12 Manias,Panics,and Crashes and real estate,and often these declines have been associated with a crash or a financial crisis.Some financial crises were preceded by a rapid increase in the indebtedness of one or several groups of borrowers rather than by a rapid increase in the price of an asset or a security. The thesis of this book is that the cycle of manias and panics results from the pro-cyclical changes in the supply of credit;the credit supply in- creases relatively rapidly in good times,and then when economic growth slackens,the rate of growth of credit has often declined sharply.A mania involves increases in the prices of real estate or stocks or a currency or a ommodity in the present and near-future that are not consistent with the prices of the same real estate or stocks in the distant future.The forecasts that the price of oil would increase to s80 a barrel after the ear- lier increase from $2.50 a barrel at the beginning of the 1970s to $36 at the end of that decade was manic.During the economic expansions in- vestors become increasingly optimistic and more eager to pursue profit opportunities that will pay off in the distant future while the lenders become less risk-averse.Rational exuberance morphs into irrational ex- uberance,economic euphoria develops and investment spending and consumption spending increase.There is a pervasive sense that it is 'time to get on the train before it leaves the station'and the exception- ally profitable opportunities disappear.Asset prices increase further.An increasingly large share of the purchases of these assets is undertaken in anticipation of short-term capital gains and an exceptionally large share of these purchases is financed with credit. The financial crises that are analyzed in this book are major both in size and in effect and most are international because they involve several different countries either at the same time or in a causal sequential way. The term bubble'is a generic term for the increases in asset prices in the mania phase of the cycle.Recently,real estate bubbles and stock price bubbles have occurred at more or less the same time in Japan and in ome of the Asian countries.The sharp increases in the prices of gold and silver in the late 1970s have been tagged as a bubble,but the increases in the price of crude petroleum in the same years were not;the distinction is that many of the buyers of gold and silver in that tumultuous and inflationary decade anticipated that the prices of both precious metals would continue to increase and that profits could be made from buying and holding these commodities for relatively short periods.In contrast many of the buyers of petroleum were concerned that the disruptions in oil supplies due to actions of the cartel and the war in the Persian Gulf would lead to shortages and increases in prices
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 12 Manias, Panics, and Crashes and real estate, and often these declines have been associated with a crash or a financial crisis. Some financial crises were preceded by a rapid increase in the indebtedness of one or several groups of borrowers rather than by a rapid increase in the price of an asset or a security. The thesis of this book is that the cycle of manias and panics results from the pro-cyclical changes in the supply of credit; the credit supply increases relatively rapidly in good times, and then when economic growth slackens, the rate of growth of credit has often declined sharply. A mania involves increases in the prices of real estate or stocks or a currency or a commodity in the present and near-future that are not consistent with the prices of the same real estate or stocks in the distant future. The forecasts that the price of oil would increase to $80 a barrel after the earlier increase from $2.50 a barrel at the beginning of the 1970s to $36 at the end of that decade was manic. During the economic expansions investors become increasingly optimistic and more eager to pursue profit opportunities that will pay off in the distant future while the lenders become less risk-averse. Rational exuberance morphs into irrational exuberance, economic euphoria develops and investment spending and consumption spending increase. There is a pervasive sense that it is ‘time to get on the train before it leaves the station’ and the exceptionally profitable opportunities disappear. Asset prices increase further. An increasingly large share of the purchases of these assets is undertaken in anticipation of short-term capital gains and an exceptionally large share of these purchases is financed with credit. The financial crises that are analyzed in this book are major both in size and in effect and most are international because they involve several different countries either at the same time or in a causal sequential way. The term ‘bubble’ is a generic term for the increases in asset prices in the mania phase of the cycle. Recently, real estate bubbles and stock price bubbles have occurred at more or less the same time in Japan and in some of the Asian countries. The sharp increases in the prices of gold and silver in the late 1970s have been tagged as a bubble, but the increases in the price of crude petroleum in the same years were not; the distinction is that many of the buyers of gold and silver in that tumultuous and inflationary decade anticipated that the prices of both precious metals would continue to increase and that profits could be made from buying and holding these commodities for relatively short periods. In contrast many of the buyers of petroleum were concerned that the disruptions in oil supplies due to actions of the cartel and the war in the Persian Gulf would lead to shortages and increases in prices
Financial Crisis:A Hardy Perennial 13 Chain letters,pyramid schemes,Ponzi finance,manias,and bubbles Chain letters,bubbles,Pyramid schemes,Ponzi finance,and manias are s The neric te asset prices at distant future dates.The Ponzi schemes g renerally involve ises to pay an interest rate of 30 or 40 or 50 nt onth:the s that th schemes alw dis ered a new secret formula so they can earn these high rates of return They make the r omised interes ents for the first few months with the m uad from their n by the prom of return.But by the fourth or fifth month the m these new customers is less than the mo nies pr nised the first sets mers and the e entrepreneurs go to Brazil or jail or both. A chain letter isa lar for the dure is that indivi mid a gem ceive a letter tham t nd $1 (or $10 o $100)to the name at the to of the ramid and to send the same letter to five friends or ac thirty davs 64 for aach ing nt Pyramid arrangements often involve sharing of commission incomes from the sale of securities or cosmetics or food su lements by those whe actually make the sales to those who have recruited them to become sales nal The bubble involves the purchase of an asset,usually real estate or a security not beca ise of the r ate of return on the in estment but in anticination that the asset o can be sold to some ne else at an 、highe erm 'the ater fool'has to the last huve tas always counting stock or the condo artment or the baseball cards could be sold. The ter mania describes the frer zied natte of increase in an increase in trading volumes:indi r to buy before the prices increase further.The term bub ble su ggests that when the prices stop increasing,they are likely almo Chain letters and pyramid schemes rarely have macroeconomic conse nents of the econ my and involve m the late-comers to thos who were ir early Asset iated with e phora and increases in both business and household sp ending because the futures are so much brighter,at least until the bubble pop Virtually every mania is associated with a robust economic expansion but only a few economic expansions are associated with a mania.Still the association between manias and economic expansions is sufficiently frequent and sufficiently uniform to merit renewed study
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 13 Chain letters, pyramid schemes, Ponzi finance, manias, and bubbles Chain letters, bubbles, pyramid schemes, Ponzi finance, and manias are somewhat overlapping terms. The generic term is nonsustainable patterns of financial behavior, in that asset prices today are not consistent with asset prices at distant future dates. The Ponzi schemes generally involve promises to pay an interest rate of 30 or 40 or 50 percent a month; the entrepreneurs that develop these schemes always claim they have discovered a new secret formula so they can earn these high rates of return. They make the promised interest payments for the first few months with the money received from their new customers attracted by the promised high rates of return. But by the fourth or fifth month the money received from these new customers is less than the monies promised the first sets of customers and the entrepreneurs go to Brazil or jail or both. A chain letter is a particular form of pyramid arrangement; the procedure is that individuals receive a letter asking them to send $1 (or $10 or $100) to the name at the top of the pyramid and to send the same letter to five friends or acquaintances within five days; the promise is that within thirty days you will receive $64 for each $1 ‘investment.’ Pyramid arrangements often involve sharing of commission incomes from the sale of securities or cosmetics or food supplements by those who actually make the sales to those who have recruited them to become sales personnel. The bubble involves the purchase of an asset, usually real estate or a security, not because of the rate of return on the investment but in anticipation that the asset or security can be sold to someone else at an even higher price; the term ‘the greater fool’ has been used to suggest the last buyer was always counting on finding someone else to whom the stock or the condo apartment or the baseball cards could be sold. The term mania describes the frenzied pattern of purchases, often an increase in prices accompanied by an increase in trading volumes; individuals are eager to buy before the prices increase further. The term bubble suggests that when the prices stop increasing, they are likely—indeed almost certain—to decline. Chain letters and pyramid schemes rarely have macroeconomic consequences, but rather involve isolated segments of the economy and involve the redistribution of income from the late-comers to those who were in early. Asset price bubbles have often been associated with economic euphoria and increases in both business and household spending because the futures are so much brighter, at least until the bubble pops. Virtually every mania is associated with a robust economic expansion, but only a few economic expansions are associated with a mania. Still the association between manias and economic expansions is sufficiently frequent and sufficiently uniform to merit renewed study
14 Manias,Panics,and Crashes Some economists have contested the view that the use of the term bubble is appropriate because it suggests irrational behavior that is highly unlikely or implausible:instead they seek to explain the rapid increase in real estate prices or stock prices in terms that are consistent with changes in the economic fundamentals.Thus the surge in the prices of NASDAQ stocks in the 1990s occurred because investors sought to buy shares in firms that would repeat the spectacular successes of Microsoft, Intel,Cisco,Dell,and Amgen. The policy implications The appearance of a mania or a bubble raises the policy issue of whether governments should seek to moderate the surge in asset prices to reduce the likelihood or the severity of the ensuing financial crisis or to ease the economic hardship that occurs when asset prices begin to decline Virtually every large country has established a central bank as a domestic lender of last resort'to reduce the likelihood that a shortage of liquidity would cascade into solvency crisis.The practice leads to the question of the role for an international 'lender of last resort'that would assist countries in stabilizing the foreign exchange value of their currencies and reduce the likelihood that a sharp depreciation of the currencies because of a shortage of liquidity would trigger large numbers of bankruptcies. During a crisis,many firms that had recently appeared robust tumble into bankruptcy because the failure of some firms often leads to a decline in asset prices and a slowdown in the economy.When asset prices de- cline sharply,government intervention may be desirable to provide the public good of stability.During financial crises the decline in asset prices may be so large and abrupt that the price changes become self-justifying. When asset prices tumble sharply,the surge in the demand for liquidity may drive many individuals and firms into bankruptcy.and the sale of assets in these distressed circumstances may induce further declines in asset prices.at such times a lender of last resort can provide financial sta- bility or attenuate financial instability.The dilemma is that if investors knew in advance that governmental support would be forthcoming un- der generous dispensations when asset prices fall sharply,markets might break down somewhat more frequently because investors will be less cautious in their purchases of asset and of securities. The role of the lender of last resort in coping with a crash or panic is fraught with ambiguity and dilemma.Thomas Joplin commented on the behavior of the Bank of England in the crisis of 1825,There are times
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 14 Manias, Panics, and Crashes Some economists have contested the view that the use of the term bubble is appropriate because it suggests irrational behavior that is highly unlikely or implausible; instead they seek to explain the rapid increase in real estate prices or stock prices in terms that are consistent with changes in the economic fundamentals. Thus the surge in the prices of NASDAQ stocks in the 1990s occurred because investors sought to buy shares in firms that would repeat the spectacular successes of Microsoft, Intel, Cisco, Dell, and Amgen. The policy implications The appearance of a mania or a bubble raises the policy issue of whether governments should seek to moderate the surge in asset prices to reduce the likelihood or the severity of the ensuing financial crisis or to ease the economic hardship that occurs when asset prices begin to decline. Virtually every large country has established a central bank as a domestic ‘lender of last resort’ to reduce the likelihood that a shortage of liquidity would cascade into solvency crisis. The practice leads to the question of the role for an international ‘lender of last resort’ that would assist countries in stabilizing the foreign exchange value of their currencies and reduce the likelihood that a sharp depreciation of the currencies because of a shortage of liquidity would trigger large numbers of bankruptcies. During a crisis, many firms that had recently appeared robust tumble into bankruptcy because the failure of some firms often leads to a decline in asset prices and a slowdown in the economy. When asset prices decline sharply, government intervention may be desirable to provide the public good of stability. During financial crises the decline in asset prices may be so large and abrupt that the price changes become self-justifying. When asset prices tumble sharply, the surge in the demand for liquidity may drive many individuals and firms into bankruptcy, and the sale of assets in these distressed circumstances may induce further declines in asset prices. At such times a lender of last resort can provide financial stability or attenuate financial instability. The dilemma is that if investors knew in advance that governmental support would be forthcoming under generous dispensations when asset prices fall sharply, markets might break down somewhat more frequently because investors will be less cautious in their purchases of asset and of securities. The role of the lender of last resort in coping with a crash or panic is fraught with ambiguity and dilemma. Thomas Joplin commented on the behavior of the Bank of England in the crisis of 1825, ‘There are times
Financial Crisis:A Hardy Perennial 15 when rules and precedents cannot be broken:others.when they cannot be adhered to with safety.'Breaking the rule establishes a precedent and a new rule that should be adhered to or broken as occasion demands. In these circumstances intervention is an art rather than a science.The general rules that the state should always intervene or that the state should never intervene are both wrong.This same question of interven- tion reappeared with whether the Us.government should have rescued Chrysler in 1979,New York City in 1975,and the Continental Illinoi Bank in 1984.Similarly,should the Bank of England have rescued Baring Brothers in 1995 after the rogue trader Nick Leeson in its Singapore branch office had depleted the firm's capital through hidden transac tions in option contracts?The question appears whenever a group of borrowers or banks or other financial institutions incurs such massive losses that they are likely to be forced to close.at least under their current owners.The United States acted as the lender of last resort at the time of the Mexican financial crisis at the end of 1994.The International Monetary Fund acted as the lender of last resort during the Russian financial crisis of 1998,primarily after prodding by the U.S.and German governments.Neither the United States nor the International Monetary Fund was willing to act as a lender of last resort during the Argentinean financial crisis at the beginning of 2001.The list of episodes highlights that coping with financial crises remains a major contemporary problem. The conclusion of The World in Depression,1929-1939,was that the 1930s depression was wide,deep,and prolonged because there was no international lender of last resort.?Great Britain was unable to act in that capacity because it was exhausted by World War I,obsessed with pegging the British pound to gold at its pre-1914 parity and groggy from the aborted economic recovery of the 1920s.The United States was unwilling to act as an international lender of last resort;at the time few Americans had thought through what the United States might have done in that role.This book extends the analysis of the responsibilities of an international lender of last resort. The monetary aspects of manias and panics are important and are examined at length in several chapters.The monetarist view-at least one monetarist view-is that the mania would not occur if the rate of growth of the money supply were stabilized or constant.Many of the manias are associated with the surge in the growth of credit,bu some are not;a constant money supply growth rate might reduce the frequency of manias but is unlikely to consign them to the dustbins of history.The rate of increase in U.S.stock prices in the second half of the
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= Financial Crisis: A Hardy Perennial 15 when rules and precedents cannot be broken; others, when they cannot be adhered to with safety.’ Breaking the rule establishes a precedent and a new rule that should be adhered to or broken as occasion demands. In these circumstances intervention is an art rather than a science. The general rules that the state should always intervene or that the state should never intervene are both wrong. This same question of intervention reappeared with whether the U.S. government should have rescued Chrysler in 1979, New York City in 1975, and the Continental Illinois Bank in 1984. Similarly, should the Bank of England have rescued Baring Brothers in 1995 after the rogue trader Nick Leeson in its Singapore branch office had depleted the firm’s capital through hidden transactions in option contracts? The question appears whenever a group of borrowers or banks or other financial institutions incurs such massive losses that they are likely to be forced to close, at least under their current owners. The United States acted as the lender of last resort at the time of the Mexican financial crisis at the end of 1994. The International Monetary Fund acted as the lender of last resort during the Russian financial crisis of 1998, primarily after prodding by the U.S. and German governments. Neither the United States nor the International Monetary Fund was willing to act as a lender of last resort during the Argentinean financial crisis at the beginning of 2001. The list of episodes highlights that coping with financial crises remains a major contemporary problem. The conclusion of The World in Depression, 1929–1939, was that the 1930s depression was wide, deep, and prolonged because there was no international lender of last resort.2 Great Britain was unable to act in that capacity because it was exhausted by World War I, obsessed with pegging the British pound to gold at its pre-1914 parity and groggy from the aborted economic recovery of the 1920s. The United States was unwilling to act as an international lender of last resort; at the time few Americans had thought through what the United States might have done in that role. This book extends the analysis of the responsibilities of an international lender of last resort. The monetary aspects of manias and panics are important and are examined at length in several chapters. The monetarist view—at least one monetarist view—is that the mania would not occur if the rate of growth of the money supply were stabilized or constant. Many of the manias are associated with the surge in the growth of credit, but some are not; a constant money supply growth rate might reduce the frequency of manias but is unlikely to consign them to the dustbins of history. The rate of increase in U.S. stock prices in the second half of the
16 Manias,Panics,and Crashes 1920s was exceptionally high relative to the rate of growth of the money supply,and similarly the rate of increase in the prices of NASDAQ stocks in the second half of the 1990s was exceedingly high relative to the rate of growth of the U.S.money supply.Some monetarists distinguish between'real'financial crises that are caused by the shrinkage of the monetary base or high-powered money and'pseudo'crises that do not. The financial crises in which the monetary base changes early or late in the process should be distinguished from those in which the money supply did not increase significantlv The earliest manias discussed in the first edition of this book were the South Sea and Mississippi bubbles of 1719-1720.The earliest manias analyzed in this edition are the Kipper-und Wipperzeit,a monetary crisis from 1619 to 1622 at the outbreak of the Thirty Years War,and the much-discussed 'tulipmania'of 1636-1637.The view that there was a bubble in tulip bulbs in the Dutch Republic followed from widespread recognition at the time that exotic specimens of tulips are difficult to breed,but once bred propagate easily-and hence their prices would decline sharply.3 The early historical treatment centered on the European experiences. The most recent crisis noted in this edition is that of Argentina in 2001. The attention to the financial crises in Great Britain in the nineteenth century reflects both the central importance of London in international financial arrangements and the abundant writings by contemporary ana- lysts.In contrast Amsterdam was the dominant fnancial power for much of the eighteenth century,but these experiences have been slighted be- cause of the difficulties in accessing the Dutch literature The chapter-by-chapter story The background to the analysis,and a model of speculation,credit ex- pansion,financial distress at the peak,and then crisis that ends in a panic and crash is presented in Chapter 2.The model follows the early classi- cal ideas of 'overtrading'followed by 'revulsion'and'discredit'-musty terms used by earlier generations of economists including Adam Smith, John Stuart Mill,Knut Wicksell,and Irving Fisher.The same concepts were developed by the late Hyman Minsky,who argued that the finan- cial system is unstable,fragile,and prone to crisis.The Minsky model has great explanatory power for earlier crises in the United States and in Westem Europe,for the asset price bubbles in Japan in the second half of the 1980s and in Thailand and Malaysia and the other countries
c01 JWBK120/Kindleberger February 13, 2008 14:58 Char Count= 16 Manias, Panics, and Crashes 1920s was exceptionally high relative to the rate of growth of the money supply, and similarly the rate of increase in the prices of NASDAQ stocks in the second half of the 1990s was exceedingly high relative to the rate of growth of the U.S. money supply. Some monetarists distinguish between ‘real’ financial crises that are caused by the shrinkage of the monetary base or high-powered money and ‘pseudo’ crises that do not. The financial crises in which the monetary base changes early or late in the process should be distinguished from those in which the money supply did not increase significantly. The earliest manias discussed in the first edition of this book were the South Sea and Mississippi bubbles of 1719–1720. The earliest manias analyzed in this edition are the Kipper- und Wipperzeit, a monetary crisis from 1619 to 1622 at the outbreak of the Thirty Years War, and the much-discussed ‘tulipmania’ of 1636–1637. The view that there was a bubble in tulip bulbs in the Dutch Republic followed from widespread recognition at the time that exotic specimens of tulips are difficult to breed, but once bred propagate easily—and hence their prices would decline sharply.3 The early historical treatment centered on the European experiences. The most recent crisis noted in this edition is that of Argentina in 2001. The attention to the financial crises in Great Britain in the nineteenth century reflects both the central importance of London in international financial arrangements and the abundant writings by contemporary analysts. In contrast Amsterdam was the dominant financial power for much of the eighteenth century, but these experiences have been slighted because of the difficulties in accessing the Dutch literature. The chapter-by-chapter story The background to the analysis, and a model of speculation, credit expansion, financial distress at the peak, and then crisis that ends in a panic and crash is presented in Chapter 2. The model follows the early classical ideas of ‘overtrading’ followed by ‘revulsion’ and ‘discredit’—musty terms used by earlier generations of economists including Adam Smith, John Stuart Mill, Knut Wicksell, and Irving Fisher. The same concepts were developed by the late Hyman Minsky, who argued that the financial system is unstable, fragile, and prone to crisis. The Minsky model has great explanatory power for earlier crises 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