speaks volumes for the nature of capitalism that a slim
little book first written more than half a century ago
can still seem so fresh and relevant. John Kenneth Galbraith’s
wise and delightfully written tract ''A Short History
of Financial Euphoria'' has just been reissued by Penguin
Books, but one variant of it has been almost continuously
in print since it was first published to mark the twenty-fifth
anniversary of the Great Depression.
As Galbraith himself charmingly notes in his Preface
to the 1993 edition, every time the book was about to
pass out of print, some new speculative episode or disaster
would renew public demand for it. ''Over a lifetime
I have been, in a modest way, a steady beneficiary of
the speculative aberration in its association with more
than occasional insanity. Only a stalwart character
keeps me from welcoming these events as proof of personal
prescience and as a source of small financial reward.''
Galbraith begins with what is now more widely accepted:
that the capitalist economy is prone to recurrent bouts
of speculation. He documents some of the classic examples
from history: ''Tulipomania'' in 17th century Holland;
the frenzy around the Banque Royale created by the remarkable
adventurer John Law in early 18th century France; the
South Sea Bubble just after that in London; the state
debt bubble in the US in the 1830s; the euphoria and
crash of 1929, heralding the Great Depression; and the
more recent Wall Street debacle of September 1987.
Each of these is a fascinating story in itself, perceptively
told. But what is most interesting is how Galbraith
draws upon the commonality of experience in all these
varying episodes to describe what he sees as an essential
tendency in market behaviour.
Usually such episodes begin with what the economist
Charles Kindleberger called ''displacement'' - some
new discovery or invention, a new market, a new economic
policy, or even a feel-good rumour - which captures
the financial imagination and encourages a price rise
in a particular market. As the price of the object of
the speculation goes up, it inevitably attracts new
buyers, who ensure a further price increase, in an upward
spiral providing its own momentum.
The buyers are of two kinds: those who believe that
the market will just keep going up, because economic
realities have changed fundamentally (much as in the
''new economy'' bubble), and those who think they can
ride the wave and jump off before it breaks, so as to
get maximum reward from the rise before what they also
see as inevitable collapse.
In all such events there is a thought that there is
something new, and an element of pride in discovering
what is seemingly new and greatly rewarding as financial
instrument or investment opportunity. But Galbraith
convincingly argues that financial operations do not
lend themselves to innovation. ''All financial innovation
involves, in one form or another, the creation of debt
secured in greater or lesser adequacy by real assets.''
(p. 17) And consequently, all crises essentially involve
debt that in some way or the other has grown dangerously
out of scale with the underlying means of payment.
The moment of the crash rarely comes gently and quietly:
mass disillusion is always accompanied by desperate
(and largely unsuccessful) attempts by the public at
large to get out, when it is already too late.
This seems obvious post facto, but seems to be forgotten
with surprising regularity, reflecting what Galbraith
calls ''the brevity of financial memory''. In the boom,
some new innovation is treated as somehow reducing or
doing away with risk (whether it is supposed increases
in productivity from new technology or instruments like
mortgage-backed securities or credit-default swaps).
Euphoria also involves the widespread perception that
those driving and benefiting from the boom are inherently
brighter and more deserving than others: ''we compulsively
associate unusual intelligence with the leadership of
great financial institutions... In practice (they) are
often there because, as happens regularly in great organizations,
theirs was mentally the most predictable, and, in consequence,
bureaucratically the least inimical of the contending
talent.'' (p. 15) Nevertheless, public fascination with
them, and the sense that with so much money involved
they cannot be wrong, also reduces any tendency they
may have for self-scrutiny. Meanwhile any dissenting
voices are ignored at best or pilloried for their defective
imagination, mental inadequacy or even suspect motivation.
Of course the crash, when it inevitably occurs, changes
the public mood totally. Those who were celebrated are
now scorned as the objects of public anger and recrimination,
and those who received the greatest adulation for their
financial genius are the ones on whom the most opprobrium
Surprisingly, in all the talk of regulation and reform
that ensues in the aftermath of the crash, the basic
reality of the aberrant public optimism that encouraged
the speculation is all but ignored. Instead, some blame
is placed on the more spectacular and felonious of the
previous speculators, but not to all participants who
entered the market, who are seen instead as victims.
Culprits are sought, who are to be punished, and there
is also scrutiny of the same financial instruments that
facilitated and financed the speculative phase. But
there is no questioning of the essential principles
of market functioning that underlay the entire process
of boom and crash.
One reason for this is of course human unwillingness
to accept the widespread naiveté or even stupidity
that was displayed during the period of euphoria. But
a more basic reason for this lack of recognition of
the broader public tendency could be theological: the
sacrosanct nature of markets.
''In accepted free-enterprise attitudes and doctrine,
the market is a neutral and accurate reflection of external
influences; it is not supposed to be subject to an inherent
and internal dynamic of error. This is the classical
faith. So there is need to find some cause of the crash,
however farfetched, that is external to the market itself.
Or some abuse of the market that has inhibited its normal
performance... Markets in our culture are a totem; to
them can be ascribed no inherent aberrant tendency or
fault''. (pp. 23-24)
This is what leads Galbraith to argue that ''there is
nothing in economic life so wilfully misunderstood as
the great speculative episode''. (pp. 107-108) After
such wisdom, his final conclusion is a bit of a disappointment:
''beyond a better perception of the speculative tendency
and process itself, there is probably not a great deal
that can be done.'' (p. 108) He even dismisses regulation
as leading to an ineffective body of law, and suggests
that only a philosophical acceptance of this inevitable
tendency will allow us to cope with it.
Yet the answer as to what is to be done lies in Galbraith’s
own analysis, not even buried but just under the surface.
The nature of capitalism itself and the associated theological
devotion to free markets are clearly at the root of
the problem, and so the solution too has to go beyond
capitalist markets and profit motivation. It may be
too much to expect those who have invested their lives,
imagination and resources in this system to consider
moving away from it, but surely that cannot be true
of the general public. If we are not to be condemned
to keep repeating this unfortunate and even embarrassing
history, we must be willing to understand and move away
from this system.