Attached File by wuyyok


									                  A TURNING POINT OR BUSINESS AS USUAL?
                   Daniel Chirot, University of Washington, Seattle1

“We are all Keynesians now.” Milton Friedman quoted in Time, December 31, 1965.

I. A local story with global implications
        In the spring of 2009, as the crash of 2008-2009 seemed to be dragging the
American economy toward a new depression, and the entire world was following, I
talked to some knowledgeable bankers in the state of Washington about the fall of
Washington Mutual (WaMu) in 2008, the largest bank failure in American history up to
that time.2   (Lehman’s collapse was bigger and more consequential, but that was
because it was much more than a bank. Other likely candidates for collapse among banks
bigger than WaMu, Bank of America and Citi, were saved by government intervention.)
I asked them to explain what had happened. Their stories were all much the same.
        WaMu’s chief executive, ousted in 2008 as his bank was about to fail, was
primarily a financial expert whose chief accomplishment was to acquire a large number
of small to medium banks (mostly thrifts specializing in mortgages) throughout the
United States, thus turning his own bank into a giant. He further increased WaMu’s
business by then acquiring mortgage companies, especially in the five years prior to his
bank’s collapse. This included mortgage companies in Southern California where an
enormous housing price bubble was developing. Maintaining the momentum of growth
and keeping up profits was critical to keeping the stock price high. Falling or even
stagnant profits would cause the stock price to decline, thus making WaMu itself
vulnerable to being taken over by another giant. Bonuses for top executives and
maintaining their own self-esteem as successful executives were dependent on keeping
up the stock prices. In order to maintain and even increase those profits WaMu had to

1 I would like to thank my colleagues Tony Lucero, Sunila Kale, and Wolf Latsch for
their helpful comments. Also, I owe thanks to an anonymous reviewer and to Craig
Calhoun for their suggestions.
2 I did not speak with highly placed WaMu employees or former employees who in any

case did not feel free to speak, but with bank executives in the region who saw how that
giant bank was operating.

initiate an increasing number of mortgages, as this was its principal business. Acquiring
banks and mortgage companies throughout the country, it could increase its depository
base and leverage this to make yet more loans.
       Aside from never efficiently integrating the operating procedures and systems of
the many institutions it took over, a problem that made it ever harder to control what
these branches were doing, WaMu began to run into an even deeper quandary that was
spreading throughout the global financial system. Keeping up profits was becoming
increasingly difficult as the real economy’s stock of investment opportunities was not
growing fast enough except through various kinds of financial speculation and in the
mortgage market. To keep on generating rising profits WaMu had to find ways of
continuing to grow a housing market that was increasingly saturated and overpriced. Too
much money was going into new constructions of ever larger houses, more office space,
and bigger shopping malls. But if there were too few other places to invest, this is where
business had to be increased. So the bank pressured its executives to find new ways of
increasing loans, and this led to a catastrophic decline in lending standards. Loans with
absurdly small short term payments were peddled to buyers with weak credit, and they
were promised that when their rates would be increased, as specified in the contracts they
were given to sign, they would be able to refinance or sell at a profit. (How this was
done in a way that made it seem legitimate will be detailed in the next section, below.)
Of course, lending more money to ever more insecure borrowers made that much more
cash available to buy property, thus increasing demand and inflating real estate prices.
But this could not go on indefinitely. Rising prices stimulated more speculative building
until the combination of too much supply and ever more unrealistic prices caused the
bubble to break. Then, collapsing prices created problems for those who were suddenly
faced with higher interest rates as their short term low rate period expired. Large
numbers of loans went bad, and WaMu began to collapse.
       The question I asked bankers who knew about WaMu’s dealings, and that of other
banks in the years before 2008’s crash was whether or not top executives at WaMu knew
what they were doing, and if so, was this deliberate fraud? Was it like the case of
Bernard Madoff’s 60 plus billion dollar fraudulent investment company that never
invested, but only paid off old investors with the funds invested by new ones? There are

certainly allegations that crimes were committed (Carter, The Seattle Times, March 18,
2009). These are being investigated by American government officials. The consensus
among bank executives familiar with events is that the top WaMu executives, including
its Chief Executive Officer Kerry Killinger, did not think they were committing fraud at
all, unlike Madoff who knew he was a crook and eventually admitted it.3 Rather, these
top banking officials were caught up in a typical, frenzied kind of speculative bubble.
New financial instruments were being produced that generated huge profits, made the
bank’s leaders highly successful, and created what seemed like thousands of good, secure
jobs in their banks. They became ever more influential and admired community leaders.
The top people at WaMu were generous donors to charities and socially prominent role
models, as were their counterparts in big financial institutions around the entire country
and world. The game was too good to stop, it all seemed perfectly legal, and it was
making the United States increasingly prosperous. More people got their own houses,
even poor families who could not afford them, and this was a socially desirable objective.
National political authorities went along, and touted the beneficial effects as proof that
unregulated free markets worked.
       To be sure, the causes of the crash of 2008 are more complicated than that. On
the other hand the transformation of WaMu’s chief executive from a cautious, sober
banker into a high flying financier needing to show that he could generate growing profits
lie at the heart of what caused institutions such as his to get involved with hugely

3  Killinger’s biography is a classic tale of a straight laced, smart, hard working mid-
Western boy who made good. He is from Iowa and got an MBA at the University of
Iowa, started off in finance in Nebraska, and worked his way to the top of WaMu, which
he turned into one of America’s leading banks. Some who know him well complain that
in his last years as head of his bank he got carried away, changed his life style from one
that was relatively modest to one that was extravagant, and stopped paying close attention
to what WaMu was doing. Perhaps he began to feel he needed the 14 million dollars plus
that he made in his last good year as CEO, and so much of that was based on stock
options that the stock price had to be kept up. As this article is not designed for those
interested in gossip columns, there is no point in going into personal details of how his
life changed in his last years as the head of WaMu. Anyway, the larger system in which
he was enmeshed did not rise or fall on the accidental vagaries of any individual’s
personal life style choices; however, his own personal transformation perhaps reflected a
wider “bubble” cultural transformation that swept among high officials in the financial
world, and even more widely throughout American society.

insecure, speculative actions. That this happened came as a great surprise to the financial
world, and to a great many economists as well.
        What I propose to do in the following pages is to show that, first of all, even in the
nineteenth century farsighted economic thinkers, notably Karl Marx, understood that such
speculative crashes were likely in capitalist economies. Secondly, ever since the Great
Depression of the 1930s, it has been understood that enormous swings in the business
cycle that follow some (but hardly all) speculative crashes need to be mitigated by
government action, and speculative behavior has to be regulated. A good many
prominent economists, including some of the greatest of all such as John Maynard
Keynes, understood this perfectly well. At the same time, dominant late twentieth
century economic models became increasingly disconnected from reality and failed to
take into account the hard won lessons of the 1930s. The crash of 2008 has brought more
realistic economic thinkers back to the fore. Finally, a bit over one year after the height
of the crisis, but long before it will end, I intend to speculate briefly about its long term

II. The Causes of the Financial Crash of 2008
        The banking and stock market crises of 2008 should not have come as such a
surprise. The exact timing of panics that inevitably follow large asset bubbles cannot be
predicted, but they have occurred repeatedly since at least the early 1600s. Robert
Shiller, a well known Yale economist, ascribes their advent partly to the rise of
newspapers, though this coincided so closely with the beginning of the modern capitalist
era that it is difficult to separate the two (Shiller 2000: 71, 245). Shiller predicted the
stock market crash of 2001 when the “dot com” high tech bubble burst, and he is one of
the best analysts of the current housing and mortgage crisis that led to the 2008 stock
market crash (Shiller 2008). Shiller explains that bubbles are created by the rapid spread
of news about spectacular gains to be obtained by certain kinds of investments, from
Dutch tulips in the 1630s to securities and derivatives backed by sub-prime mortgages
370 years later. The rise of the internet, huge increases in televised news about stock
markets, and electronic trading have exacerbated the tendency toward “irrational
exuberance,” but such bubbles existed long before.

       Karl Marx noted that capitalism generates its own regular periods of over
investments, wild speculation, and subsequent crashes. These are as much a part of
capitalism as sustained periods of economic growth and technological progress. Charles
Kindleberger’s classic Manias, Panics, and Crashes agrees and charts the history of such
busts from the seventeenth to the twenty-first century (fifth edition, Kindleberger and
Aliber 2005). Needless to say, since 2008 a huge number of new books and articles have
been written about the same topic, some excellent, others less so, and classics such as
Kindleberger’s have again been reprinted, with a sixth edition in 2009. Before 2008, this
was a somewhat marginalized, but still well developed area of economic history. Today,
it is in the forefront of the news, though much of the new material goes over the same
theories and history that were available long before this particular crisis. Almost every
new issue of The Economist, the leading general news magazine for serious English
language readers in the world, reviews some new books on the crisis. (See, for example,
the March 20, 2010 issue with five new books on this topic reviewed on pages 91-92.)
Some of the best broader new works for the general public are books by Carmen Reinhart
and Kenneth Rogoff (2009) and Paul Krugman (2009b). All of these remind us that none
of what has happened should have come as such a surprise. But it did.
       Karl Marx would not have been so astonished. A century and a half ago he wrote
that as capital piles into the most lucrative investments available, the marginal rate of
return falls, and capital gets attracted to risky investment areas in order to keep up profits
(Marx/McLellan 1893/1995: 447-457). Even if Marx’s general theories about how
capitalism’s crises would inevitably lead to mass pauperization and the rise of
communism turned out to be far off the mark, there was a lot about capitalism he did
understand. He wrote, “Concentration increases simultaneously, because beyond certain
limits a large capital with a small rate of profit accumulates faster than a small capital
with a large rate of profit...[T]his in turn causes a new fall in the rate of profit. The mass
of small dispersed capitals is thereby driven along the adventurous road of speculation,
credit frauds, stock swindles, and crises.” (Marx/McLellan 1893/1995: 456)
       In an article in The Atlantic, Simon Johnson (May 2009) pointed out that the share
of total profits of all American businesses generated by the financial industry rose from
around 10% in the early 1980s to 40% by the early 2000s. During that time the pay per

worker in the financial sector went from being about the same as the average
compensation for the United States as a whole to being 80% higher. This was not a
pattern restricted to the United States, but spread throughout the world. Financial stocks
became a much larger portion of total market capitalization. In a New York Times
editorial Paul Krugman (2009a) pointed out that in the 1960s finance and insurance
together accounted for less than 4% of American Gross Domestic Product (GDP), and the
Dow Jones Industrial index that is meant to reflect America’s major big industries did not
contain a single financial company until 1982. Before the bursting of the financial
bubble in 2008, 8% of American GDP came from finance and insurance, and five of the
30 Dow Jones companies were financial institutions. The evolution of General Electric
(the only company in the original Dow Jones index created in 1896 to remains part of it)
approximates what happened. It went from being a company that produced some of
America’s most important industrial machinery to being one that generated more than
half of its profits from its purely financial business. It still makes major machines,
including jet engines, but in 2008 before the effects of the financial crisis were felt, 62%
of its total profits were from its financial services division (Malone, Reuters, April 17,
         By the 2000s, after the collapse of the speculative binge in internet and computer
related stocks, the stock market revived and increasing amounts of investment funds went
into the financial industry because it seemed safe as well as highly profitable. But this
was where WaMu and other giant financial institutions got caught in a trap as they
plunged into what seemed like the surest way to increase profits, namely housing,
construction, and the many new financial instruments being devised to back loans in
these areas.
         Mortgage backed securities were the key to staying on this accelerating treadmill.
WaMu and others would securitize their mortgages (turn them into marketable securities)
and get them off their books as quickly as possible. The money they would be paid for
these securitized loans could then be used as the asset base for yet more loans, which
would then be securitized and sold. Each operation earned WaMu and its branches fees
for generating new mortgages, and earned yet more fees for financial institutions such as
Merrill Lynch and other big operators in this market that bought, split up, and repackaged

these loans to sell to other financial institutions around the world. The word went out to
WaMu branches to initiate as many mortgage loans as possible and not pay close
attention to whether or not they were lending money for overpriced houses to individuals
unable to afford them. Securitizing mortgage loans began well before the current crisis
developed, and this did indeed free capital for more loans. But another financial
instrument that was much newer was invented to accelerate business. This was the
variable interest loan that started at very low interest rates scheduled to hugely increase
later. This would lure poorer purchasers with the promise that they could afford more
expensive houses with low monthly payments. This would not be a problem because
presumably house prices always rose, so refinancing the loan as soon as payments went
up would be easy. And with rising prices, if the purchaser defaulted, the holder of the
mortgage could easily foreclose and sell the house back at a profit. Beyond this WaMu
(and other loan institutions) would bear little risk anyway, as the mortgages would have
been sold to other financial institutions. This was the common wisdom.
       Some of the biggest buyers of these securities were Fannie Mae (Federal National
Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation).
The fees they charged for these operations and the revenue flows from mortgages were
deemed well worth the supposedly small risk.
       Fannie Mae was created in 1938 to securitize mortgage loans in order to stimulate
the housing market. It was privatized in 1968, though it retained implicit government
backing for its debt; this enabled it to take on ever larger amounts of mortgages, vastly
increase its profits, and provide generous dividends as well as big bonuses for its
executives. Freddie Mac was created as a competitor to Fannie Mae in 1970 along the
same lines, and was also private with implicit government backing. This implicit
support, never legally defined, allowed these institutions to obtain financing from
investors at below market rates because there was – supposedly – no risk (Eichler 1989:
46-49). Indeed, when the crash of 2008 occurred and it turned out that Fannie and
Freddie were bankrupt because of the vast number of failed mortgage securities they
were holding, the American government took over their trillions in debts to prevent a
complete collapse of financial markets around the world.

       Legally, this may not have been a Ponzi scheme, particularly because of relaxing
regulatory rules pushed through under the Reagan, Bush 41, Clinton, and Bush 43
administrations. The reality, however, was that these were actually quite similar to Ponzi
schemes because they relied increasingly on passing risk to others as quickly as possible
while creating loans that could never be paid off.4 Furthermore, ratings firms, chiefly
Moody’s and Standard and Poor’s (S&P) were collecting huge fees by giving AAA –
meaning safest possible ratings – to the mortgage backed securities that were being sold.
       A further step to disaster was taken when these loans started to be split up into
different parts, repackaged in complex ways, and sold as a new kind of instrument called
CDOs (Collateralized Debt Obligations). These CDOs were actually bundled
combinations of so many different loans in so many places that it became impossible for
anyone to know what they were really worth or how sound they were. The reason these
were created was that repackaging ordinary mortgage backed securities generated yet
more fees for the initiators, and the fact that Moody’s and S&P were rating them as ultra-
safe AAAs meant that they could be sold easily. A number of senior bankers I spoke
with admitted that by 2006 some of the securities floating around were incomprehensible
because they were composed of so many different obligations split up into little pieces,
and it was only because of the trust placed in ratings agencies that they were still being
sold; but even those agencies were no longer able to judge what they were rating, so they
collected their own fees and gave them high marks because they were being issued by
respected investment banks.
       The height of folly was reached when it became acceptable to extend so called
“NINJA” loans to people with “No Income, No Jobs or Assets.” Repackaged into
trusted, complex financial instruments, these were camouflaged in ways that made the
lunacy of the whole operation invisible.

4 Charles Ponzi, an Italian immigrant in the United States persuaded many in 1920 to
invest with him, promising huge returns. Rather than investing, he simply paid off old
participants with money from new ones. This worked only as long as the inflow of
money was greater than his obligations. The scheme collapsed within months and he
went to jail. Bernard Madoff’s vastly larger scheme ran for much longer before being
exposed in 2008, but was based on the same principle.

       The crash of 2008 brought back the work of a formerly rather obscure economist
named Hyman Minsky. He had postulated three stages in the way credit is extended that
lead to crashes. First, there is what he called “hedge finance” when loans go to firms
with enough operating cash to easily pay back both interest and principle. As lenders
seek to expand activities beyond the most reliable firms to increase their own profits,
Minsky said they engage in “speculative finance” with firms borrowing the money
having enough money to pay interest on the loan, but having to borrow more to pay back
owed principle. Finally, as lending expands more, money is loaned to firms that need to
borrow merely in order to pay both interest and principle, meaning that such firms
quickly fall ever more deeply into unpayable debt. Then, only a sudden appreciation in
the borrower’s assets can save the firm and allow the lender get its money back. Minsky
called this “Ponzi finance” because it turns into an ever riskier gamble that asset prices
will keep on going up or, ultimately, that a miracle will occur (Minsky 1982;
Kindleberger and Aliber 2005: 25-37).
       Financial institutions, however, were reassured because they worked out complex
risk models that showed that that they were operating within safe limits. Unfortunately
for them, these risk models were worked out by well paid math wizards who tended to be
young and have little financial experience. They were based on historical, and therefore
obsolete assumptions that used prior rates of mortgage failure as a base for calculating
risk. So, even if the math in the models was impeccable, the models themselves were
useless as default rates were no longer likely to be nearly as low as they had traditionally
been. Before these new financial instruments had been devised, and older ones abused,
the standards for providing mortgages had been stricter, so of course, default rates had
been much lower.
       Another source of reassuring stability was Fannie Mae, the single largest player in
the game. It had long been involved in what amounted to a giant lobbying (that
sometimes amounted to sheer bribery) campaign with the American Congress to keep the
system going. It claimed to be doing all of this to help the poor and minorities obtain
their own houses, but it was in fact boosting profits for the sake of its stock holders and
its executives who were receiving large bonuses for their work.

       Perhaps bank executives should have known that they were increasingly engaged
in “Ponzi finance,” and in some sense they probably did, but as the measure of success in
such circles was narrowly based on rising stock prices, as long as these were going up, it
all seemed fine. To not play the game risked a backlash from shareholders, demands for
resignations, and possibly a hostile takeover resulting in embarrassment and loss of
prestige for the institution’s leaders. For Karl Marx whether or not this was “criminal” or
not would have been irrelevant, as it was the system that forced capital, and therefore
capitalists to act that way. Indeed, that is exactly the excuse given by the executives of
the many failed institutions, including the former leader of WaMu, though it is unlikely
that any of these bankers are Marxists, or that many have even read any Marx.
       We know the end of the story. Housing prices fell, loans became due that could
not be paid, and complex securities based on packaged bundles of loans lost their values.
American International Group (AIG), a huge insurance company, went bankrupt (not
technically, as the American government stepped in to save it) because it had made a lot
of money insuring the loans and investments of big financial institutions around the
world. The assumption had been that these were all “secure” investments, so AIG never
bothered to obtain reserves to pay policy holders if these insured products actually
collapsed. Big banks, some insurance companies, and hedge funds turned out to be
overleveraged because they had invested in risky loans without having adequate capital
reserves to cover them in case of failure. WaMu was only one of the institutions to fail.
Lehman Brothers, Merrill Lynch, and banks everywhere from Iceland to Switzerland to
Hong Kong had to admit to huge losses; stock markets around the world crashed.
       Karl Marx would have recognized this. There was too much capital investment
going into products that were yielding decreasing marginal returns. This time, the
“products” were financial instruments, not physical products, but otherwise, this is
exactly what happened. Chasing profits, financial institutions created all sorts of new
products from sub-prime loans to complex, virtually incomprehensible securities and
derivatives that became increasingly tenuous. Finally, there were far too many such
products around to keep them profitable, underlying values on which they were based
fell, and the least efficient institutions like WaMu collapsed. As Marx predicted, in such
a crisis the most efficient firms survived and absorbed many of the failed ones. J.P.

Morgan Chase the most successful giant bank in the U.S. obtained WaMu at fire sale
prices that ruined what was left of its stockholders. Top WaMu executives emerged with
smaller, but still substantial fortunes, while many employees lower down in the bank lost
their life savings and pensions. Thousands lost their jobs.
       Where Marx was wrong, however, was to think that such crises would soon spell
the end of capitalism. Contrary to Karl Marx’s expectations, capitalist economies have
shown a remarkable ability to rebound; furthermore, while Marxists from the late
nineteenth century until now always see each new crisis as the beginning of the end of
capitalism, it has turned out that only some of them have had long term repercussions.
But a few have provoked major changes, and why that is so needs to be explained.

III. Conflicting Explanations of Why Some but Not Most Panics Change the World
       Panics have happened many times before. Kindleberger’s and Aliber’s book on
this topic lists 38 periods when major panics (the old word for what are now called
recessions) in the capitalist world caused deep economic troubles between the start of the
seventeenth century and the end of the twentieth (Kindleberger and Aliber 2005: 6-7,
294-03). If we were to count lesser panics, there would be many more. But most,
including those of the 1980s and 1990s from the United States to Japan to Russia to
Southeast Asia and Latin America did not cause major worldwide disruptions, only some
localized, mostly temporary pain.
       That was the case with the stock market crash of 1987 that actually saw a bigger
one-day percentage drop in the New York stock market than the crash of 1929 that many
think set off the Great Depression. Other panics, such as the one in the United States
1907, or even more recently, the dot com stock market crash of 2000-2001, extended by
the panic generated by the 9/11, 2001 terrorist attack on New York, dissipated quickly.
       On the other hand, the crash of 1929 and the subsequent Great Depression of the
1930s permanently altered the world capitalist system. When do financial panics lead to
fundamental changes? What will be the outcome of the crisis that began in 2008?
       One reason for the seriousness of the 2008-2009 financial panic is that the
American economy is so big, and U.S. Dollars are such an important reserve currency
that when there is a panic in the United States that is a world shaking event. Japan’s

burst real estate and stock market bubble in the 1990s did not cause a major global
economic setback, whereas the United States’ problems in 2008 did.5 Yet, not every
American burst bubble has such major consequences. The largest ever one day stock
market crash on October 19, 1987 (the S&P average fell 20%) was quickly handled as the
American Federal Reserve Bank (the Fed) pumped enough liquidity into markets to ease
the panic. There were few long-term effects. Stock markets collapsed around the world
but there was no subsequent recession (Carlson 2006). Similar Fed action in 1997 at the
time of the Asian economic crisis, in 1998 when Russia’s currency collapsed along with
its new and highly speculative stock market, and at the time of the 2000-2001 American
market crash also contributed greatly to limiting the damage (Kindleberger and Aliber
2005, 236).
        More serious than these temporary panics was the mid- to late 1980s massive
Savings and Loans (S&Ls) and Thrift Banks debacle. This was the most costly financial
failure in American history until that time (but dwarfed by the failures of 2008). More
than 700 banks failed and the U.S. government laid out over $100 billion to pay off
depositors and merge failed banks into viable ones. The reasons for this failure can be
summarized by saying that Ronald Reagan’s administration deregulated what had been a
sedate kind of banking devoted to making home mortgage loans at fixed rates, and
opened the door to wild speculation in home construction. The S&Ls had been run by
small bankers who did not understand the new system and fell prey to takeovers by
speculators, some of whom were, to say the least, engaged in fraudulent development
schemes. They created a housing bubble with a lot of buildings booked at inflated prices,
but when these could no longer be sold or leased, loans defaulted, and S&Ls failed
(Eichler 1989: 86-146). WaMu was one of the successful survivors at that time and used
the occasion to launch its vast expansion by taking over less successful banks. This made
it a leader in the banking disaster that initiated the current global crisis two decades later,

5 Kindleberger and Aliber, however, point out that the collapse of investment
opportunities in Japan caused Japanese capital to flow into Southeast Asia and created a
new bubble that burst with the Southeast Asian economic crisis of 1997, and eventually
money “sloshed” into the American economy and contributed to the stock market bubble
that burst in 2000 (2005: 142-164). So, in a sense, they suggest that collapsing bubbles
that do not provoke major economic crashes may well have longer term effects that show
up in later crashes.

but in the 1980s the American and world economies did not suffer greatly because the
American government stepped in and limited the damage.
       In other words, there can be fairly serious American financial panics that get
contained. So why has 2008 caused the most serious global economic downturn since the
1930s? Will it result in changes as important as the ones provoked by the Great
       To answer that question, we must look at the nature of long-term technological
economic cycles in the world capitalist economy. There is a huge literature in the field of
economics about business cycles, but much of it seems rather inconclusive and more
focused on short-term fluctuations than very long ones. This was not always true. A
1944 volume published by the American Economic Association (AEA) on business
cycles reprinted leading articles on that subject from the 1920s and 1930s. Its first two
substantive articles were by Joseph Schumpeter and Nikolai Kondratieff. There followed
pieces authored by Wesley Mitchell, Jan Trinberger (later to share the first Nobel Prize in
economics with Ragnar Frisch in 1969), Paul Samuelson (winner of the second such
Prize in 1970), Friedrich Hayek (co-winner of the 1974 Prize), Alvin Hansen, and other
luminaries. If most of the articles in this collection dealt with cycles measured in terms
of a few years, many reflected on the causes of long-term cycles. Alvin Hansen’s article,
the 1938 speech he gave as president of the American Economic Association, said:
              “The growth of modern industry has not come in terms of millions of small
            increments...Characteristically    it   has   come   by   gigantic   leaps   and
            bounds...discontinuous, lumpy, and jerky...And when a revolutionary new
            industry like the railroad or the automobile, after having initiated in its youth
            a powerful upward surge of investment activity, reaches maturity and ceases
            to grow, as all industries finally must, the whole economy must experience a
            profound stagnation, unless, indeed, new developments take its place. It is
            not enough that a mature industry continues its activity at a high level on a
            horizontal plane...It is the cessation of growth that is disastrous...And when
            giant new industries have spent their force, it may take a long time before
            something of equal magnitude emerges.” (AEA 1944, 379).

       Schumpeter himself also believed that long term cycles were caused by the arrival
of new technologies in “swarms.” He looked at the work of Nikolai Krondatieff, a Soviet
Marxist economist who had postulated that there were long “waves” of rise and decline in
capitalist economies. A long “A” phase of growth of roughly 25 to 30 years would be
followed by a declining “B” phase of roughly the same length (Schumpeter 1935/1944,
14-15; Kondratieff 1926/1944, 20-42). Kondratieff had no explanation for why this
happened, so it is Schumpeter’s theory that these waves are caused by the uneven rise of
new technologies that has become accepted by those who believe in Kondratieff waves.
(Kondratieff himself was imprisoned in the 1930s by Stalin and executed for his
deviationist views in 1938.)
       Schumpeter was very conservative, even rightwing (he had an embarrassing
tendency to say nice things about Hitler [Swedberg 1991, 28]), and he is rarely cited by
contemporary economists except as a historical figure. Ironically both he and
Kondratieff appeal far more to the academic far left than to conservative economists
(Kleinknecht, Mandel, and Wallerstein 1992; Goldstein 1998), though some others, for
example the economic historian Walt Rostow (1975), have had some faith in this
approach. The problem is that repeated efforts to justify these long wave theories with
empirical facts have failed to do so. As early as 1940 Simon Kuznets (who developed his
own theory of long-term cycles of growth) analyzed Schumpeter’s Business Cycles and
concluded that its use of statistical data to confirm Kondratieff waves was incompetent
(Kuznets 1940; Swedberg 1991, 58-59). Similarly, a more recent test by Solomos
Solomou also found that the evidence for Kondratieff waves simply doesn’t hold up.
There are business cycles, and obvious periods of growth and decline, but they are not
regular, and cannot conceivably be explained by any simplistic mechanism (1987, 169-
171). Solomou, on the other hand, favors Kuznets’ theories about swings or cycles. A
more recent statistical test of cycles by Bert de Groot and Philip Hans Franses (2008)
concludes that there are indeed cycles in the economy, but looking at American, British,
and Dutch data they find a large number of such cycles that are not systematically
correlated with each other. Therefore, they conclude, they tend to negate each other, and
produce smoother economic growth than if they were interconnected, or than if any one
of them were dominant.

       Kuznets’ cycles worked out during his long and productive career that also led to
his being awarded the third (in 1971) Nobel Prize in economics essentially laid out a
multi-causal explanations of changes in rates of economic growth in the nineteenth and
twentieth centuries. In the nineteenth century agricultural swings were important: a good
market for certain products led to overproduction, and that lowered prices, which in turn
led to farm failures. Investment swings in all areas followed similar patterns. Climate,
international trade, migration, demographic trends, and many other variables could
account for cycles that lasted roughly some 15 to 25 years each. As Kuznets spent more
of his time on accumulating international comparative data on the history of economic
growth, however, his earlier work on cycles took a secondary place. Interestingly, in his
1971 Nobel Prize speech in Sweden he did not mention cycles or swings, but talked about
the causes of economic growth and backwardness. In this speech he emphasized the role
of technology and how it interacted with social and political institutions that were more
permissive of growth, or blocked it. He also discussed what he called major
technological epochs:
          The major breakthroughs in the advance of human knowledge, those that
          constituted dominant sources of sustained growth over long periods and
          spread to a substantial part of the world, may be termed epochal
          innovations. And the changing course of economic history can perhaps be
          subdivided into economic epochs, each identified by the epochal
          innovation with the distinctive characteristics of growth that it generated
          (Kuznets 1971).
       Contrary to this rich tradition in economic thought, for a while in the 1980s and
1990s a leading economic line of business cycle research came to rely instead on the
rational expectations theories of Robert E. Lucas. Finn E. Kydland and Edward C.
Prescott won a Nobel Prize in Economics in 2004 for their work in this area. What they
claim is that because markets anticipate various kinds of future pressures such as those
from policy changes by governments, the economy should always be in equilibrium.
Firms anticipating changes will alter their behavior to adapt and supply and demand
should quickly match each other. Since, however, that is not always the case, an
explanation must be found, and this amounts to unanticipated technological shocks. (Six

papers from the 1980s and 1990s by Kydland and Prescott together and by Prescott alone
on what came to be called “real business cycles theory” can be found in Hartley, Hoover,
and Salyer, eds. 1998.) Lawrence Summers in a 1986 paper (also in Hartely, Hoover, and
Salyer, 97-101) demolished the Kydland and Prescott arguments by saying that
essentially it was too abstract and based on models that do not corresponds to reality.
Obviously, Summers’ argument had little effect on the reputation of this kind of
theorizing (since its proponents won Nobel Prizes), but it remains persuasive. Summers
concluded his short, powerful paper by saying that economists cannot explain economic
fluctuations that are caused by too many variables.
       N. Gregory Mankiw said something similar about “real business cycle” theory in
a 1989 article. While admiring the theory’s elegance and parsimony, he pointed out that
it lacked empirical evidence about the nature of technology shocks. Rather, he said that
what he called a “New Keynesian perspective” would prove more persuasive, despite
being messier, because it rejected “the axiom of rational, optimizing individuals.”
(Mankiw 1989, 89).
       What are we to make of all this? In the arguments cited above, there does appear
to be some (but by no means total) agreement that technological changes are important,
even if there is not much consensus about how, or why in some cases uneven
technological “shocks” produce catastrophic recessions or depressions, and at other
times, only mild economic swings. Schumpeter, for all the defects in his theories, was on
to something important in making technological change the centerpiece of his work on
cycles. Other explanations – climate cycles, rates of population change, wars, policy
errors by governments, among many, work poorly if used too mechanically or alone,
even if they seem to explain some individual cases.6

6 The disorganized state of macroeconomic theory is shown by the insistence of some of
the foremost Chicago School economists, Gary Becker and Robert Lucas, that the
development of stronger and more widespread property rights, the realization among
people that knowledge was important, and the consequent rational decline in birth rates
were the main factors in producing the industrial revolution’s great spurt of economic
progress. With secure property rights and a rational expectation among families that
spending more time training their smaller number of children would pay off, birth rates
fell, workers became more capable, and economic growth took off (Lucas 2002). After
proving this with a set of elegant, abstract mathematical models Lucas concludes,
“Defined as the onset of sustained growth, the industrial revolution was not exclusively,

       How do these arguments work if applied to the Great Depression of the 1930s?
One of the most famous arguments about the Great Depression was pioneered by the
University of Chicago’s Milton Friedman who won the Nobel Prize in 1976. This pays
no attention to technological waves or cycles at all, and claims that it was primarily
caused by errors made by the Fed in tightening the money supply at the wrong time
(Friedman and Schwartz 1963; for a short, updated version, see Schwartz 1981). Because
the American economy was so important, the whole world was affected.
       As a result of the crisis of 2008, however, the whole monetarist and related
rational expectation approach of the “Chicago School” is being increasingly questioned
(The Economist, July 18, 2009, 65-69). From John Maynard Keynes to John Kenneth
Galbraith to Charles Kindleberger and most recently Paul Krugman (winner of the 2008
prize), the main assumptions about the causes of the Great Depression have been
different. Demand was too weak (and therefore had to be stimulated by government
action), and the financial system was in a precarious state to begin with because of
excessive, unregulated speculation. Kindleberger (1973) concluded that the international
financial system had to be backed by a single powerful actor able to sustain liquidity in
times of panic, but in 1929 the British could no longer do this, and the United States, that
could have, was unwilling. Keynes believed this, and such thinking was behind the
Breton Woods reforms carried out after World War II to prevent another depression.
Weak demand in the 1930s had various causes, among them too high a degree of income
inequality (Galbraith 1955/1980, 157). So, in that respect, too, government action was

or even primarily, a technological event.” (Lucas 2002, 169) In an article on business
cycles, Lucas stated that technological changes are so common in modern economies that
they do not cause meaningful cycles. For him, fluctuations in the business cycles,
following the monetarist “Chicago” model, are caused by changes in the money supply
(Lucas 1976/1995). This relegation of technological progress to a minor position as a
cause of the industrial revolution might strike many, including me, as the ultimate in
absurd reasoning by economists who refuse to let facts get in the way of their elegant
theoretical models. This school’s insistence that unemployment is caused by the wrong
incentives that reward idleness over work, and that markets forces make involuntary
unemployment impossible, is even more contrary to reality. (See Mankiw 1989, 82, 85,

        Underlying these explanations is the idea that is at the core of the recent book by
Akerlof and Shiller (2009). Depressions and recessions are caused by a psychological
breakdown in confidence, and therefore, a retrenchment by investors, bankers, and
consumers. They follow Keynes in calling desire of investors to invest in risky new
products and firms the “animal spirits” that are essential to keep capitalism working and
progressing. Though Akerlof (who won the Nobel prize in 2001) and Shiller’s book is
provocative and reflects sophisticated new work on the psychology of economic decision
making going well beyond the static “rational expectations” models, it does not quite
explain why these psychological shifts occur. This is where technology shocks can play
a useful role.
        We can admit that the way in which financial institutions are regulated (or not)
and the degree to which excessive speculation creates problems can increase or decrease
the likelihood of financial panics, and that government actions or inactions can mitigate
or worsen panics. Policy errors by major central banks in the 1930s certainly contributed
to prolonging the Great Depression of the 1930s (Temin 1981). But ultimately, no such
explanations can adequately deal with the fact that some economic crises are world
shaking, and most are not. Without trying to pretend that the kind of analysis that follows
would satisfy a quantitative economist, I would like to suggest how major technological
changes lie at the heart of any explanation of why sometimes financial panics lead to far
more serious outcomes, and sometimes not.

IV. When Panics Coincide With Changes in Long-term Technological Cycles
        Basic innovations have initiated new industrial ages. Application of new
technologies in cloth making created the first industrial period in England in the late
eighteenth century, and this spread to Western Europe and the U.S. until markets were
saturated and weaker firms began to fail, producing a running series of depressions in the
industrial West from the 1820s to the 1840s. This lengthy crisis became the basis of Karl
Marx’s theories about capitalism’s inevitable ultimate demise. But then new products,
led by railroad construction and the demand for iron, produced a new and spreading
period of growth until the 1870s, when a new series of crises opened up a troubled couple
of decades into the 1890s. By then, however, new products, chiefly in the chemical and

electric machinery industries and the rapid growth of steel production had created another
long period of growth that was only stopped by World War I (Chirot 1986, 61-63 and
223-226; and more generally Landes 1969).
       After the recovery from World War I, automobiles and household consumer
electric machines should have led the way to another boom, and in some ways did. On
the other hand, after the recovery from the war, commodity prices, particularly in
agriculture, fell as supply recovered, and there resulted a long-term agricultural
depression in the United States and elsewhere. The new technologies, particularly in the
United States, led to a speculative boom in the stock market that went well beyond what
demand could bear. On top of this, conservative British policies trying to sustain the
Pound Sterling destroyed London’s capacity in the 1920s to sustain the international
financial system (that it had done before 1914) and depressed the British economy, a
major world importer. Then overly conservative economic policies in reaction to the
stock market panic of 1929-1930 in all the leading economies failed to overcome these
problems and were compounded by growing trade protectionism from 1930 on, led by the
adoption of the completely irresponsible American Smoot-Hawley tariff in June of 1930.
This created enormous trade barriers, and provoked similar protectionist measures among
other industrial powers, thus contributing greatly to making the depression more serious.
Herbert Hoover signed the tariff bill, giving in to Republican xenophobia and hysteria
about falling agricultural prices, despite the unanimous recommendation by America’s
1000 leading economists to not sign (Kindleberger 1973, 31-198, 294; Bairoch 1993, 5).
This combination of factors, behind which there lay a failure to adapt to and fully
understand the consequences of the dramatic changes brought about by the vastly
increased capacity to produce new kinds of consumer goods, especially in the United
States, was the main reason for the Great Depression. Financial institutions capable of
dealing with the new situation by insuring the flow of credit and backing international
trade at adequate levels did not exist. The nature of the new kind of consumer oriented
economy was not well understood. All this made the transition to this new age
particularly traumatic.
       The political consequences of the Great Depression, however, were even more
serious than the economic ones as it was in reaction to their perceived economic

problems that Germany became Nazi and Japan turned to aggressive militarism
(Kindleberger 1973, 177; Bairoch 1993, 8-14; Beasley 1999, 241-245).
       After World War II the new economic age of mass personal consumption of the
new machines, from automobiles to refrigerators to televisions, did take off in a
spectacular way (Hobsbawm 1996, 257-286). But by the 1970s, another series of crises
occurred as new technologies made the old centers of automobile and steel production
obsolete. The American stock market stagnated for a decade, the United States had to
renege on allowing dollars to be converted into gold, and there emerged what has come to
be called a “rust belt” in some of the major industrial areas of the American Middle West
as well as in parts of industrial Western Europe. Combined with the social changes of the
1960s and 1970s, some saw this as the dawn of a new revolutionary age that would
replace obsolete capitalism with something better (Hobsbawm 1996, 403-432).
       Once more, however, a new product revolution occurred, and instead of
producing either major wars or depressions, the crises of the 1970s gave way to the rising
boom stimulated by the electronics and computer revolutions of the 1980s and 1990s.
For all the talk in the 1970s about the demise of the world capitalist system, nothing of
the sort happened, and a calamity such as the Great Depression was avoided. To be sure,
as usual, Neo-Marxists saw the disturbances, wars, and various panics of the 1980s,
1990s, and early 2000s as signs that a new cataclysm was about to occur (for example
Sweezy and Magdoff 1988, Wallerstein 1995, 210-251 and more generally Wallerstein
2003), but instead international trade expanded, China and India as well as much of the
rest of East and Southeast Asia began a rapid march toward greater economic prosperity,
and despite wars and periodic financial panics, the United States and other Western
economies remained prosperous (Hodgson 2004, 249-276). Once again, technological
innovation and the adaptability of entrepreneurial capitalists, if they are more than mere
speculators, revived the world economy.
       The panic of 2008 coincides with the rise of new age led by revolutionary changes
in communications, biotechnology, health care, and probably the start of the development
of new sources of electrical power. Those are areas where enormous technological and
scientific progress has been made, and where many more are possible. The question,
therefore, is whether or not, as in the late 1940s and 1950s, and again in the1970s and

1980s, the institutions exist to make this a relatively smooth transition. Or could it be
that, as in the 1920s and 1930s, outdated institutions and ways of thinking will hinder,
and possibly block emerging new patterns of production and consumption from creating
the right environment for progress.
       It is the conjunction of the panic of 2008 with the failure of political institutions,
social habits, and economic structures to keep up with the new age that has produced
serious disruptions, particularly in the United States and Europe. As many critics have
pointed out, neither regulatory rules for international finance nor distributive mechanisms
to take into account the new technologies have kept up with changes that have occurred.
Health care is a particularly important new area because of the enormous progress being
made in biological and medical research, and in the long run, the demand for better health
is practically unlimited as long as ways are found to pay for it.
       Paul Krugman has put it this way, “What does it mean to say that depression
economics has returned? Essentially it means that for the first time in two generations,
failures on the demand side of the economy – insufficient private spending to make use
of productive capacity – have become the clear and present limitation to prosperity for a
large part of the world.” (Krugman 2009b, 182). Krugman does not think it very likely
that the world will slip into another Great Depression (though he wishes he were
absolutely sure), but he believes that for the first time since the 1930s the American and
world economies are not structured in ways that take advantage of high productivity.
       Very few if any top bankers or financial managers of the sort who produced the
panic of 2008 understood how big a change technology and new kinds of goods were
producing, or how badly many institutions had fallen behind the changes of the past
generation. It does not take too many conversations with some of them to see that these
are essentially socially and politically conservative, cautious people who find it difficult
to think beyond conventional wisdom. That has always been the case, and does not
necessarily block progress that comes from more rash innovators and risk takers, but it
does mean that institutional reforms that need to be made tend to be blocked by some of
the very banking and Wall Street people who are supposed to understand the economy
but really fail to understand the need for change until a massive crisis occurs, or perhaps,
not even then.

       In 2008 the necessary social and political reforms to produce enough demand for
the dawning new age’s innovations were not present, at least in the United States.
Instead the prosperity of the electronic and computer innovations in the 1980s and 1990s
was leading to growing income inequality as a fairly small proportion of the populations
in rich and emerging countries was benefiting. And the investable surplus being
accumulated was going into “safe” real estate and financial products designed to promote
a boom in traditional asset values. There is little question that the conservative
atmosphere of the 1980s and 1990s (sometimes called the triumph of “neoliberalism” of
the Ronald Reagan / Margaret Thatcher kind, though most Americans don’t think of this
as being any kind of “liberalism” at all) contributed greatly to this lack of reform. In a
way, the transition that had occurred in the 1970s to a new technological era was handled
too well by the major capitalist powers, and lulled them into believing that fundamental
reforms to adapt to future changes were unnecessary. The panic of 2008 has exposed the
flaw in this kind of conservative thinking.

V. The Benevolent and Postponing Scenarios: To Reform or Not
       These observations lead me to speculate about the future consequences of the
panic of 2008 by looking at three possible scenarios. First, there could be some serious
reforms. For a while in 2009 it seemed that steps were being taken by most major
economies, including those of the United Sates, China, and several of the major West
European ones, to stimulate demand. These, and the bailout of major financial
institutions clearly demonstrated that the main errors of the 1930s were not going to be
repeated. The Keynesian conclusions about this have been learned. Most major central
banks, including of course the most important one in the U.S., have poured liquidity into
their economies, thus avoiding any possible repetition of the wrong policies criticized by
Friedman and Schwartz. A major Great Depression was avoided. This is not enough,
however, because confidence in the future growth of the economy has to be fully restored
to stimulate investment flows, and this in turn depends on creating both better economic
institutions and a more equitable income distribution within and between economies.
       Efforts are under way to significantly improve regulatory oversight of financial
institutions to avoid the kind of speculation that was the immediate cause of the 2008

panic. China most of all, but also India, Brazil, Russia, and a few other major players
have been brought into the international economic system to join Europe, America, and
Japan in reforming global policies.
       In order to improve demand for the leading products of the new industrial age,
governments have to take the lead, particularly in the United States. The required
investments and product prices are too expensive and too risky to attract enough private
capital or to be affordable by ordinary consumers. Just as new products such as
automobiles once created a huge new economic sector, so will health care, but investment
in usable products is hampered by uncertainty and the question of who will pay for
expensive drugs and treatments.
       This is even truer when it comes to producing and paying for new energy sources
and improved infrastructure to accommodate an increasingly mobile world. This hardly
means that making these changes is impossible or that private capital will not play a role,
but it does mean that the ways of steering the economy toward less regulation and less
government involvement championed by the United States in the 1980s, 1990s, and early
2000s cannot continue.
       All this is entirely curable and can be remedied without bringing about the
catastrophic events of the 1930s that led to World War II, as long as there is some
recognition of what needs to be done by the politically powerful elites of the world.
       On June 11, 2008, Kerry Killinger, then still head of WaMu, spoke to the Seattle
Downtown Rotary Club and explained that his bank had strict lending standards, was not
to blame for anything that had gone wrong, and that the looming crisis was the fault of
the Fed’s low interest rates, the government’s push to extend home ownership too widely,
and various unscrupulous brokers. He did not mention any need for reform. A little over
a year later, on July 15, 2009, Jamie Diamond, the head of J.P.Morgan Chase, by then
America’s largest bank, and the one that had taken over WaMu, gave a speech to the
same Seattle Downtown Rotary Club with many of the area’s most influential business
people present. He stressed that the time had come to recognize that changes had to be
made in how health care was delivered, that new sources of energy had to be developed,
and better ways had to be found to preserve the environment. He recognized that
regulatory rules and institutions had to be updated and reformed. (I heard these

speeches.) More than boilerplate public relations, he was expressing what had at the time
become increasingly obvious to the thoughtful parts of the American establishment as
well as to much of the electorate.
       Of course, this perception was widespread throughout the world in 2009. The
“emerging” powers of China, India, and Brazil as well as the Europeans all agreed that
much reform was necessary, and that they all need to cooperate with each other to
accomplish this (Le Monde 2009). They also all were committed to preserving and
expanding the world capitalist system that has served them well in recent decades.
       Unfortunately, all that was when another Great Depression seemed very possible.
Since then, many of these promises for major reform have fallen through. Mr. Dimon of
Chase, and the large financial firms saved by government actions have become less
enamored of reforms that might curb their profits and bonuses (Eggen and Tse 2010).
Generally, there is less of a sense of urgency throughout the world, and more of a
tendency for various interests to block needed changes. Not even the most recent
ramification of the crisis of 2008, the Greek and more widespread European sovereign
debt crisis of 2011 seems to be pushing leaders in the major economies to take the need
for change seriously enough.
       The second scenario is that the world will slowly get over the crisis caused by the
financial panics unleashed by the crash of 2008 that mutated into the European crisis of
2011, but without making enough reforms to prevent a possible calamity when the next
bubble bursts. As Robert Aliber pointed out in a brief article during the summer of 2009,
the large new emerging economies Brazil, China, and India in particular have emerged
quite well from the crisis and are accumulating surpluses that could well produce new,
giant asset bubbles and another, even more serious crash in the future (Aliber 2009).
Meanwhile, in Europe and the United States, the sense of urgency about the need for
major social, economic, and regulatory reform is lessening and only short term, and quite
shortsighted fixes are being considered by the leaders of the major economies. In this
scenario, the panic of 2008 and those that have followed will have turned out to be very
serious, but not quite catastrophic enough to reorient the world capitalist system in the
right way. So, the system will neither collapse nor fundamentally change. But because
technological and social changes continue without slowing down in the least, when the

next panic occurs the consequences could be even direr. That seems to be what Joseph
Stiglitz fears in his probably overheated denunciation of the Obama administration’s
efforts at reform as grossly insufficient (Stiglitz 2010). There are many forces at work
hindering reform, and others still pursuing it, so we will not know for some time whether
eventually enough occur, but if all the current crisis has done is to provoke some fairly
mild and temporary fixes, that could bring up a third possible longer term and very dark

VI. The Catastrophic Third Scenario: Political Madness, Depression, and War
       The world recovered from the Great Depression of the 1930s, but at tremendous
cost. What happened was that most political elites in Europe and Japan, supported by
widespread popular discontent, turned to ultra-nationalism and autarkic measures to
protect themselves. For Germany, Italy, and Japan this led to fascism and disastrous wars
that were supposed to guarantee their future security. The United States, France, and
Britain failed to coordinate reform efforts that could have eased the effects of the Great
Depression, so these institutional changes had to wait until after World War II. In the late
1930s the major democracies were run by cautious, frightened conservative elites who
resisted change until it was too late. Could all this happen again?
       A sense of panic in a time when political elites and their people feel vulnerable
can easily lead to protectionism, nationalist defensiveness, and ultimately wars. Though
World War I was not caused by any obvious economic panic, it was the product of
increasingly fearful nationalist hysteria among the largely conservative elites of the major
powers. (For a very short synopsis of my view of what happened, see Chirot and
McCauley 2006, 135-139.) In the 1930s, along with many of the same sentiments, there
was the added shock of the Depression. That led to an even worse war that came close to
destroying Europe and East Asia.
       There is no shortage of political leaders in all countries, including the United
States, China, Russia, and some of the most important and largest Latin American and
Muslim countries ready to follow this kind of path once more: moves toward economic
protectionism and autarky, heightened xenophobic nationalism, rejection of international
cooperation, and militarization. The economic disruptions that have followed the panic

of 2008 feed popular resentment, fear, and anger against the seemingly hidden, hard to
understand, distant financial dealings that led to all this. This is certainly the case
increasingly in Europe as well.
        Economic analysis is not well suited to predicting the future of the current crisis.
Economists may propose possible solutions, and despite considerable disagreement about
the causes of economic swings, there is an emerging consensus about the need for certain
kinds of reform. But as in the 1930s, academic economists are not the main decision
makers. Crises bring out deep reactionary forces that want to prevent necessary change
on one side, and it calls forth revolutionaries on the other side who want to overthrow
entire systems. It produces masses that do not know which way to turn. Political and
ideological entrepreneurs spring up to lead various factions. Which of these political
forces prevail in the major countries of the world will decide whether the outcome of the
current crisis is delay and failure to reform or the more benign path toward necessary
change. Inadequate institutional reform would open the way for another, possibly even
more acute crisis in the future, and that could well result in something similar to what
happened in the 1930s.
        If we want to know what will happen, it is probably more useful to study what
kinds of political elites emerge from this crisis in the world’s most important countries
than to untangle the arguments of their leading economic theorists. It is how these
political forces react to the economic crisis, and to future ones that will determine our

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