“Economic crisis are the financial equivalent of a heart attack. If handled properly, they need not be fatal,” said Pulitzer winning author, Liaquat Ahamed, on Wednesday.
Delivering the 13th Vasant J Sheth Memorial Lecture in the city on ‘Financial Crises: Lessons in History’, Ahamed said the collapse of a ‘bubble’ does not always end in a crises citing the dot.com bust of 2000 that had no run off on the financial system.
“Bubbles result in net positives for the economy. The surge in optimism leads to investment in infrastructure,” said the former hedge fund manager. “A bear market purges the system. It becomes dangerous when large amount of borrowed money is at stake as during (the Great Depression of 1929) and the recent economic slowdown.”
He said when banks get into trouble, the whole economy is in trouble. “The business of banking is based on a giant bluff,” he ribbed adding how banks take money from one and lend it to another relying on premise that not all will pull out their cash.
In his book, Lords of Finance: The Bankers Who Broke the World, Ahamed traced the events that led to the Great Depression through the lives of four central bankers who dominated that postwar era: Benjamin Strong (Federal Reserve Bank of New York); Montagu Norman (Bank of England); Émile Moreau (Banque de France); and Hjalmar Schacht (Reichsbank).
A proponent of central banking, Ahamed said that while central banks cannot prevent bubbles they can control financial crises by ensuring that banks have enough capital and that they don’t rely on short-term sources of money.
A classic bubble, he said takes shape when “speculators buy what they recognise as an over-valued item on the hope of selling it at a greater price to a greater fool”.
The Tulip bubble in the seventeenth century, where Europe became so obsessed with the bulbous flower that each cost more than the cost of ten bottles of the good Bordeaux wine, he said embodied all ingredients of a classic bubble.
He added that even Isaac Newton fell prey to the South Sea Bubble (1720) and on losing a small fortune was quoted as saying, “I can calculate the movement of stars but not the madness of men”.