Table Of ContentFinancial Crises, 1929 to the Present,
Second Edition
M4124-HSU_9781785365164_t.indd 1 07/12/2016 13:22
To my father, John Hsu.
M4124-HSU_9781785365164_t.indd 2 07/12/2016 13:22
Financial Crises,
1929 to the Present,
Second Edition
Sara Hsu
Assistant Professor of Economics, State University of New
York at New Paltz, USA
Cheltenham, UK • Northampton, MA, USA
M4124-HSU_9781785365164_t.indd 3 07/12/2016 13:22
© Sara Hsu 2017
All rights reserved. No part of this publication may be reproduced, stored
in a retrieval system or transmitted in any form or by any means, electronic,
mechanical or photocopying, recording, or otherwise without the prior
permission of the publisher.
Published by
Edward Elgar Publishing Limited
The Lypiatts
15 Lansdown Road
Cheltenham
Glos GL50 2JA
UK
Edward Elgar Publishing, Inc.
William Pratt House
9 Dewey Court
Northampton
Massachusetts 01060
USA
A catalogue record for this book
is available from the British Library
Library of Congress Control Number: 2016949988
This book is available electronically in the
Economics subject collection
DOI 10.4337/9781785365171
ISBN 978 1 78536 516 4 (cased)
ISBN 978 1 78536 517 1 (eBook)
Typeset by Servis Filmsetting Ltd, Stockport, Cheshire
6
0
M4124-HSU_9781785365164_t.indd 4 07/12/2016 13:22
Contents
About the author vi
1 The financial system and roots of crisis 1
2 1930s and 1940s: the Great Depression and its aftermath 17
3 1950s through 1970s: the inter- crisis period 39
4 1980s: emerging markets, debt default and savings and loan
crises 58
5 Early 1990s: advanced countries crises 73
6 Mid-1 990s: Mexican crisis and Asian financial crisis 95
7 Late 1990s and early 2000s: Russian financial crisis, Brazilian
financial crisis, Argentine crisis 119
8 Late 2000s: the Great Recession of 2008 140
9 Global imbalances 175
10 Preventing future crises 181
References 201
Index 235
v
M4124-HSU_9781785365164_t.indd 5 07/12/2016 13:22
About the author
Sara Hsu is an Assistant Professor of Economics at the State University
of New York at New Paltz. Dr Hsu specializes in Chinese economic
development, sustainable development, financial crises, and trade. Prior to
working at the State University of New York at New Paltz, Dr Hsu was a
Visiting Professor at Trinity University in San Antonio, Texas. She earned
her PhD from the University of Utah in 2007 and her BA from Wellesley
College in 1997.
Dr Hsu also worked in the dot-c om industry in New York in the late
1990s and early 2000s, at which time she became interested in the origins
and behavior of financial crises. The Asian financial crisis, Russian
financial crisis, Brazilian financial crisis, and Argentine financial crisis
unfolded over this period, just as the dot- com industry entered a mini- crisis
of its own.
vi
M4124-HSU_9781785365164_t.indd 6 07/12/2016 13:22
1. T he financial system and roots of
crisis
Financial crises have occurred for centuries, and after the Great Recession
of 2008 which began in the United States (US) and spread globally, both
economists and policy makers have realized that economically developed
countries are not immune from such phenomena. After the Asian financial
crisis that began in 1997, much literature was generated which sought to
decrease the volatility of capital flows, but in most studies, these short-t erm
flows were seen as problematic only in combination with underdeveloped
financial systems. Yet at this point, we have witnessed the final death knell
of the efficient-markets hypothesis (according to reasonable economists)
which holds that prices immediately reflect all available information. We
have also watched a key economic figurehead, former US Federal Reserve
Chairman Alan Greenspan, admit that he was wrong in approaching mon-
etary policy from a free market ideology. Free market ideology, in which
markets are viewed as self-c orrecting and symmetric, remains prevalent in
the United States, but cracks in the system can no longer be ignored. As
history has shown, rather than reaching equilibrium, markets can descend
into stagnation without active policy maneuvers. The correct policies are
still subjects of sharp debate.
This book seeks to describe and analyze the events, causes, and
outcomes of crises from the Great Depression to the Great Recession,
unifying a vast amount of literature on each crisis. We start from a
general discussion of the global financial system and the roots of crises,
both theoretical and empirical. We then discuss crises between 1929 and
2011. We briefly discuss select events before 1929, but focus on the Great
Depression and beyond since these crises were created within or bore
the current policies and institutions of our current financial system. Our
approach differs from what we consider the two leading texts on financial
crises (in terms of comprehensive content coverage and analysis), Manias,
Panics and Crashes by Kindleberger (1978),1 and more recently, This Time
is Different, by Reinhart and Rogoff (2009). While Kindleberger discusses
major themes in financial crises from the Dutch Tulip Crisis to the Asian
financial crisis, and while Reinhart and Rogoff analyze empirically several
centuries of crises, we analyze major crises separately to view them in light
1
M4124-HSU_9781785365164_t.indd 1 07/12/2016 13:22
2 Financial crises, 1929 to the present, second edition
of the scholarly consensus on each crisis and of more recent understanding
of financial fragility.
FINANCIAL CRISIS, DEFINED
First we must agree on a definition for financial crises. We know that
we can clearly define a recession in economic terms. Even though there
are alternative definitions outlining the time spans in which a downturn
occurs, a recession is considered a decline in gross domestic product
(GDP) or GDP growth. Financial crises are bigger, confidence- negating
episodes. Liquidity may be lost or frozen, in the case of banking crises, or
currency may lose its value, in the case of currency crises. At what point
does a recession, a credit crunch, an inflationary or deflationary episode, a
payment default, or a change in currency value, become a crisis?
The two classic definitions of financial crises, posed by Hyman Minsky
(1977) and Charles Kindleberger (1978), make use of the notion of
financial fragility. In both definitions, an excessive boom leads to an
inevitable crisis or contraction as part of the natural business cycle and
the unstable nature of finance. In Minsky’s definition, there is a forced
liquidation of assets, a credit crunch, and then a sharp drop in asset prices,
leading to a depression. A lack of prudence and undue financial fervor
(a “mania” in Kindleberger’s terms) bring about a financial crisis.
Minsky, whose work was not popularized in the mainstream media until
the Great Recession of 2008, after his death, viewed financial markets as
essentially fragile and crisis prone, and described three financial postures
that the market can take. The first is hedge financing, in which financial
institutions have sufficient cash to cover principal and interest on debts.
The second is speculative financing, in which institutions can cover i nterest
but not principal; and the third is Ponzi financing, in which financial
institutions cannot cover either principal or interest on debts (Minsky
1991; originally in Minsky 1980).
Within Minsky’s framework, procyclical credit expansions, or increases
in flows of credit in conjunction with an expansionary period during
economic growth, can reverse during contraction and lead to financial
fragility. Finance is stable when the market is successfully operated, and
unstable when events in an uncertain environment push the market into a
precarious position. The increase in the number of financial transactions
and the speed at which they have been performed in the past 30 years have
demonstrated the fragile nature of finance, as the world economy has of
late spent a great deal of time in speculative and Ponzi mode.
In his original work, Kindleberger (1978) first describes the beginning
M4124-HSU_9781785365164_t.indd 2 07/12/2016 13:22
The financial system and roots of crisis 3
of a crisis as a speculative mania, of which there are two stages. The first
stage of a mania is a response to an external shock, such as war; while the
second is related to profit seeking. Secondly, credit expansion aggravates
the mania, and over time, expectations reverse. Kindleberger dubs the
sequence “biological in its regularity.” Financial distress may then develop
into a crisis, triggered by a causa proxima, any event that causes investors
to sell. Hence a crash or panic may ensue. Unlucky countries engaged in
financial activity with the country in turmoil may experience contagion of
the crisis. A wide range of policy responses, from simply doing nothing to
enforcing bank holidays, to using a domestic or international lender of last
resort, may be and have been used.
However, researchers have also used various quantitative measures
to determine crises. Carmen Reinhart and Kenneth Rogoff, American
economists who have written extensively on crises and other macroeconomic
events, construct a database that extends over a period of eight centuries
and provides indicators on the existing financial environment (Reinhart
and Rogoff 2009). Reinhart and Rogoff define inflation crises as infla-
tionary episodes of greater than 20 percent per year, currency crises
as exchange rate depreciations over 15 percent per year, banking crises
as events in which important or besieged (run upon) banks submit to
government takeovers, sovereign default as failure to meet a payment on
the due date, and domestic debt crises as situations where payments cannot
be met or bank deposits are frozen or forced to convert to local currency.
As a result of their analysis, themes emerge from descriptive and
econometric analysis. Reinhart and Rogoff find that almost all countries
experience serial default during the intermediate stages of economic
development, and these occurrences are often accompanied by high
inflation, currency crashes, and devaluation. The authors also find that
periods of extensive financial opening are often followed by domes-
tic banking crises. Looking at data on crises between 1800 and 2006,
Reinhart and Rogoff find that there are five long periods in which coun-
tries are in default or financial restructuring. These conclusions are in
line with the idea that finance is generally unstable, and that increased
instability leads to crisis.
Less comprehensive definitions also exist. Carron and Friedman (1982)
define a financial crisis from a microeconomic perspective, in which some
borrowers face a risk premium arising from unrelated financial develop-
ments, which may induce solvency and liquidity problems. This causes a
banking crisis. Bordo and Wheelock (1998) also define a financial crisis
as a banking panic. These definitions, however, do not account for cur-
rency crises. At the opposite end of the spectrum, Andrade and Teles
(2004) define a financial crisis from a macroeconomic perspective, in which
M4124-HSU_9781785365164_t.indd 3 07/12/2016 13:22
