- Lords of Finance: The Bankers Who Broke the World, by Liaquat Ahamed (The 2010 Pulitzer Prize Winner in History and on the New York Times “The 10 Best Books of 2009”)
- How Markets Fail: The Logic of Economic Calamities, by John Cassidy (Nominated as a finalist for the 2010 Pulitzer Prize Winner in general nonfiction and one of The Economist’s “Books of the Year”)
Lords of Finance tells the story of the slide from the boom of the 1920’s to the Great Depression by profiling four men in charge of the principal central banks: Benjamin Strong (Federal Reserve Bank of New York), Montagu Norman (Bank of England), Hjalmar Schacht (German Reichsbank), and Emile Moreau (Banque de France).
These men had the task of restructuring the international finance system after World War One. Individually, each banker’s objective was to preserve the value of their country’s currency. All of the currencies were on the gold standard, which tied the value of their currency to the specific quantity of gold it held. The amount of gold reserves held by the central bank determined their supply of money and credit.
This belief -- the need to adhere to the gold standard because it provided stability -- became an economic straightjacket. Since the total amount of gold reserves available globally had not grown recently (South African gold deposits had not yet been discovered) and the value of a country’s currency was directly tied to the specific quantity of gold reserves, the world supply of money and credit was severely constrained.
Central bankers, without the ability to stimulate their economies by increasing the supply of money and credit, by 1931, faced a global economy which was in its second year of a depression. Manufacturing and production in most countries had shrunk, and unemployment had risen. The New York Fed, to preserve its gold, stopped the flow of capital to Europe. The stock market crash followed. Then, a series of banking panics – bank closings – led to the collapse of the banking system, threatening the stability of the global economic system. The Great Depression followed, along with the political rise of Hitler and Nazism, and then World War Two.
In Lords of Finance, Ahamed has written a fascinating history of the inter war period between World War One and Two. The author uses the relationships between the four central bankers (each an interesting character) to narrate his story. He shows how the relationships among the four men ultimately led to difficulties, how the central banking systems were interconnected, and how a problem in one country inevitably led to problems elsewhere.
In How Markets Fail, John Cassidy, a veteran financial journalist whose work primarily appears in The New Yorker, has combined a history of ideas, the story of the present financial crisis, and a “call to arms.”
First of all, Cassidy believes it is important to understand the intellectual and historical context in which financial crises occur. For the present crisis, he describes the increased belief in, and adherence to, “free market” or “utopian” economics. Simply put, the late 20th century economic belief system has been: “self-interest plus competition equals nirvana.” Cassidy then describes “reality economics;” the study of economics focused on inter-dependencies: what you do affects my welfare and what I do affects yours. Free market economics often fails to consider these inter-dependencies.
Cassidy demonstrates how the underlying economic thought – adherence to free market philosophy – and the pursuit of self interest, both created and prolonged the “Great Recession.” For example, companies and individuals in the real estate industry made quick and easy profits through the sale of subprime mortgages; they acted rationally as individuals in their self interest. Yet, the combined levels of subprime mortgages were deeply detrimental to the economy.
Why did our present financial crisis occur? According to Cassidy: bad economic policy decisions – based on adherence to the free market philosophy – played an important role. Also, the Federal Reserve kept interest rates too low for too long, distorting the price signals the market sends and creating the conditions for a housing bubble. Finally, very few people paid attention to the inter-dependencies in the market system; when the crisis began, the markets reacted in ways that no one had anticipated.
Cassidy’s call to arms -- he makes a strong case that the intellectual and historical context and dominate economic ideas have important practical consequences. Individuals reacted to the immediate financial incentives they faced, and regulatory frameworks in which the economy operated reflected a free market philosophy. There were no institutionalized concerns for the limitations of the free market idolatry, and no concern for the complexity and inter-dependencies of the international financial system.
Cassidy’s study of the intellectual and historical context of the “Great Recession" is especially interesting reading. For someone interested in expanding your understanding of free market economics, you will find this book especially interesting.
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