What turns a stock market crash into a financial crisis?

In view of the popularity of catastrophising in the UK, The Great Crashes by Professor Linda Yueh should have no trouble finding a ready audience here. Its subtitle, Lessons from global meltdowns and how to prevent them, is less compelling; surely she realises that stock market crashes are as endemic to market economies as stagnation is to command economies?

The list of plaudits from the economic establishment, including Christine Lagarde, Ken Rogoff, Jim O’Neill, Nouriel Roubini and Martin Wolf, settles it: Yueh must have something interesting to say. At least the book, with under 200 pages, is not too arduous a read.

The introduction, a superficial few pages covering The Great Crash of 1929, is followed by seven chapters detailing the crises of the last 40 years: the currency crises of the 1980s and 1990s; the US Savings & Loan crisis of the 1980s; Japan’s property and stock market crash of the early 1990s; the dotcom crash of 2000-2001; the global financial crisis of 2008; the euro crisis of 2010 and the Covid crisis of 2020. She then goes on to outline why China might provide the next crash (the book was written in 2022).

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There are some gaps in the narrative. The section on Japan fails to point out that the slowdown in Japanese growth to 1% was, given Japan’s declining population, better than the developed countries’ per capita average from the early 2000s. Black Wednesday, Britain’s exit from the Exchange Rate Mechanism in 1992, was hardly a crisis, rather the end of one. Yueh notes the devaluation of sterling but fails to point out that it climbed all the way back up again in the next five years as a yawning fiscal deficit turned into surplus.

Much more damaging is Yueh’s failure to ask why stock market crashes caused permanent damage in some countries but not in others; whether policy actions that alleviated the crises in the short term did lasting damage in the longer term; and why the frequency of crashes has increased the more governments struggle to prevent them.

How Britain recovered from the 1929 stock market crash so quickly

Britain handled the 1929-1933 slump better than anyone else because, having re-adopted the gold standard in 1925, it avoided the unsustainable boom of the late 1920s experienced by other countries. By leaving the gold standard in 1931, two years before the US and Germany, it ensured that its economy quickly recovered, led by new industries and innovation, putting Britain, unlike France, in a strong position to withstand war in 1939. Yet this merits no mention, despite its priceless lesson.

Why did the 2000-2001 dotcom crash cripple the technology and biotechnology sectors in the UK but only present the US with a temporary setback? Why did the US government make a huge profit (with more to come from Fannie Mae and Freddie Mac) from rescuing the financial sector in 2008-2009 while the UK government made a large loss and the UK’s financial sector never fully recovered? Why has the UK been so slow to recover from the pandemic compared to the US?

The answer is surely that the policy responses of the US have been much better than those of the UK, which has caused permanent damage to our productive potential. Yueh never questions whether the measures taken by the EU at vast cost did more than hold the euro together in the short term or ask whether the poor subsequent economic performance of the eurozone is the result of those measures.

This may explain why the book is so lavishly praised by the economics establishment. The decisions taken by them and their mates are never questioned; every crisis is an opportunity to show how brilliant they are at steering the world through turbulent times. The book is a triumphal march of the great and the good through the volatility caused by the ignorant masses and the barbarians of the market.

As a result, “the next great crash”, that of the Chinese property and banking sectors, does not show the futility of China’s attempt at a middle way between communism and capitalism, merely that mistakes have been made by inexperienced bureaucrats. What they really need is those experts of the European Troika: the European Central Bank, the European Commission and the International Monetary Fund!

Yueh ends by accepting that “financial markets have crashed regularly for centuries”, so it’s best to assume that “the next crisis is never far away”. But don’t panic! “Policymakers” can resolve a crisis “if their actions are viewed as credible”. They can “orchestrate a managed deflation of the market and cushion any impact on the economy”. They can not only “regulate debt levels”, but also “rapidly deploy credible tools to address a crisis”.

This naïve faith in the authorities to solve financial crises without sowing the seeds of the next one is profoundly dangerous, not least because it encourages complacency. The expert administrators on hand are just fallible human beings who are as swept along by euphoria and crises as everyone else. They are anxious to do something, anything, to alleviate the short term and be lauded in the court of public opinion without considering the long-term consequences.

For example, the solution to a credit crunch, caused by excessive credit expansion, is always a bailout, which merely shifts the losses into public hands. The cost of these bailouts, never considered by Yueh, drags down the economy.

In the last few pages, Yueh expresses hope for a “great reset” incorporating environmental, social and governance (ESG) into business to build “a happier, fairer, greener world fostered by regulation, supra-national institutions and a societal shift”. She commends net-zero carbon-emissions targets and legislation, oblivious to its key role in causing the most recent great crash (after her book’s publication): that of the renewable energy sector. “Put not your trust in princes”, or their modern equivalent of officialdom and governments, would be a better ending.

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