READING: Charles Kindleberger: Anatomy of a Typical Financial Crisis

From the master of those who know about financial crises and Minskynomics...

From: Charlie Kindleberger, A Financial History of Western Europe: Anatomy of a Typical Financial Crisis:

p. 90 ff: No discretion was allowed in the issuance of bank notes, however.... Sir Robert Peel, the Prime Minister, first contemplated allowing a relaxing power in the 1844 legislation, but ultimately decided against it.... Peel protected himself... in a letter from Windsor Castle, written on 4 June 1844:

My confidence is unshaken that we have taken all the precautions which legislation can prudently take against a recurrence of a pecuniary crisis. It may occur in spite of our precautions; and if it does and if it be necessary to assume a grave responsibility, I dare say men will be found willing to assume such a responsibility (BPP 1847 [1969], Vol. 2, p. xxix).

The difficulty in making the note issue inelastic... is that it became inelastic at all times, when the requirement in an internal financial crisis is that money be freely available....

The Bank of England came to the rescue of the South Sea Company... belatedly, and at a punishing price..,. to dispose of a dangerous rival. Its recognition of its responsibilites in preventing, or at least mitigating, financial crisis in the public interest took more time. There was a lag in understanding the need to have the money supply inelastic in the long run but elastic in the short. A further question was whose task it was to serve as lender of last resort.

Thomas Ashton has stated that... the Bank of England was already the lender of last resort in the eighteenth century.... It is true that the Bank of England was pressured... but its response was, on the whole, reluctant and defensive.... The Bank occasionally took steps that increased the public's fear... 1745... 1772... 1782... 1793....

Critical debate over who should act as lender of last resort... took place behiind closed doors in December 1825.... [Chancellor] Lord Liverpool, having warned the market... that the speculators were going too far and that the government would not save them... threatened to resign if Exchequer bills were provided.... The emergency required action by someone.... Lord Liverpool... applied enormous pressure on the Bank to force it to issue special advances to merchants against inventories....

The lender of last resort function reached full flower under the Bank Act of 1844. 'Overtrading' which Adam Smith held to be the cause of financial crises—which were in his lexicon 'revulsion' and 'discredit'—produced incidents in 1847, 1857, and 1866.... [M]en of responsibility, as foreseen by Sir Robert Peel, figured out a way to suspend the Bank Act.... [T]he Chancellor of the Exchequer issued a letter to the Bank of England...

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p. 270 ff: The macroeconomic system receives some shock--caused by Hyman Minsky, who virtually alone of modern economists is interested in financial instability, a 'displacement' (1982). This displacement can be monetary or real... changes expectations... with respect to the profitability of some range of investments.... [I]t can happen, and historically has happened, that the sum total of all the people reacting to the opportunity is excessive... credit is extended... stimulates business... credit is extended further... euphoria... speculation... more pervasive credit expansion.

Time and time again in these pages it has been stressed that when the macroeconomic system is constrained by a tight supply of money, it creates more, at leaset for a time... bank money, bank notes, bills of exchange, especially chains of bills of exchange, bank deposits, open-book credits, credit cards, certificates of deposit, euro-currencies, and so one....

At some stage... it becomes clear to a few, and then to more, that... positions are extended beyond some limit sustainable in the long run, and that the maintenance of capital gains depends on getting out of assets rising in price ahead of others.... More and more speculators seek to get out of whatever was the object of speculation, to reduce their distended liabilities, and switch into money; and more and more it becomes cleer that not everyone can do so at once. There is a rush, a panic, and a crash--or perhaps the lender of last resort intervenes to make clear it will furnish the market with all the cash it insists it requires. In this circumstance, perhaps belatedly, panic and distress subside....

Historically, the burden of proof runs against a theorist who says that destabilizing speculation is impossible when the record shows displacement, euphoria, distress, panic, and crisis occurring decade after decade, century after century, and noted by such classical observers as Adam Smith in the eighteenth century and Lord Overstone in the nineteenth, quoted with approval by Walter Bagehot (1852 [1978], Vol. 9, p. 273).... Bagehot adds:

Common sense teaches that booksellers should not speculate in hops, or bankers in turpentine; that railways should not be promoted by maiden ladies, or canals by beneficed clergymen... in the name of common sense, let there be common sense…

But history demonstrates that common sense in these questions is uncommon, at least at ten-year intervals....

Whether there is a theoretical rationale for letting the market find its way out of a panic or not, the historical fact is that panics that have been met most successfully almost invariably found some source of cash to ease the liquidation of assets before prices fell to ruinous levels. An important question is who has responsibility to provide that cash....

The lender of last resort role is riddled with... ambiguity, verging on duplicity. One must promise not to rescue banks and merchant houses that get into trouble, in order to force them to take responsibility for their behavior, and then rescue them when, and if, they do get into trouble for otherwise trouble might spread....

[T]he central bank presumably seeks to follow rules of helping only sound houses with good paper. The dilemma is that if it holds off too long, what had been good paper becomes bad.... Lending to sound houses introduces a note of discretion and judgment... questions of insider-outsider, favoritism, and prejudice.... [T]here are bound to be questions raised as to whether the Establishment took care of its own and rejected the outsiders and pushy upstarts...

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