Manias, Panics, and Crashes: A History of Financial Crises
Fourth Edition, 2000, John Wiley & Sons, Inc.
Charles P. Kindleberger
Kindleberger reviews 38 financial crises over four centuries from 1618 to 1998 with an overarching theme of needing some kind of a lender of last resort to finally resolve each of these crises. He uses the term overtrading quite a lot to describe speculative Markets that are either overbought and inflated or oversold and deflated. Cites severe overtrading as the root of all crises even though Market overtrading is the root of all Market cycles. Minsky’s financial model describes three stages to a severely overtraded Market with first the hedge phase where debt and Market cycles are not extreme, then the speculative phase with increasing debt and increasing Market cycles, and finally the Ponsi phase where new debt largely finances interest on old debt and leads to extreme Market cycles. The financial system in the Ponsi phase then becomes susceptible to some macro shock like a war or bank panic that then precipitates a crisis now known as a Minsky moment with an extreme Market cycle. Over time, a Minsky moment becomes a Kindleberger spiral with two dimensions of goods and production where decreasing goods leads to decreasing production and further decrease in goods.
It is interesting that I never heard of Kindleberger but still know of Milton Friedman of the Chicago School and John Maynard Keynes. Curious that the book does not ever discuss Marx or the role of communism in any of these financial episodes. Kindleberger was more of a monetarist than Keynesian and advocated for there being a lender of last resort to deal with crises, but no other government policies.
Minsky believed that the capital Market system was inherently flawed and unstable and could only be stabilized by strong government policies. Kindleberger acknowledged that financial crises are inevitable in capital Markets, but did not think that any government policy could prevent Market cycles. Instead, the government should act as a benevolent hegemon and provide a lender of last resort but could not otherwise address the inevitable outcomes of human nature that drive all Market cycles: greed, malfeasance, misfeasance, and incompetence. Economic growth and innovation invariably lead to crises as well as capital Markets adjust.
Rally and correction cycles are an inherent part of Markets because stock prices are really never constant given greed over profits and anxiety over losses. Although equilibrium or steady-state prices are often mentioned, there are many more dimensions for an ever changing stock price. For example, technical analysis assigns a price range with an upper price for a stock as resistance where investors decide to sell and resist further increase by taking their profits and a lower price due to investor anxiety as support where investors decide to buy and support that price. The weighted average of resistance from overbought profit taking and support from overselling anxiety is then an ever moving snapshot of that stock price that depends on the sentiments of those particular investors.
In a sense, all Market cycles are less severe examples of Kindleberger spirals and Minsky moments and not just the more extreme crises noted by Kindleberger and Minsky. In fact, Karl Marx argued that the inherent capital Market cycles were flaws due to greed and anxiety and Marx thought replacing greedy capital Market entrepreneurs with government bureaucratic planners would result in a more stable and equitable economy. Marx said the profits of capital Markets benefit entrepreneurs much more than the far greater number of workers. Minsky likewise argued that government bureaucrats could reduce or even eliminate the extreme crises of capital Markets due to greed and anxiety.
Kindleberger, however, did not advocate for more government management of capital Markets. Rather, Kindleberger advocated for a benevolent hegemon like the U.S. to act as the lender of last resort during severe crises. Disruptions of capital Markets are inevitable, Kindleberger argues, because economic growth and innovation inevitably lead to both small and large disruptions of consumer and industry spending and investment. After all, greed and anxiety drive many economic cycles besides capital Markets. Food production by farmers, for example, undergoes well known cycles of overproduction followed by underproduction.
Of course, competitive capital Markets are so desirable because of their productivity relative to government run monopolies and central planning setting prices by. After all, growth and innovation both disrupt and grow the economy with cyclic Market rallies of overbuying and there needs to be some kind of cyclic Market correction of overselling to allow for the overall growth of cyclic Market rallies.
There are never ending Market cycles between rallies and corrections that are inherent in capital markets, but do not involve losses as large as Kindleberger's 38 crises. Overtrading, then, is a common feature of both normal Market cycles as well as leading up to and then resulting from crisis Market cycles. Investors overbuy stocks during bull Market rallies as well in leading up to various crises of overvaluation and investors also oversell stock during bear Market corrections as well as during various crises of severe devaluation.
