Author: Robert Z. Aliber
Robert Z. Aliber
Reading time: 24 minutes
Synopsis
Manias, Panics, and Crashes (1978; 8th edition 2023) looks at financial problems over 300 years. It finds common patterns in market ups and downs. It shows how people buying risky things, too much lending, and great excitement have often caused fear and market crashes. This has happened in different times and types of economies. The book uses examples from history, like the South Sea Bubble and the 2008 financial crisis. It helps us understand why money problems always happen in economies that use a lot of credit.
What’s in it for me? Learn the common steps every financial crisis follows.
In 1720, shares of the South Sea Company quickly went up from £100 to over £1,000 in just a few months. Investors rushed to buy them because the company had special rights to handle British government debt. But by September, the price fell back to £100. Many people lost all their money. This caused a huge crisis. The government even took the property of the company directors. Even 300 years later, this story still feels very familiar.
Manias, Panics, and Crashes: A History of Financial Crises by Robert Z. Aliber, Charles P. Kindleberger & Robert N. McCauley helps us understand why money systems often break down. Over 300 years of financial problems – from the South Sea Bubble to the 2008 Global Financial Crisis and even cryptocurrency crazes – the same steps happen again: something new happens, people take risks, more money is lent, everyone feels too happy, then problems start, and finally, fear spreads. People always think “this time it will be different.” But the basic reasons are always the same.
In this Blink, you’ll learn how financial problems start. You’ll also see why four big financial problems since 1980 were linked by money moving around the world. You’ll understand how central banks became the main helpers for the whole world when there were money problems. You’ll learn why warnings often don’t work. You’ll also see why cheating increases when markets are good, and why saving companies from failure encourages them to take more risks later. Finally, you’ll see how these old patterns appear in the Bitcoin craze and China’s property problems. This shows that money problems are a basic part of the system, not just random mistakes. Let’s get started.
Blink 1 – How financial crises develop
Financial crises follow a very similar pattern, no matter the time or place. Economist Hyman Minsky showed that lending naturally grows when times are good and shrinks when times are bad. This natural change is a basic part of how money systems work.
A crisis happens in six steps: something new happens, people take risks, more money is lent, everyone feels too happy, then problems start, and finally, fear spreads. The cycle starts with something new happening from outside, which changes how much profit people expect. This could be a new technology, the end of a war, a very good harvest, or new rules that make it easier to lend money. If this new event is big enough, it creates chances for new profits. People start buying things just to sell them later for more money. They do not buy for use or regular income. People borrow more money to buy these things, seeing others make money. This creates a fast growth in the market, or a ‘boom’.
Minsky created three groups to show how strong companies are based on their debts. Companies in the “Hedge finance” group make enough money to pay all their debts easily. “Speculative finance” companies can pay the interest on their loans. But they need to borrow again to pay back the main amount of the loan when it’s due. “Ponzi finance” companies cannot even pay the interest from their normal business. They have to borrow more or sell things just to keep up with payments. When the economy grows, companies move up these groups in a risky way. Safe companies become speculative, and speculative companies become like Ponzi schemes. Good times make risky ways of handling money seem okay.
More lending makes things speed up. Almost every market craze happens because a lot of money is lent quickly. This happens in ways that normal money rules cannot stop. When leaders try to stop lending in one way, the system finds new ways. Examples include bills of exchange in the 1800s, the Eurodollar market in the 1960s, and mortgage-backed securities in the 2000s.
New financial products make crises worse. This is because companies compete and are new to these products. So, they price new products too low. These new products seem to spread out risk. But often they just hide it. In the 1980s, ‘junk bonds’ promised high profits. But these profits were not enough to cover the losses when people did not pay back loans. Certain home loan products seemed to put the risk in some parts, making other parts safe. This worked until a big economic downturn happened.
Normal ways of measuring money in the economy often don’t warn us about problems. Lending grows through ‘shadow banking’ (less regulated lenders), money moving between countries for large loans, and lenders who are not banks. These ways are not watched by normal systems. The US housing bubble shows this: the amount of money measured in the economy did not grow much. But lending grew a lot through special home loan products, funded by big loans and money from other countries.
In the ‘euphoria’ phase, good news makes more good news. Prices go up, creating chances for new profits. This brings in more investors, which pushes prices even higher. Banks want to get more customers. They report high profits as the value of things used as loan security goes up. So, they lend more easily, even when they should be very careful.
Finally, money problems appear. Something happens, like a company going broke, cheating being found out, or a change in government rules. This changes what people expect. News of the problems spreads. People might quickly try to get their money back. Everyone tries to sell what they own for cash. It can become a wild rush. When prices fall, people get demands for more money. They are forced to sell, which makes prices fall even more. Fear grows by itself. The money system stops working. No one lends money. Selling of assets spreads quickly through all parts of the market.
This crisis pattern has happened many times in history. But since the 1980s, there have been four clear waves of crises. When one crisis ended, it caused the next one. This happened because money moved from one country to another. That’s what we will look at next.
Blink 2 – Four waves: evidence in action
Four big financial crises happened around the world from the early 1980s to 2008. Each time a crisis ended, money moved somewhere else. This created the next big rise in prices, or ‘bubble’. This pattern was not by chance, but followed a system. When some countries had a crisis, money moved to new countries. This set up the next period of fast growth and then crash.
The first crisis wave started with a lot of lending in the 1970s. This led to a crisis in the early 1980s. In the 1970s, banks from different countries had a lot of dollars. They lent a lot of money to Mexico, Brazil, Argentina, and other developing countries. These countries’ debts to foreign banks grew by 20% each year. But the interest they paid was only about 8%. This could not last. In October 1979, the US central bank (Federal Reserve) made money much harder to borrow. Interest rates on dollar investments went up very fast. The dollar became much stronger. By the early 1980s, the money of developing countries lost a lot of value. Many borrowers could not pay back their loans.
After 1985, the dollar became weaker. This helped create a market bubble in Japan. Japan was selling many goods to other countries, so its money (the yen) was getting stronger. The Bank of Japan (Japan’s central bank) tried to stop this. They bought dollars and kept interest rates low. This put a lot of money into banks. Rules for lending money for property were made easier. Lending and asset prices grew very fast. By 1989, the total value of all stocks in Japan was twice that of the US. This was even though Japan’s economy was less than half the size of the US economy. When lending growth was finally slowed down in 1990, stock prices fell 30% in 1990. They fell another 30% in 1991.
When Japan’s bubble burst, Japanese companies moved their factories to Southeast Asian countries. These countries had lower costs. A lot of money was invested in Thailand, Malaysia, Indonesia, and South Korea. Stocks in ’emerging markets’ became a popular new investment. Stock prices went up by 300% to 500% in the first half of the 1990s. Banks borrowed US dollars from other countries to support a lot of lending at home. In July 1997, Thailand could no longer keep its currency linked to the US dollar. In six months, the money in these countries lost 30% or more of its value. Stock prices fell by 30% to 60%. Most banks outside Singapore and Hong Kong went out of business.
When Asian countries paid back their foreign loans, money moved quickly to the West. The Federal Reserve lowered interest rates three times because of the Asian crisis. This helped create a stock market bubble that reached its highest point in 2000. When that bubble burst, money moved to property. From 2002 to 2007, property prices went up very fast in the United States, Britain, Ireland, Spain, and Iceland. Special home loan products in the US and big loans from international markets made it seem like there was endless money to lend. Money invested in Iceland from other countries was 20% of its total economy each year. The collapse started in 2006 with US housing. It then spread to other areas until 2008.
These four waves show a clear system: each crash made money move, which created the next market bubble. To know if a loan is risky, you cannot just look at what is happening in one country. It is very important to know where money is moving around the world and why. This helps to guess where the next big increase in lending will be.
Blink 3 – Central bank dilemmas when managing crises
Knowing how crises happen is one thing. Dealing with them is another. When lending stops and asset prices fall sharply, central banks face a difficult choice that always comes up. Should they give out as much money as needed, which might make banks take too many risks later? Or should they do nothing and watch healthy banks fail as problems spread?
Walter Bagehot explained a main rule in 1873. He said central banks should lend as much money as needed to banks that are good but just don’t have enough cash right now. They should ask for good assets as security. And they should charge higher interest rates than normal. These higher rates make sure banks only ask for help when no one else will lend to them. Lending enough money stops banks from having to sell their assets very cheaply. Such cheap sales can make even good banks go broke as asset prices fall.
There is a big problem called ‘moral hazard’. If bank managers think they will always be saved, they will take too many risks when times are good. But if central banks do not help, there is another danger. Each bank might try to sell its assets. This makes sense for one bank, but if all banks do it, it hurts everyone. It also spreads problems to healthy banks.
The hard part is telling the difference between a bank that just doesn’t have enough cash (illiquid) and one that is truly broke (insolvent). Whether a bank is truly broke depends on the value of its assets. But during a panic, asset prices fall sharply because no one wants to buy. Are banks broke because prices are very low during a panic, or do they just not have enough cash? The longer the fear lasts, the more asset prices fall. This turns banks that were healthy before into broke ones. The central bank, as the last lender, has to act even before it knows which banks really need saving.
When to act is also very hard. If you act too early, companies that should go broke will survive. This keeps bad habits alive. If you wait too long, the crisis will spread to healthy banks. In 1929, the Federal Reserve tried to help by buying things in the market. But it was not enough. Compare this to 1987. After the crash, the Fed quickly put a lot of money into the markets. This timing was perfect.
Politics makes every decision harder. Should the central bank save those who are already powerful, or new companies? Those with good connections, or new businesses? In real life, it might be best if people are not sure if help will come. Not knowing for sure makes private companies more careful. But the central bank can still help if needed. The skill of central banks is to help in the end. But they must keep people guessing until the very last moment. But this way of working in one country is not enough when crises affect many countries and their money.
Blink 4 – The Fed’s global role emerges
The four crises since 1980 showed that money problems are always global. But there is no world government to lend money when no one else will. So, the US central bank (Federal Reserve) became the main helper for the whole world’s dollar system, even without it being official.
The problem comes from how important the US dollar is. By 2008, companies that were not banks outside the US had borrowed almost $4 trillion in US dollars. Banks outside the US, especially in Europe and Japan, owed $13 trillion in US dollars. They used this money to lend more. They relied a lot on short-term loans from US money market funds and currency exchange markets.
When Lehman Brothers failed in September 2008, people quickly took their money out of money market funds. These funds then stopped lending to banks outside the US. These banks lost at least $175 billion in just a few days. Dollar interest rates in other countries, like Libor (used for US company loans and adjustable home loans), went up very fast. This happened even when the Fed was lowering its own interest rates in the US. The Fed’s way of controlling money in the economy had stopped working.
The Fed’s actions changed things forever. It gave special currency agreements to the European Central Bank and the Swiss National Bank. This let these banks give dollars to European banks. As the crisis got worse, the Fed said in October 2008 that it would provide unlimited dollar swaps to five big central banks. This promise was a very important moment in how central banks work together. At its highest point, the Fed had swapped almost $600 billion.
The COVID-19 crisis in March 2020 showed this new role of the Fed was real. The Fed quickly started the swap lines again. It gave out almost $500 billion. Even more amazing, the Fed bought a lot of US government and company bonds. This helped not just US markets, but also the whole $6 trillion global market for dollar bonds. Bonds from foreign companies also got better, just like US bonds.
The Fed did two things at the same time. It kept its money policy working for American homes and businesses. And it also brought financial stability to the world. The Federal Reserve had become the world’s last lender for dollars. This role was needed for both the US’s own good and for the world.
Blink 5 – Why crises keep recurring
If crisis patterns are so clear, why do they keep happening? The reason is in the basic parts of the system. These make it almost impossible to stop crises. Warnings don’t work, cheating grows, and every time a system is saved, it sets up the next big market rise.
Official warnings always fail to work well. In December 1996, Federal Reserve Chairman Alan Greenspan warned about “irrational exuberance” (people being too excited without good reason). Investors stopped for a short time, then started buying again. Stock prices went up for three more years. History since 1825 shows the same: when asset prices go up 20–30% each year, people taking risks think careful officials don’t understand. Experts might see that prices are too high. But they cannot say when prices will fall. This lack of clear timing makes people stop believing them. By the time a warning is clearly right, it is already too late.
More cheating shows how far the happy, risky mood has gone. People’s desire for money grows faster than actual wealth when markets are good. Companies like Enron, WorldCom, and Madoff did their cheating when rising prices hid their bad actions. Rich people think they can make a lot of money. They see the chance of getting caught as small. When markets crash and cheating is found out, desperate people cheat more. They hope to avoid big trouble. It’s like risky traders who bet even more, hoping one big win will undo all their earlier losses.
These problems happen again because the way the system is set up stops prevention. Saving failing banks creates a problem called moral hazard. Bank managers who think they will always be saved will lend money very freely during the next good period. No single bank can be careful if other banks lend more easily and get more customers. People forget past crises. New managers who were not around for the last crash make the same old mistakes. Success makes people confident. Confidence makes them take too many risks. And too many risks always lead to a crisis.
This cycle keeps itself going. It is part of the system, not just a mistake from bad rules. Every new generation has to learn again that real, steady growth is not the same as taking big risks. This cycle happens again and again over hundreds of years and in many countries. This means it is a basic part of money systems that use credit a lot. It is a feature, not a mistake. Better warnings or stricter rules cannot stop it.
Blink 6 – Contemporary lessons
The crisis pattern still happens, but in new ways. Bitcoin shows a new kind of market craze. It is an asset that promises no payments and never ends. By late 2021, all cryptocurrencies together were worth $3 trillion. Some people say it’s a Ponzi scheme. But that makes Bitcoin sound better than it is. Madoff lied to people. Bitcoin makes no promises and cannot have a ‘run’ (people rushing to get their money out). People who own Bitcoin can only get out by selling to other people. It is more like a ‘pump-and-dump’ scheme. Early investors only make money if new investors buy at higher prices.
Bitcoin is worse than a Ponzi scheme in an important way: it’s a ‘negative-sum game’. People who ‘mine’ Bitcoin use billions of dollars of electricity each year to check transactions. These are real resources that are wasted forever. When Bitcoin crashes, the total money lost will be more than the money gained. This is because of all the mining costs. More companies using cryptocurrencies through sites like Coinbase and Binance, using unstable ‘stablecoins,’ and using a lot of borrowed money in unregulated markets create dangers. These could cause a crash without any warning.
China’s property market shows how old market crazes happen in a country where the government controls the economy. The start of the craze came from many people moving to cities and housing becoming privately owned. Great excitement made apartment prices in Beijing and Shanghai become 40–50 times a person’s yearly income. This was much higher than in other big cities around the world. Families took on a lot of debt. The amount of debt was similar to what happened before Japan’s crash in 1989. Builders sold apartments before they were finished. This gave them wrong reasons to act. When the government made it harder to borrow money, building slowed down. People started to not pay back their loans.
The main lesson is still the same: money systems that use a lot of credit are naturally unstable. New technologies and government controls cannot stop this cycle. They only change how it appears. For people working in banks, there are three important things to do. First, watch money moving around the world as carefully as you watch what happens in your own country. Second, know that new ideas create new ways for too much lending and risk-taking, instead of stopping it. And third, understand that every new generation has to learn these lessons again by living through them. This pattern happens over hundreds of years, with new technologies, and in different governments. This proves it is part of the system, not by chance. Warnings still don’t work. Cheating grows during good times. And saving banks from failure keeps the cycle going.
Final summary
In this Blink to Manias, Panics, and Crashes by Robert Z. Aliber, Charles P. Kindleberger & Robert N. McCauley you’ve learned that money crises follow the same pattern for hundreds of years: something new starts it, people take risks, money lending grows with new ideas, everyone feels too happy, and then fear always follows.
Since 1980, four big crises were linked by money moving around the world. This made the Federal Reserve become the world’s last lender for dollars. Warnings often don’t work. This is because people’s desire for money is stronger than their caution when markets are good. Cheating increases as people try to get rich. And saving banks from failure guarantees that too many risks will be taken again.
From Bitcoin’s new kind of negative-sum craze to China’s property crisis, the pattern still happens. Money problems are not by chance. They are a basic part of money systems that use a lot of credit. They will always happen.
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