Manias, Panics and Crashes A History of Financial Crises Charles P. Kindleberger and Robert Z. Aliber Manias, Panics and Crashes 1403_93651X_01_preiv.qxd 14/5/05 11:28 AM Page i Examine the record of history, recollect what has happened within the circle of your own experience, consider with attention what has been the conduct of almost all the great unfortunate, either in private or public life, whom you may have either read of, or heard of, or remember; and you will find that the misfortunes of by far the greater part of them have arisen from their not knowing when they were well, when it was proper for them to sit still and be contented. —Adam Smith The Theory of Moral Sentiments Much has been written about panics and manias, much more than with the most outstretched intellect we are able to follow or conceive; but one thing is certain, that at particular times a great deal of stupid people have a great deal of stupid money. … At intervals, from causes which are not to the present purpose, the money of these people – the blind capital, as we call it, of the country – is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone, and there is ‘speculation’; it is devoured, and there is ‘panic.’ —Walter Bagehot ‘Essay on Edward Gibbon’ I permit myself to note in this connection the words said to me by a very high personage of the Republic: ‘I know my country well. It is capable of supporting anything with calm except a financial crisis.’ —Raymond Philippe Un point d’histoire: Le drame financier de 1924–28 I can feel it coming, S.E.C. or not, a whole new round of disastrous speculation, with all the familiar stages in order – blue-chip boom, then a fad for secondary issues, then an over-the-counter play, then another garbage market in new issues, and finally the inevitable crash. I don’t know when it will come, but I can feel it coming, and damn it, I don’t know what to do about it. —Bernard J. Lasker Chairman of the New York Stock Exchange in 1970, quoted in 1972 in John Brooks, The Go-Go Years 1403_93651X_01_preiv.qxd 14/5/05 11:28 AM Page ii Manias, Panics and Crashes A History of Financial Crises Fifth Edition Charles P. Kindleberger and Robert Z. Aliber 1403_93651X_01_preiv.qxd 14/5/05 11:28 AM Page iii © This edition Charles P. Kindleberger and Robert Z. Aliber 2005 © Charles P. Kindleberger 1978, 1989, 1996, 2000 Foreword © Robert M. Solow 2005 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published in 2005 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world. PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 978–1–4039–3651–6 paperback ISBN-10: 1–4039–3651–X paperback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. 10987654321 14 13 12 11 10 09 08 07 06 05 Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne 1403_93651X_01_preiv.qxd 14/5/05 11:28 AM Page iv Contents Foreword by Robert M. Solow vii 1 Financial Crisis: a Hardy Perennial 1 2 Anatomy of a Typical Crisis 21 3 Speculative Manias 33 4 Fueling the Flames: the Expansion of Credit 55 5 The Critical Stage 77 6 Euphoria and Economic Booms 97 7 International Contagion 106 8 Bubble Contagion: Tokyo to Bangkok to New York 123 9 Frauds, Swindles, and the Credit Cycle 143 10 Policy Responses: Letting it Burn Out, and Other Devices 176 11 The Domestic Lender of Last Resort 195 12 The International Lender of Last Resort 211 13 The Lessons of History and the Most Tumultuous Decades Ever 239 Appendix 256 Notes 266 Index 296 v 1403_93651X_02_prevviii.qxd 14/5/05 11:28 AM Page v This page intentionally left blank Foreword Charlie Kindleberger (CPK from now on) was a delightful colleague: perceptive, responsive, curious about everything, full of character, and, above all, lively. Those same qualities are everywhere evident in Manias, Panics and Crashes. I think that CPK began to work on the book in the spirit of writing a natural history, rather as Darwin must have done at the stage of the Beagle – collecting, examining and classifying interesting specimens. Manias, panics and crashes had the advantage over rodents, birds and beetles that they were accompanied by the rhetoric of contemporaries, sometimes with insight, sometimes just blather. It was CPK’s style as an economic historian to hunt for interesting things to learn, not to pursue a systematic agenda. Of course, he was an economist by training and experience, and he soon found patterns and regularities, and causes and effects. What caught his eye especially were the irrationalities that seemed so often to enmesh those directly or indirectly enmeshed in the events themselves. By itself that would have been merely entertaining. The story got interesting for CPK with the interaction of behavior and institutions. The occurrence of manias, panics and crashes, and their ultimate scope, also depended very much on the monetary and capital- market institutions of the time. CPK could not have known at the start just how hardy a perennial financial crises would turn out to be. The quarter-century after the publication of the first edition featured a whole new level of turbulence in national banking systems, exchange-rate volatility and asset-price bubbles. There was always new material to be digested in successive editions. This history cannot have been merely the result of increasing human irrationality, though CPK would have been charmed by what a German friend of ours called ‘Das Gesetz der Verschlechtigung aller Dinge’ (the Law of the Deterioration of Everything). Increasing wealth, faster and cheaper communication, and the evolution of national and international financial systems also played an indispensable role, as sketched in Chapter 13, added to this edition by Robert Aliber. CPK’s effort at economic history found a subject that does not appear to be going out of style. The shape of a ‘new financial architecture’ and the possible utility of a lender of last resort – national and/or international – along with the guidelines that ought to govern it were also among CPK’s preoccupations. Those who are engaged in reforming (or at least changing) the system would do well to ponder the lessons that emerge from this book. One of those lessons is very general, and is most applicable in contexts where irrationality may trump sober calculation. CPK was a skeptic by nature, just the vii 1403_93651X_02_prevviii.qxd 6/7/05 12:56 Page vii opposite of doctrinaire. He mistrusted iron-clad intellectual systems, whether their proponents were free marketeers or social engineers. In fact, he considered clinging to rigid beliefs in the face of disconcerting evidence to be one of the more dangerous forms of irrationality, especially when it is practiced by those in charge. The international economy would be a safer place if CPK’s tolerant skepticism were more common among the powers that be. I am thinking, in particular, about current discussions of the so-called ‘Washington consensus’, and the pros and cons of both freely floating exchange rates and unfettered capital markets. Any reader of this book will come away with the distinct notion that large quantities of liquid capital sloshing around the world should raise the possibil- ity that they will overflow the container. One issue omitted in the book – because it is well outside its scope – is the other side of the ledger: What are the social benefits of free capital flow in its various forms, the analogue of gains from trade? CPK, whose specialties as an economist included international trade, international finance and economic development, would have been sensitive to the need for some pragmatic balancing of risks and benefits. One can only hope that the continued, up-to-date availability of this book will help to spread his open-minded habit of thought. It seems to me that the Aliber version preserves this basic Kindleberger orien- tation but imposes a little more order on CPK’s occasionally wayward path through his specimen cabinets. More manias, panics and crashes may plague us, but readers of this book will at least have been inoculated. R OBERT M. SOLOW viii Foreword 1403_93651X_02_prevviii.qxd 6/7/05 12:56 Page viii 1 Financial Crisis: a Hardy Perennial The years since the early 1970s are unprecedented in terms of the volatility in the prices of commodities, currencies, real estate and stocks, and the frequency and severity of financial crises. In the second half of the 1980s, Japan experi- enced a massive bubble in its real estate and in its stock markets. During the same period the prices of real estate and of stocks in Finland, Norway and Sweden increased even more rapidly than in Japan. In the early 1990s, there was a surge in real estate prices and stock prices in Thailand, Malaysia, Indonesia and most of the nearby Asian countries; in 1993, stock prices increased by about 100 percent in each of these countries. In the second half of the 1990s, the United States experienced a bubble in the stock market; there was a mania in the prices of the stocks of firms in the new industries like infor- mation technology and the dot.coms. Bubbles always implode; by definition a bubble involves a non-sustainable pattern of price changes or cash flows. The implosion of the asset price bubble in Japan led to the massive failure of a large number of banks and other types of financial firms and more than a decade of sluggish economic growth. The implosion of the asset price bubble in Thailand triggered the contagion effect and led to sharp declines in stock prices throughout the region. The exception to this pattern is that the implosion of the bubble in US stock prices in 2000 led to declines in stock prices for the next several years but the ensuing recession in 2001 was brief and shallow. The changes in the foreign exchange values of national currencies during this period were often extremely large. At the beginning of the 1970s, the dominant market view was that the foreign exchange value of the US dollar might decline by 10 to 12 percent to compensate for the higher inflation rate in the United States than in Germany and in Japan in the previous few years. In 1971 the United States abandoned the US gold parity of $35 an ounce that had been established in 1934; in the next several years there were two modest increases in the US gold parity although the US Treasury would no longer buy and sell gold. The effort to retain a 1 1403_93651X_03_cha01.qxd 14/5/05 11:29 AM Page 1 [...]... they were not already in the public sector.) Virtually all of the Mexican banks failed at the end of 1994 when the peso depreciated sharply Most of the banks in Thailand and Malaysia and South Korea and several of the other Asian countries went bankrupt after the mid-1997 Asian Financial Crisis (the banks in Hong Kong and Singapore were an exception) These financial crises and bank failures resulted... euphoria of the economic upswing endangers financial stability only if it involves at least two or more objects of speculation, a bad harvest, say, along with a railroad mania or an orgy of land speculation, or a bubble in real estate and in stocks at the same time The monetary dimensions of both manias and panics are analyzed in Chapter 4 The occasions when a boom or a panic has been triggered by a monetary... This edition appears after thirty tumultuous years in global financial markets, a period without a good historical precedent There was a mania in real estate and stocks in Japan in the 1980s, and a crash in the 1990s; during the same period there was a mania in real estate and stocks in Finland and Norway and Sweden and then a crash There was a mania in US stocks in the second half of the 1990s – the... of the 1990s real estate prices and stock prices in Japan imploded Within a few years many of the leading Japanese banks and financial institutions were broke, kaput, bankrupt, and insolvent, and remained in business only because of an implicit understanding that the Japanese government would protect the depositors from financial losses if the banks were closed A striking story of a mania and a crash... new markets and of new sources of supply and the development of different innovations – the railroad, electricity and e-mail A particular recent form of displacement that shocks the system has been financial liberalization or deregulation in Japan, the Scandinavian countries, some of the Asian countries, Mexico and Russia Deregulation has led to monetary expansion, foreign borrowing and speculative... great explanatory power for earlier crises Financial Crisis: a Hardy Perennial 15 in the United States and in Western Europe, for the asset price bubbles in Japan in the second half of the 1980s and in Thailand and Malaysia and the other countries in Southeast Asia in the mid-1990s, and for the bubble in US stocks, especially those traded on the NASDAQ , at the end of the 1990s The mania phase of the... Crisis: a Hardy Perennial 19 compensation package of more than $150 million; the exchange served both as a tent for trading stocks and as a regulator and it appeared that the managers of some of the firms that were being regulated served as directors of the exchange and participated in determining the compensation package Then a number of large US mutual funds were revealed to have allowed firms to trade... one of several different channels The bubble in Japan in the 1980s had significant impacts on South Korea, Taiwan and the State of Hawaii South Korea and Taiwan were parts of the Japanese supply chain; if Japan is doing well economically, its former colonies will do well Hawaii is to Tokyo as Miami is to New York; Japanese travel to Hawaii for rest and recreation in the sun Hawaii experienced a real...2 Manias, Panics and Crashes modified version of the Bretton Woods system of pegged exchange rates that was formalized in the Smithsonian Agreement of 1972 failed and there was a move to floating exchange rates early in 1973; in the 1970s the US dollar lost more than half of its value relative to the German mark and the Japanese yen The US dollar appreciated significantly in the first half of the... on stale news More individuals have already gone to prison than in the aftermath of any previous crisis, and a number are still awaiting trial Six Enron senior managers already have been jailed One Arthur Andersen partner who worked on the Enron account went to prison Two of the senior financial officials of MCIWorldCom have gone to jail Martha Stewart was found guilty of obstruction of justice and . Manias, Panics and Crashes A History of Financial Crises Charles P. Kindleberger and Robert Z. Aliber Manias, Panics and Crashes 1403_93651X_01_preiv.qxd 14/5/05 11:28 AM Page i Examine. historical precedent. There was a mania in real estate and stocks in Japan in the 1980s, and a crash in the 1990s; during the same period there was a mania in real estate and stocks in Finland and. not already in the public sector.) Virtually all of the Mexican banks failed at the end of 1994 when the peso depreciated sharply. Most of the banks in Thailand and Malaysia and South Korea and