Here's the Proof that Banking Crises Simply Don't Need to Happen. Period.
I recently watched a presentation that exposed the kind of intergenerational amnesia that is killing the hopes and dreams of humanity today, especially for Millennials and Gen Z.
The presentation was by Moritz Schularick, an economist that I deeply respect for having stewarded the compilation of some of the first multi-country and multi-century economic datasets that include data points on bank money creation.
In his talk, Moritz was explaining that he and his team have been analyzing dozens of banking crises in seventeen countries over a 140 year period.
Dear reader: If hearing “banking crises” doesn’t put your nervous system on high alert, you may not be aware of Moritz’s earlier work showing that bank-led credit crises trigger our most destructive economic crises. Economic recessions caused by bank lending booms and busts have longer and deeper periods of unemployment, more bankruptcies and foreclosures, and worse debt crises for households, businesses, and governments. So, if you dislike living through economic crises, you should be very concerned about banking crises!
During his talk, Mortiz showed the following chart detailing all the banking crises that have taken place since 1870 in seventeen countries, which I’ve re-created to remove distracting text:
After speaking about all the things his team had learned by studying how central banks had responded to each of the banking crises, Moritz received a question from a leading economist for the Bank of France:
“On the table there was almost nothing between 1930 and 1990. There is a big chunk in the table which is blank. So I was wondering: Is it true that there were no banking or financial crises at that time?”
- Bussiére Matthieu, Phd, Director of the Directorate, Economics and International and European Relations, Banque de France
Now, just to put this in perspective, you need to understand that the Bank of France is France’s central bank. As the bank’s director of economics and international relations, Bussiére is an active participant in international negotiations about how the Euro currency is managed by the European Central Bank. He also is involved in decisions about how European central banks regulate the banks in their countries to ensure stability.
With this one comment Bussiére revealed that the experts currently tasked with ensuring banking stability for an entire continent are likely to also be unaware that a previous generation of economic leaders figured out how to not have any banking crises, at all, for thirty straight years.
At least, if Bussiére is unaware that there even was a 30 year period without a single banking crisis and Bussiére is participating in high-level monetary policy and bank regulation conversations in the EU, it seems safe to assume that today’s European monetary and banking leaders are not having urgent conversations about why their leadership is completely failing to match the perfect stability achieved by a previous generation of leaders between 1940 and 1970.
A previous generation of economic leaders figured out how to not have any banking crises, at all, for thirty straight years.
This is stunning for a lot of reasons
For one, Moritz’ 2012 dataset isn’t the first one to highlight this wondrously tranquil period in banking history. Even before the 2008 financial crisis, a team of researchers at Harvard Business School had compiled a similar dataset that covers 66 countries, which revealed the same pattern, shown here in one of their 2013 papers:
The leaders of that Harvard study, Carmen Reinhart and Kenneth Rogoff, even wrote an influential book in 2009 which identified intergenerational amnesia as a culprit in banking crises: “short term memories make it all too easy for crises to recur.”
Unfortunately, Carmen and Kenneth made some mistakes in their analysis and came to the incorrect conclusion that austerity is a good solution to banking and financial crises. The fact that many politicians around the globe cited their analysis when passing austerity cuts post-2008 is a devastating lesson in the dangers of drawing causal conclusions from data correlations.
Nevertheless, their analytical errors don’t change the fact that by 2009 and 2012 there were multiple highly-cited datasets shining a bright light on the 1940-1970 era as being a high-water mark in the history of banking stability, and therefore economic stability. Certainly, it was a remarkably better banking era than what came before and what we’ve experienced since.
Banking Crises vs Wellbeing
Between 1940 and 1970, the countries that had zero banking crises experienced significant increases in public investment, such as new schools and universities, affordable housing, hospitals and healthcare, parks, and more. Employment and wages rose for the working classes, creating middle classes. Household savings rose and leisure time increased. Debt levels, poverty, and inequality went down substantially.
To illustrate how much of a difference it makes for societies to be able to build their communities on the solid ground of an economy that is free of banking crises, I like to flip Carmen and Kenneth’s chart upside down so that the crises appear as crevices that open up under households. The truth is that that banking crises are economic earthquakes that crack open the ground and swallow-up the hopes, dreams, and investments of generations.
With the chart flipped like that, the flat line of the 1940-1970 era reflects what it was: stable ground on which to build a healthy society. I hope that people see it and get curious about or even envious of the economic stability of that era. Maybe even get a little angry, too. Why did only one generation get to enjoy the hard-earned discovery that banking crises are completely avoidable before the wisdom was lost???
Why does a leading central bank economist not know all this?
Why are Bussiére and his colleagues in the leadership ranks of European central banks not anxiously comparing their own performance to that high-water mark era?
I’d love for someone to study that question extensively. Tracing the loss of the wisdom that guided economic leaders during the 1940s, 50s, and 60s would be a good way to learn how to stop such intergenerational amnesia in the future. But for now…
The important thing to observe is that, today, some of the economists leading our monetary systems are not aware that banking crises are completely avoidable.
In some sense, this shouldn’t come as a surprise considering how much we hear our central banks talk about “promoting stability” instead of “permanently eliminating instability”. They simply don’t have an abolition mindset – even though history shows that abolishing banking crises is completely within our ability. Not just in theory, but in practice.
So what exactly did so many countries do at the same time to completely eliminate banking crises?
That’s a big story that will have to be told in another post because countries took diverse pathways to achieve the same goal of ending banking crises. (The fact that today’s leaders can’t find even one pathway to completely eliminate banking crises is damning in consideration of the historical evidence that there are multiple ways that work.) At a high level, the pathways that countries took included one or more of these elements (and this is a non-exhaustive list):
The subordination of the banking sector to government-led economic development policies. There were multiple ways of doing this, which can be found in the literature under keywords such as “financial repression”, “fiscal dominance”, “credit segmentation”, “credit guidance”, “public banking”, and “bank nationalization”)
Joining international monetary system agreements that obligated countries to cooperate in stabilizing exchange rates and stopping money from flowing across borders in rapid and harmful ways (speculative “hot money”).
Government regulation of interest rates to keep borrowing costs low and stable.
The creation of new money specifically for funding government priorities (“monetary financing”)
I don’t have the time at the moment to curate a bibliography of the best papers and books on each of those strategies, but if you tell me you are interested in that, I will come back and add that. So let me know!
In general, all of these measures had a common goal, which was to ensure that the legal privilege to create money was being directed into the service of public priorities.
Since I don’t have the capacity to go into that in depth, I hope you will embrace knowing that if you want to be a banking crisis abolitionist, that is an entirely reasonable position. No one can tell you that it can’t be done. It’s been done already in dozens of countries for decades at a time!
Thanks for reading my blog! Subscribe for free to receive new posts and support my work.