Friday, March 19, 2010
The Age of Instability is published
Posted by David Smith at 12:00 PM
Category: Thoughts and responses

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My new book is out, and available on Amazon for a big discount, and elsewhere. This is a taster from the Introduction to whet your appetite:

Most economic and financial crises follow a set pattern. Either governments and central banks deliberately engineer slowdowns which spill over into recession or there is a big initial economic ‘shock’, such as a sudden rise in oil prices, followed by a series of smaller aftershocks. This was different.

The shocks kept coming and increased rather than decreased in intensity. The initial events, the crisis for some US mortgage lenders, the problems at two Bear Stearns’ hedge funds followed by difficulties at some European banks and then the run on Northern Rock, almost paled into significance in comparison with what followed. Most crises, too, have a finite sense about them. Even in the darkest days you know the mechanisms exist for getting out. In the 2007-9 crisis, in contrast, the slough of despond seemed never-ending.

There were times when, as we shall see, even professionals thought their money was safest under the mattress. In the autumn of 2008, when as we now know the banking system came perilously close to shutting down, the most frequent question I was asked was where people should put their money. There was a straight answer to this which was that for those who had it, they should divide their savings among different banks, staying within the £50,000 compensation limit at each. Similar considerations applied in other countries. The truth was, however, that if the banking system went down there would be no compensation. There would be no economy.

How did we get to such a situation? Can we ever rely on our banks again? Most people have a pretty good general idea about the crisis of 2007-9, a series of economic and financial events that changed the world. The near-collapse of the global banking system was not supposed to happen. In an era of financial globalisation and sophisticated modelling of risk, the manias, panics and crashes of the past had apparently become historical curiosities.

Financial derivatives were based on the idea that parcelling up loans and selling them to a wide range of investors across the globe would spread risk – Alan Greenspan said so. Instead these instruments amplified such risk and produced the biggest collapse of financial confidence in the modern era. It also ushered in a new and more uncertain era which would last beyond the immediate crisis.

And just as there was nothing new in the nature of the panic – except for its scale and global reach – so there was little new in these kinds of shifts in the economic environment. We get comfortable, then we get complacent, then we panic, then we take years to get over it – as was said during the Asian crisis of 1997-8: ‘Confidence grows at the rate a coconut tree grows, but it falls at the rate a coconut falls’.

Thus, the golden age of the 1950s and 1960s was followed by the turbulence of the 1970s and 1980s, a period of high inflation and mass unemployment. This appeared to be the new norm. But the 1990s ushered in a new golden age of stability, in which inflation was low, unemployment fell and the world economy enjoyed its best run for decades. The new golden age lasted until the summer of 2007, surviving smaller crises, terrorist attacks and political upheaval, when it crumbled abruptly. The new instability meant the world could face years of adjustment to the biggest financial shock since the Great Depression.

The aim of this book will be to set the events of 2007-9 into wider context, partly picking up from where an earlier book of mine, From Boom to Bust, left off in the early 1990s, For Britain, that coconut tree of confidence grew over many years – a 16-year period in which the UK did not experience a single quarter of falling gross domestic product – giving rise to Britain’s own version of hubris.

The long timespan is appropriate; the development of the so-called shadow banking system began in the early 1980s, while the era-defining events of 1989 also set in train new economic forces. I have looked at those events, together with the Asian, Russian and hedge fund crises of 1997-98, and the extent to which they were a dress rehearsal for the much bigger crisis a decade later. There is the story of Britain leading up to the crisis and that famous, now embarrassing, phrase beloved of Tony Blair and Gordon Brown, ‘no return to boom and bust’. How could they have been so bold, or so foolish?

No account would be complete without examining the housing boom, both in Britain but also America’s subprime boom. In telling the story of the crisis itself, I have tried to steer a course between detailing every takeaway pizza and expletive as bankers negotiated to save their skins with governments, central bankers and regulators, and not getting too bogged down in it. Important moments may have been inadvertently missed out but there is also a risk of not seeing the wood for the trees. Each one of those crisis weekends probably merited a book itself. There was high drama and there was plenty of it. The book also examines where the crisis leaves the subject of economics and where it leaves the world.