Paul Lachine

The Anti-History Boys

When modern economic historians explain why the world is currently in the grips of a financial crisis and a deep economic downturn, they point to a long train of similar bubbles, crashes, crises, and recessions. Macroeconomists, by contrast, either profess ignorance or offer models that are utterly implausible.

BERKELEY – If you asked a modern economic historian like me why the world is currently in the grips of a financial crisis and a deep economic downturn, I would tell you that this is the latest episode in a long history of similar bubbles, crashes, crises, and recessions that date back at least to the canal-building bubble of the early 1820’s, the 1825-1826 failure of Pole, Thornton ampamp; Co, and the subsequent first industrial recession in Britain. We have seen this process at work in many other historical episodes as well – in 1870, 1890, 1929, and 2000.

For some reason, asset prices get way out of whack and rise to unsustainable levels. Sometimes the culprit is lousy internal controls in financial firms that over-reward subordinates for taking risk. Sometimes the cause is government guarantees. And sometimes it is simply a long run of good fortune, which leaves the market dominated by unrealistic optimists.

Then the crash comes. And when it does, risk tolerance collapses: everybody knows that there are immense unrealized losses in financial assets and nobody is sure that they know where they are. The crash is followed by a flight to safety, which is followed by a steep fall in the velocity of money as investors hoard cash. And that fall in monetary velocity brings on a recession.

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