In the opening session of the 64th CFA Institute Annual Conference in Edinburgh, Scotland, Liaquat Ahamed, former CEO of Fisher Francis Trees & Watts and author of the Pulitzer–Prize winning book Lords of Finance: The Bankers Who Broke the World, argued that although the causes of the recent financial crisis and the 1929 crash and Great Depression are eerily similar, the ways in which these crises have been handled by policymakers are quite different.
Ahamed observed that in both cases heavy dependency on foreign borrowing—in the 1920s, Europe’s dependency on the United States; in today’s economy, the United States’ dependency on Asia—resulted in massive asset bubbles. This time around, we’ve seen U.S. real estate replace the stock market as the source of irrational exuberance. In addition, as a consequence of the weak fiscal positions in many Western economies at the outset of major crises, “the patient went into these problems with an underlying chronic disease which has truly hampered the [authorities’] ability to make the medicine work,” Ahamed explained. “Budget deficits were too high, limiting the opportunity to use countercyclical fiscal policy,” he said. The locus of the most recent crisis was the same, but Greece, Ahamed contended, is today’s Germany.
In their response to the 2008 global financial crisis triggered by the credit crisis, policymakers “got the medicine correct.” But in the 1920s, Ahamed claims that the authorities took “a very sick patient, diagnosed [it] incorrectly, and eventually killed the patient.” Ahamed pointed to the combination of allowing bank failures without intervention, the demonizing of fiscal expansion and deficits at any cost, and the decision to raise interest rates as critical errors in the handling of the earlier crisis.
Ahamed also pointed out that the size of the financial sector is much greater today than it was at the outset of the Great Depression, making it both more difficult and more important to ensure stability. The U.S. financial sector is valued at 1.5 times U.S. GDP, while the UK’s financial sector is roughly 400% of UK GDP. By contrast, the U.S. financial sector in 1929 stood at just 50% of U.S. GDP. “We’ve created a financial Frankenstein and we’re really not sure how to stabilise it,” said Ahamed.
The author likened today’s global trend of quantitative easing to the competitive and uncoordinated fashion in which most countries abandoned the Gold Standard after 1933. But unlike the ensuing currency wars that ultimately led to unprecedented trade barriers, particularly in France and Germany, Ahamed is cheered that protectionism has not resurfaced. Still, he is concerned that the United States’ demotion from its role as the clear leader of the international financial system may create a vacuum in terms of policy direction that is akin to the interwar years, when the UK lost its top position in the global economic order.
“There is no question that the U.S. is not in a position to act as the leader in the same sort of way [as it has],” Ahamed contended, “and there’s no other obvious candidate for the role of world economic leadership.”
So when it comes to financial crises, how can we avoid repeating history? Ahamed offered three prescriptions for economic policymakers: 1) Avoid dogmatism; 2) Try lots of things (in the style of former U.S. President Franklin D. Roosevelt, the architect of the New Deal); and 3) Be very modest about the cures that are promised to sick patients.