As economic activity around the world shrinks at a pace that few expected, the obligatory amnesia of bull markets is now being replaced by a new respect for the past.
Bull markets inevitably lead to the arrogant and ignorant belief that the old rules can be swept away and that economic history is irrelevant. And wiser people who warn that grief has inevitably followed earlier bubbles are scoffed at.
Historian Niall Ferguson recounts a telling episode in his new book, The Ascent of Money. He was invited to speak to a group of bankers at an expensive conference held in the Bahamas in November 2006. “The theme of my speech was that it would not take much to cause a drastic decline in the liquidity that was cascading through the global financial system and that we should be cautious about expecting the good times to last indefinitely. My audience was distinctly unimpressed. I was dismissed as an alarmist,” writes Ferguson.
The tendency to dismiss what happened in the past is less common these days. In fact, as the intensity of the recession in the rich nations increases, the urge to dig deeper into history rises in tandem. And many old and buried ideas are being resurrected.
The initial trek into the past that started after the first credit shock in September 2007 did not go too deep into history. Most economists and analysts were content comparing the downturn—and speculating about the revival—by looking at the mild recessions of the 1990s and the early part of the current decade in the US and Europe. This one was expected to be a repeat of the immediate past.
But they started traveling further back in time when the initial hopes of a quick dip and rebound evaporated. After jumping to the sharp and painful recession of the early 1980s, the debate has now settled into the 1930s: What caused the Great Depression and how can a repeat be avoided in these times?
The D-word has already got an airing in recent weeks. British Prime Minister Gordon Brown said earlier this month that the world needed to agree on monetary and fiscal stimulus to get out of depression. His opponents pounced on him while his media managers dismissed it as a slip of the tongue. But the International Monetary Fund said a few days later that the rich nations are already in depression.
Memories of the gloomy 1930s and greater attention to Japan’s economic stagnation over the past two decades have also helped resurrect economists who provided unconventional explanations for what happened during these two episodes. The old consensus has crumbled.
We have already seen the Keynes revival, as economists have scrambled to learn from the insights of the most influential economist of the interwar years. But others have also got a new prominence. I will just mention two economists here: an American who lived during the Great Depression and a Japanese who has a refreshingly different take on why his country’s economy has stagnated.
Irving Fisher has been the target of several barbs because he made one of the worst market calls ever. He said mere days before the US shares fell off a cliff in the crash of 1929: “Stock prices have reached what looks like a permanently high plateau.”
But Fisher also later came up with an explanation about the depression that followed. This is the debt deflation theory, which essentially says that indebtedness forces families and businesses to sell collateral that pushes down their prices even more and further raises the threat of insolvency. I doubt Fisher is taught to economics students these days. In an article in VoxEU.org, Enrique G. Mendoza of the University of Michigan offers some advice to government around the world: Hire Irving Fisher.
Meanwhile, many are taking a closer look at what Richard Koo of the Nomura Research Institute described earlier this decade as Japan’s balance sheet recession. In an analysis that has striking parallels with Fisher’s prognosis in the 1930s, Koo says over-leveraged Japanese firms trying to reduce debt did not have the stomach for new investment. The fall in the value of pledged shares is creating a milder variant of this problem in India.
The point is not that economists such as Fisher and Koo have the keys to the kingdom. Economists will struggle to explain why economic activity waxes and wanes—and why some recessions can be long, brutish and nasty.
One of the few good things to emerge from the current crisis is that it is has partially rehabilitated heterodox economists such as Fisher, Koo, Hyman Minsky and even John Kenneth Galbraith. And there is a greater respect for economic history.
It is easy to pretend that you are living in unique times when the laws of economics are suspended. But that is only till you get ambushed by reality.
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