An essay on “financial crisis: a hardy perennial” and “anatomy of a typical crisis”

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Faculdade de Economia da Universidade Nova de Lisboa





An Essay on


“Financial Crisis: a Hardy Perennial” and “Anatomy of a Typical Crisis”


From Manias, Panics and Crashes: A History of Financial Crises


By Charles P. Kindleberger








Gonçalo Ladeira Dias nº 9765


Inês Ramalho Silva nº 9316







Lisbon
2010

Introduction


In thefirst two chapters of his book Manias, Panics, and Crashes: A History of Financial Crisis, Charles P. Kindleberger tries to explain the financial crises that occurred all over the world since 1970.


In the first chapter – Financial Crisis: A Hardy Perennial – the author looks at how financial crises often accompany peaks in the economic cycle and in chapter two – Anatomy of a Typical Crisis– he looks at the patterns of typical crisis.


Kindleberger notes a recurring pattern is for increased investor optimism as economies expanded – as the economy expanded credit growth accelerated and increasing numbers of individuals start to invest or speculate for short term capital gain, mania, continuing until some trigger event results in bubble bursting, panic and a crash.Development


Kindleberger starts by noting that since the early 1970s the world economies experienced an unprecedented volatility in prices of commodities, currencies, real estate and stocks, and frequency of severity of financial crises.


The author argues that most of financial crises since 1970 resulted from speculative bubbles. We can define a bubble as an unsustainable pattern of changesin prices or cash flows. This concept is based on the appearance of an obsession, as investors begin to purchase assets just because of their expectations of price increases, rather than assets productivity. When these expectations are unrealistic, it leads to a speculative process that ultimately results in the financial system crisis – the bubble bursting.


Before 1970, all countries thatsuffered crises had common traits. Everything starts with an “exogenous ‘displacement’ outside shock to the macroeconomic system” that leads to an increase in demand and consequently to higher prices. The higher prices are an incentive for investors who seek short term profits based on the price of continuous climbing. There is euphoria in progress, where GDP growth is supported by a series ofconsumption and investment fuelled by an expansion of credit supply. After stabilizing prices, investors are relying on price increases to repay their loans that are no longer able to bear its costs and become distress sellers of assets. Thereafter, panic among investors will follow as prices drop dramatically. But a financial crises will only arise if there is no lender of last resort that providesconfidence for the investors and guarantees liquidity in the market, otherwise that could be a “panic without crash”.


Usually financial crises reveal themselves in real estate sector, in stock prices and strong appreciation of national currencies. This volatility often leads to a higher public and private debt. This becomes more dramatic after the bubble burst. In the period of 1970-2000,bubbles in real estate and in stocks have often occurred together.


One of the main points of the text is that bubbles in last decades were systematically related. The author stated that financial crises began in Japan during the 1980’s, mainly in real estate and stock prices and when the bubble imploded it led to an increase in capital outflow that were capital inflows in the USA and Asiancountries. It led to crisis in Asian countries caused by capital inflows, which caused increasing prices, and another bubble burst. It resulted in more accumulation of capital in USA, leading to a financial crisis there too.


The other main point of the text is Kindleberger’s regards on Minsky’s model. This model follows the early classical ideas of “overtrading” followed by “revulsion” and...
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