Manias, crashes, panics and human nature

Written by Chris Huhne MEP and published in the New Statesman on Mon 4th Mar 2002

'Rainbow's end: the crash of 1929' by Maury Klein, published by Oxford University Press on 24th January, at £22.99.

The Great Crash of 1929 still grips the popular imagination like no other financial event in history, throwing forward its shadow even today. The speed of the interest rate cuts in the United States over the last sixteen months is testimony not only to deteriorating present circumstances but to old nightmares.

There are parallels between then and now, after a long period when capitalism diverged from its pre-1929 form. The 1929 crash was the last and worst of the financial panics that were a cyclical feature of nineteenth century capitalism on both sides of the Atlantic. It took until 1954 for share prices to recover the giddy heights of that flapper girl summer, and by then the world and its economy had been remade by the climacteric of war, Keynesian full employment and stabilising welfare states.

The Keynesian golden age lasted until 1971, and essentially broke down for two reasons. First, policymakers suffered hubris and overused their armoury. They failed to recharge their fiscal guns in the good years, leaving them weaponless in the bad ones. Secondly, we lost our fear of depression and unemployment, which had been such a disciplining characteristic of those with a folk memory of the thirties. From 1968 - another year of manias - the labour market consensus on which the Keynesian era had been built began to break down. The global response was to recreate Marx's reserve army of the unemployed, and to camouflage the reality with talk of markets and laissez faire.

Of course, not all the institutional features of the post-war period have changed. Since more than two thirds of the shares quoted on the London Stock Exchange are owned by pension funds and insurance companies for the support of the workforce in distress and old age, we live formally in a system that our forebears would have recognised as socialism: the common ownership of the means of production. But in other ways, the financial markets themselves are resuming the central role that they had in the older form of capitalism. As we grow richer, we save and invest more. As we age as societies, we need larger pools of financial assets from which to draw retirement income. And the markets themselves, whatever their underlying ownership, continue to be as unstable as ever.

The essential problem is that the value of assets today depends on expectations about their future returns, and there is nothing so uncertain as the future. Add to that uncertainty the proven enchantment of human beings with each others' obsessions - just look at the craze for Pokemon cards, or fans at football matches - and you have the mixture that took the same FTSE-100 to 6541 in March 2000 and 5191 in January 2002.

If there is a general truth about great crashes, it is that they follow great bubbles. However, attempting to forestall excessive euphoria is more difficult than it looks in hindsight. The stock market bulls dubbed the twenties the 'New Era' because of the introduction of the mass produced Model T Ford, the radio, the film and widespread use of electricity and electrically powered appliances like the Frigidaire. The stock market bulls dubbed the nineties the 'New Economy' because of the widespread introduction of personal computers, internet, e-mail and mobile telephony. In both cases, there was - maybe is - a plausible case that technological innovation is improving trend productivity, growth and hence profits. That in turn levers up share prices by a multiple of the expected profits increase.

There are some clear improvements on 1929. There are stricter rules about buying shares with borrowed money these days: in the twenties, speculators could put up as little as 10 per cent of the value of the stock they bought. If its value fell thirty per cent, they had to make up the difference with more cash. And if they could not, the broker sold the stock, adding more shares to the selling that drove prices down and down and contributed to the beginning of the great depression. Another difference is that the high amount of institutional ownership and tax-supported fund ownership (like the 401k funds in the USA) means that people appear to be less sensitive to share prices than, say, house prices when they decide whether to spend money.

Maury Klein's history is a vivid picture of life on the eve of, and during, the Great Crash. He is particularly good in describing the way in which the mania infected every part of US society and how it made social relations crumble when the Crash came. Claud Cockburn, the Times correspondent with a knack for being posted in the right place at the right time, was lunching with a Wall Street grandee at his house in Washington Square on one of the worst days of the crash. During the meal, there was a commotion from below stairs, until a servant came bursting in to alert their master to a further sharp fall in the market. They too had been investing in the market, and they had a tickertape in the kitchen.

Klein's book, though, will disappoint those who want analysis and explanation. Fortunately, J.K. Galbraith's The Great Crash 1929, first published in 1954, is as fresh as ever even though the price is now £8.99, rather higher than the 30 pence on my own dog-eared copy from 1971.

Chris Huhne, a former economics editor of the Guardian, is Liberal Democrat MEP for South East England.