Manias, Panics, and Crashes
A History of Financial Crises
By Charles P. Kindleberger Robert Aliber
John Wiley & Sons
Copyright © 2005
Charles P. Kindleberger
All right reserved.
ISBN: 978-0-471-46714-4
Chapter One
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 experienced 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 information
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 U.S. 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 U.S. 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 U.S.
gold parity of $35 an ounce that had been established in 1934; in the
next several years there were two modest increases in the U.S. gold parity
although the U.S. Treasury would no longer buy and sell gold. The effort
to retain a 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 U.S. dollar lost more than half of its value relative
to the German mark and the Japanese yen. The U.S. dollar appreciated
significantly in the first half of the 1980s, although not to the levels of
the early 1970s. A massive foreign exchange crisis involved the Mexican
peso, the Brazilian cruzeiro, the Argentinean peso, and the currencies of
many of the other developing countries in the early 1980s. The Finnish
markka, the Swedish krona, the British pound, the Italian lira, and the
Spanish peseta were devalued in the last six months of 1992; most of
these currencies depreciated by 30 percent relative to the German mark.
The Mexican peso lost more than half of its value in terms of the U.S.
dollar during the presidential transition in Mexico at the end of 1994
and the beginning of 1995. Most of the Asian currencies-the Thai baht,
the Malaysian ringgit, the Indonesian rupiah, and the South Korean
won-depreciated sharply in the foreign exchange market during the
Asian Financial Crisis in the summer and autumn of 1997.
The changes in the market exchange rates for these individual currencies
were almost always much larger than those that would have
been inferred from the differences between national inflation rates in
particular countries. The scope of 'overshooting' and 'undershooting' of
national currencies was both more extensive and much larger than in
any previous period.
Some of the changes in commodity prices in the period were spectacular.
The U.S. dollar price of gold increased from $40 an ounce at the
beginning of the 1970s to nearly $1,000 an ounce at the end of that
decade; at the end of the 1980s the price was $450, and at the end of the
1990s it was $283. The price of oil was $2.50 a barrel at the beginning of
the 1970s and $40 a barrel at the end of that decade; in the mid-1980s
the oil price was $12 a barrel and then at the end of the 1980s the price
was back at $40 after the Iraqi invasion of Kuwait.
The number of bank failures during the 1980s and the 1990s was
much, much larger than in any earlier decades. Several of these failures
were isolated national events: Franklin National Bank in New York City
and Herstatt AG in Cologne, Germany, made large bets on the changes
in currency values in the early 1970s and both banks lost the bets and
were forced to close because of the large losses. Crédit Lyonnais, once
the largest bank in France and a government-owned firm, made an exceptionally
large number of loans associated with the effort to rapidly
increase its size and its bad loans eventually cost the French taxpayers
more than $30 billion. Three thousand U.S. savings and loan associations
and other thrift institutions failed in the 1980s, with losses to the American
taxpayers of more than $100 billion. The collapse of the U.S. junk
bond market in the early 1990s led to losses of more than $100 billion.
Most of the bank failures in the 1980s and the 1990s were systemic and
involved all or most of the banks and financial institutions in a country.
When the bubbles in Japanese real estate and stocks imploded, the losses
incurred by the Japanese banks were many times their capital and virtually
all the Japanese banks became wards of their governments. Similarly
when the Mexican currency and the currencies of the other developing
countries depreciated sharply in the early 1980s, most of the banks in
this group of countries failed because of the combination of their large
loan losses and the currency revaluation losses of their domestic borrowers.
Virtually all of the banks in Finland, Norway, and Sweden went
bankrupt when the bubbles in their real estate and stock markets imploded
at the beginning of the 1990s. (Many of the government-owned
banks in these various countries incurred comparably large loan losses
and would have failed if 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 from the implosion
of the asset price bubbles or from the sharp depreciations of national
currencies in the foreign exchange market; in some cases the foreign
exchange crises triggered bank crises and in others the bank crises led
to foreign exchange crises. The cost of these bank crises was extremely
high in terms of several metrics-the losses incurred by the banks in
each country as a ratio of the country's GDP or as a share of government
spending, and the slowdowns in the rates of economic growth. The losses
incurred by the banks headquartered in Tokyo and Osaka-eventually
a burden on the country's taxpayers-were more than 25 percent
of Japan's GDP. The losses incurred by the Argentinean banks were
50 percent of its GDP-a lot of money in yen and pesos and U.S. dollars,
and a much larger share of GDP than the losses incurred by U.S. banks
in the Great Depression of the 1930s.
These bank failures occurred in three different waves: the first at the
beginning of the 1980s, the second at the beginning of the 1990s and
the third in the second half of the 1990s. The bank failures, the large
changes in exchange rates and the asset price bubbles were systematically
related and resulted from rapid changes in the economic environment.
The 1970s was a decade of accelerating inflation, the largest
sustained increase in the U.S. consumer price level in peacetime. The
market price of gold surged initially because some investors relied on
the cliché that 'gold is a good inflation hedge' as the basis for their price
forecasts; however the increase in the gold price was many times larger
than the contemporary increase in the U.S. price level. Toward the end
of the 1970s investors were buying gold because the price of gold was
increasing-and the price was increasing because investors were buying
gold. The Hunt brothers from Texas tried to corner the silver market and
the price of this precious metal in the 1970s increased even more rapidly
than the price of gold.
The prevailing view in the late 1970s was that U.S. and world inflation
rates would accelerate. Some analysts predicted that the gold price would
increase to $2,500 an ounce; the forecasters in the oil industry and in
the banks that were large lenders to firms in the oil industry predicted
that the oil price would reach $80 to $90 a barrel by 1990. One of the
clichés at the time was that the price of an ounce of gold was more or
less the same as the price of twenty barrels of oil.
The range of movement in bond prices and stock prices in the 1970s
was much greater than in the several previous decades. In the 1970s
the real rates of return on both U.S. dollar bonds and U.S. stocks were
negative. In contrast in the 1990s the real rates of return on bonds and
on stocks averaged more than 15 percent a year.
The foreign indebtedness of Mexico, Brazil, Argentina, and other developing
countries as a group increased from $125 billion in 1972 to
$800 billion in 1982. The major international banks headquartered in
New York and Chicago and Los Angeles and London and Tokyo increased
their loans to governments and government-owned firms in these countries
at an average annual rate of 30 percent a year for ten years. The
cliché at the time was that governments didn't go bankrupt. During this
period the borrowers had a stellar record for paying the interest on their
loans on a timely basis-but then they obtained all the cash needed to
pay the interest on these loans from the lenders in the form of new loans.
In the autumn of 1979 the Federal Reserve adopted a sharply contractive
monetary policy; interest rates on U.S. dollar securities surged. The
price of gold peaked in January 1980 as inflationary anticipations were
reversed. A severe world recession followed.
In 1982 the Mexican peso, the Brazilian cruzeiro, the Argentinean
peso, and the currencies of the other developing countries depreciated
sharply, share prices in these countries tumbled, and most of the banks
in these countries failed as a result of the large loan losses.
The sharp increase in real estate prices and stock prices in Japan in
the 1980s was associated with a boom in the economy;
Japan as Number
One: Lessons for America was a bestseller in the country. The banks headquartered
in Tokyo and Osaka increased their deposits and their loans
and their capital much more rapidly than banks headquartered in the
United States and in Germany and in the other European countries; usually
seven or eight of the ten largest banks in the world were Japanese.
Then at the beginning 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-but a crash without a panic, apparently because of the belief that
government would socialize the loan losses.
Three of the Nordic countries-Norway, Sweden, and Finland-replicated
the Japanese asset price bubble at the same time. A boom in real
estate prices and stock prices in the second half of the 1980s associated
with financial liberalization was followed by a collapse in real estate
prices and stock prices and the failure of the banks.
Mexico had been one of the great economic success stories of the early
1990s as it prepared to enter the North American Free Trade Agreement.
The Bank of Mexico had adopted a tough contractive monetary policy
that reduced the inflation rate from 140 percent to less than 10 percent in
a four-year period; during the same period several hundred government-owned
firms were privatized and business regulations were liberalized.
Foreign capital flowed to Mexico because the real rates of return on
government securities were high and because the prospective profit rates
on industrial investments were also high. The universal expectation was
that Mexico would become the low-wage, low-cost base for producing
automobiles and washing machines and many other manufactured
goods for the U.S. and Canadian markets. Because the large inflow of
foreign savings led to a real appreciation of the peso, Mexico developed
a trade deficit that reached 7 percent of its GDP. Mexico's external debt
was 60 percent of its GDP and the country obtained the money to pay the
interest on its increasing foreign indebtedness from the inflow of new
investments. Then several political incidents, partly associated with the
presidential election and transition in 1994, led to a sharp decline in the
inflow of foreign funds, the Mexican government was unable to continue
to support the peso in the foreign exchange market, and the currency
lost more than half of its value in several months. Once again the depreciation
of the peso resulted in large loan losses, and the Mexican banks - which
had been privatized in the previous several years-failed.
In the mid-1990s real estate prices and stock prices surged in Bangkok,
Kuala Lumpur, and Indonesia; these were the 'dragon economies' that
seemed likely to emulate the economic successes of the 'Asian tigers'
of the previous generation-Taiwan, South Korea, Hong Kong, and Singapore.
Japanese firms and European and U.S. firms began to invest in
these countries as low-wage, low-cost sources of supply, much as U.S.
firms had invested in Mexico as a source of supply for the North American
market. European and Japanese banks rapidly increased their loans
in these countries. The domestic lenders in Thailand then experienced
large loan losses on their domestic credits in the autumn and winter
of 1996 because they had not been sufficiently discriminating in their
evaluations of the willingness of Thai borrowers to pay the interest on
their indebtedness. Foreign lenders sharply reduced their purchases of
Thai securities, and then the Bank of Thailand, much like the Bank of
Mexico thirty months earlier, did not have the foreign exchange reserves
to support its currency in the foreign exchange market. The sharp decline
in the foreign exchange value of the Thai baht in early July 1997
led to capital outflows from the other Asian countries and the foreign
exchange values of their currencies (except for the Hong Kong dollar
and the Chinese yuen, which remained rigidly pegged to the U.S. dollar)
declined by 30 percent or more. The Indonesian rupiah lost 80 percent
of its value in the foreign exchange market. Most of the banks in the
area-except for those in Hong Kong and Singapore-would have been
bankrupt in any reasonable 'mark-to-market' test. The crises spread from
Asia to Russia, there was a debacle in the ruble, and the country's banking
system collapsed in the summer of 1998. Investors then became more
cautious and they sold risky securities and bought safer U.S. government
securities, with the result that the changes in the relationship between
the interest rates on these two groups of securities caused the collapse of
Long-Term Capital Management, then the largest U.S. hedge fund.
The immense scope of the financial crashes in the last thirty years reflects
in part that there are many more countries in the international financial
economy and in part that data collection is more comprehensive.
Despite the lack of perfect comparability across different time periods,
the conclusion is unmistakable that financial failure has been more extensive
and pervasive in the last thirty years than in any previous period.
(Continues...)
Excerpted from Manias, Panics, and Crashes
by Charles P. Kindleberger Robert Aliber
Copyright © 2005 by Charles P. Kindleberger.
Excerpted by permission.
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