trade. For a period in the 1970s it looked, post crisis, like the populist and protectionist movement of the unions would survive (“Who governs Britain?” as the slogan of the 1974 election ran), but Thatcherism emerged in direct response to that and completely blew it out of the water. You just can’t predict how these things are going to go, just that they’re going to happen.
And now here we are a cycle after the crash of 2008, and it’s all being disrupted. Again.
There’s a lot to unpack from this. Definitely more than I’ve got room for here, but firstly I draw a conclusion, which is this:
The perceived benefits (real or otherwise) of an established political consensus accrue to a smaller and smaller group until that creates a demos large enough to disrupt it – and the catalyst for that is a debt crisis, which crystallises disaffection.
A good example of this is the shift which occurred in 1979; the benefits of the postwar consensus accrued ever more to the unionised, nationalised industries until, in the wake of the crisis of 1972, the demos of the rest of the population disrupted it and created a new one.
In my opinion the reset of 1852 is the one which most closely matches the one we’re going through now, as not only were the Chartists totally the Occupy movement of the mid-19th century (and suffered the same fate, more or less), both major political parties tore themselves a new one and reformed. It’s most obviously going on with the Labour party, which was formed of an internal coalition of three factions – the working class, the radicals and the middle-class socialists. The problem Labour has is that the working class have been leaving for a while now which leaves only two major factions and so, without a tie-break to form a majority, they’re fighting to the death. Parties have gone into spasm and never truly recovered after a crisis (look at the poor, plucky little Liberals), and I think it perfectly possible that this might be it for Labour. However, if you’re hoping or fearing that might leave a permanent Conservative majority don’t fret too much. Firstly, the system abhors that sort of political vacuum and something else will appear to challenge them, and secondly they’ve got their own fight going on.
Unlike Labour the Conservatives have four factions in their internal coalition rather than three, which might explain their far greater historical stability. These are the Paternalists, the Corporatists, the Free Marketeers and the Agrarian ‘hang ‘em and flog ‘em’ High Tories. Thatcherism was an unusual alliance of Free Marketeers and High Tories and there was an attempt, post-Brexit, to reform that alliance which seems thus far to have come to nothing. The Cameron coalition was one of Paternalism and Corporatism which thus far seems to be holding, but what will emerge eventually will depend on what deals May needs to cut over time as she’s had to bring some senior representatives of the other factions in to cement her position.
Secondly is that it appears there are no good outcomes from a debt crisis for the established consensus. If you follow monetary loosening, then that hurts savings and pensions and loses you support. If you don’t follow monetary loosening then you get higher unemployment, which loses you support. It genuinely is a no-win situation.
This means that the early 90s liberal idea of ‘the end of history’ was a nonsense. The world does not and cannot work like that. Similarly the Marxist idea of historical inevitability is also nonsense for the same reason.
In the wake of a banking crisis, the printing and monetising option seems to work out better than the not printing and letting it grind itself out option. We can say this because we’ve two good examples; in 1873-4 the US started printing money to relieve itself of the pressure and recovered far more strongly than Britain which didn’t (and which suffered the long depression), and post 1929 Britain dropped the gold standard like a hot potato and recovered far better than the US, which remained wedded to sound money and for years more had the great depression.
For clarity, I’m not saying that monetary loosening is a great option, but it is the least worst. People seem to think there’s some sort of ideal answer, but we live in an imperfect world and anyone telling you their solution would work without downsides is either fibbing or has been kicked firmly in the head by a cart horse.
One of my favourite historical resonances is the 1940 US election. That is the second election after the crash, FDR’s oft-forgotten opponent in that election was Wendell Wilkie, a “brash outspoken businessman who pursued a populist message, and who had flirted with every side of the political spectrum in his past.”
Is it just me, or does that sound at all familiar?
So what can we learn from this? I think the following:
1) The established political consensus is the political centre ground, and nobody really challenges it during its period of ascendancy. For example, the period of market liberalism established in the reset after the ’72 crisis was never seriously challenged by anyone seeking government, in the same way that the period of state economic control and planning established in the wake of the ’29 crisis was not meaningfully challenged until it failed in the wake of the crisis of 1972. Governments tinker around the edges and pull it one way or another, but the centre holds.
2) The period following a banking crisis is marked by populist mass movements who disrupt the existing political coalitions and consensus and new ones emerge which remain largely stable until the next event.
3) These mass movements are often nationalist and protectionist as the overriding emotion in the wake of one crisis is there’ll be another one along in a minute. The language of these movements is always the same. Always. Spend our own money on ourselves, distant, unresponsive executive, ignoring democracy, they’re all corrupt, blah-de-blah-de-blah. If you’ve heard it in 1776 and 1854 and 1873 and 1929 and 1972 you’ve heard it a thousand times. The outcome is, however, unpredictable.
4) The consensus in existence before the last six events always changed during the cycle after it. This is important as it gives us clues where we’re going; in other words, it’s quite likely that the people who are hoping for a period of market liberalism and free trade post Brexit are likely to be disappointed as that’s what we’ve just had.
There’s also been a major international war at this point in the cycle two of the last five times this has happened so a little caution is warranted I’d say. Avoid tearing down institutions if you can, that sort of thing.
So what will the next consensus be? Frankly, I think it’s impossible to tell, but I think that a couple of trends are indicative.
Firstly, the younger generation are much more comfortable with state surveillance and restrictions on free speech than mine was at the same age. The is possibly a side-effect of growing up with your life constantly on view on the internet, and also not understanding why people are allowed to be so rude about your mate Fatima who you sit next to in Chemistry classes at school and is all right.
Secondly, despite a lot of fine-sounding rhetoric from some parts of the leave EU campaign about global liberal trade, both the Leadsomite right and the Corbynite left are much happier with various forms of import substitution and mercantilism and I expect this to have some influence.*
A couple of weeks ago I was chatting to someone who rather primly told me that they ‘want to live in a world where we don’t have banking crises’.
Well, I thought, that’s super, but it doesn’t really address the issue of what you do when you actually have one. Because the thing about economic crises is that it doesn’t matter what model you use, you’ll always have them because people are people. Having a strictly controlled economy just results in your crashes being worse; North Korea and Cuba and Venezuela effectively exist in a state of permanent crisis, which must totally suck for the people who live there whilst their leadership gaze helplessly at the economic rubble and wonder why introducing more rules and sending the riot police in when shopkeepers try to set their own prices based on supply and demand isn’t fixing anything.
If I have an axiom, it’s that all systems fail - and that includes the ones I like so I’d better get used to it. It includes the ones you like too, just in case you’re wondering, so I’d advise you to get used to it too. Because if you’re a fan of this consensus it’s failing, and if you’re a fan of the emerging one, well, that’s gonna fail too so make the most of it. Because in a few decades people will be telling you that you lost so get over it whilst you gnash your teeth in impotent rage wondering why all the evil and stupid people are voting against the thing you love.
Something for you to look forward to, there.
If all systems fail, the wisest course of action is to implement systems with plenty of redundancy so if one part fails then the failure doesn’t take everything with it.
Of course that’s great advice, but it cannot and will not be followed because one of the defining features of a bubble is one of euphoria; a belief that this time it’s different and it can’t fail. And when you think it can’t fail, well then. There it goes. **
Because things fall apart.
But, on a lighter note, then they get put back together again. Just differently.
*I’m not saying that import substitution and mercantilism definitely will not make a first world country richer than the liberal trade we’ve just had a period of, but I am saying I don’t know of any times in history when it has actually done so.
**There’s a great quote in The Big Short which is
“How do you know it’s a bubble?”
“Because nobody can see it.”
One of the things that happens after a crisis is everyone suddenly becomes mad keen to spot the next one coming along, and so they end up seeing a lot of bubbles that just plain aren’t there. For example, the ‘London property bubble’ one reads so much about. It’s a chimera, an illusion. There’s no euphoria in the market, price discovery mechanisms are working like they’re supposed to, and there’s nobody on your friends list or in the press boasting about how they’ve just borrowed to make their fortune in the market. Instead they’re all tearing their clothes, rubbing ashes on their faces, and generally telling you how we’re all doomed.
There’s actually a really good way to spot a bubble emerging. That friend of yours. You know the one. The one who insists there’s a bubble RIGHT NOW and it’s going to go wrong? Them**. When they tell you they’ve just borrowed pots of money to get into the market and advise you to do the same. THEN you start to sell.
***If you don’t have a friend like that, then frankly it’s probably you I’m looking at and wondering when you’re going to start borrowing.