Byline: William Rees-Mogg
Ihave long been fascinated by the history of financial bubbles andpanics; they are human, dramatic and often very important. I once plantedvariegated tulips in our garden to remind me of the Dutch tulip mania of the1630s, in which a single bulb could be sold for the value of a townhouse, andbrokers traded in tulip derivatives. I wonder what price was fetched bysub-prime tulips.
History can teach us a lot. The credit crunch which has undermined NorthernRock has followed the pattern of the classic panics, even managing to producethe first run on an English bank since the one that affected Overend & Gurneyin 1866.
When one studies the great historic panics, such as John Laws's Mississippischeme in 1719, the South Sea bubble of 1720 or the 1929 Wall Street crash, onecan see that they follow the same pattern. The first phase is one of risingeconomic activity, accompanied by easy credit conditions and rising debt.
This is followed by an inflation of asset values in general and intensespeculation in some particular area, such as the shares of the Mississippi orSouth Sea companies, or American equities in the Twenties, or housing inBritain and the United States in the recent property bubble.
At some point the bubble reaches bursting point. Prices weaken, as they havealready weakened in prime and sub-prime American property, and credit becomesless easily available. Some prominent business runs into difficulties and hasto be rescued or let go. Confidence is undermined and borrowing becomesprogressively more difficult.
At the height of a panic, even solvent businesses cannot borrow money.
At this point, the public begin to feel the pain. There is increasing pressureon the Government to intervene, and that pressure has been hard for moderncentral banks to resist. There are then calls for reforms and reconstructionsof the banking regulatory system. At some point, enough money is put in torestore confidence, and money again begins to circulate.
The world is now in the middle of this process. The storm will take longer towork itself out than most people now expect.
The worst panic in the stock market I can remember occurred on Wall Street inOctober 1987.
According to the Brady Commission, which was appointed by President Reagan toinvestigate the causes of the crash, 'from the close of trading Tuesday,October 13, 1987 to the close of trading Monday, October 19, the Dow JonesIndustrial Average declined by almost one-third, representing a loss in thevalue of all outstanding US stocks of approximately one trillion dollars'. Atrillion dollars is not what it was 20 years ago, but that is still some crash.
The initial stock-market recovery occurred in a year or so, but the longer-termeffects are still with us. Indeed, the current moneymarket panic can beregarded as the grandchild of the 1987 crash. S
Since 1987, there has been an underlying anxiety that a similar crash couldhappen again. In Britain, Nigel Lawson, in many ways an excellent Chancellor,overdid the response, which led to an inflationary surge in 1988-89, and to thelong drawn-out battle against inflation in the Nineties.
In the United States, Alan Greenspan, as chairman of the Federal Reserve, tookhis risks on the side of inflation rather than risk …