Scams, recessions, crunches and bubbles

Posted by HC in 'Good Business' / 'In the news...' / Controversies / Ethics on 11 September 2008

Evan Davis, BBC Radio 4′s new hip voice of reason, has been introducing slugs of writing about money crises for BBC Radio 4′s latest book – in this case, “books” – of the week. There is a mistake (a category error) lurking in his efforts. The show confuses different sorts of crisis in quite an important way.

Roughly speaking, the problem is this. Capitalism is prone to bubbles, but they really do differ in degree and kind.

Here’s a morphology.

(1) Stock Bubbles
At their most pure (The South Sea Bubble, the 1717 Mississippi Company), these are stock schemes in which there is no actual economic activity. But these readily get confused with, say, the 1990s Internet Bubble – in which there probably was a real business. Greed and irrationality underlies bubbles, but at least in the Internet case, people were aware that something big and real was happening. Tulipmania sits somewhere between the two, as does the art market. Will Damien Hirst’s productions get melted down for their gold?

(2) New instruments
John Law, who was behind the Mississippi Company, also came a cropper when he tried to engineer a new currency for France. But he wasn’t operating as a crook when he did the latter: he was inventing new approaches to currency and was – hardly surprisingly – out of his depth. 

This is a little like the muddle modern banking has got into as it recently sliced and diced sub-prime debt.

Indeed, many of these dramas turn out to be schemes which are crucial to capitalism’s future – it’s just that the pioneers don’t post large enough warnings as to the riskiness of innovation.

(3) Straight frauds
Some bubbles and some new instruments are introduced as straight frauds, or as screens behind which straight frauds can be perpetrated. Thus, Enron’s crime was very like the fraud perpetrated by Jabez Balfour in the late 19th Century. Enron was playing with energy futures and other devices which few people understood, just as Jabez was playing with new schemes for insurance and housing.

Enron and Jabez were developing schemes which in non-criminal hands would turn out to be valuable.

In conclusion…..
Many capitalist pioneers turn out to be crooks. Or, many crooks turn out to be pioneers. It’s spotting the difference which makes for entertainment.

Anyway, there are no signs of crookedness in the present crisis. Regulators encouraged bankers to get careless as they invented new wheezes. The bankers overdid it. The bubble burst.

The books excerpted in the R4 series
The Science of Getting Rich by Wallace D Wattles
The Moneymaker by Janet Gleeson
Little Dorritt by Charles Dickens
Liar’s Poker by Michael Lewis
When Genius Failed by Roger Lowenstein
Metamorphoses XI by Ovid 
Tulipmania by Anne Goldgar
The Bonfire of the Vanities by Tom Wolfe
The Reformation of Manners by Daniel Defoe
The Great Crash 1929 by John Kenneth Galbraith
The South Sea Bubble by John Carswell
Tulipmania by Anne Goldgar
The South Sea Bubble by John Carswell
Extraordinary Popular Delusions by Charles Mackay
The Age of Turbulence by Alan Greenspan
A Short History of Financial Euphoria by John Kenneth Galbraith

I would add:

Millionaire: The philandere, gambler and duelist who invented modern finance, by janet Gleeson
Jabez by David McKie

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