Deja Vu Economics

John Lauritz Larson, a historian from Purdue University, has an interesting article in the LA Times reviewing the previous economic meltdowns experienced by the US:

To listen to the pundits, one would think that today's banking crisis and financial meltdown is something rare and exotic. But those who stayed awake in their history classes know that financial panic is a familiar "plot device" in the drama of modern capitalism. Speculation has been followed by collapse at least as far back as the South Sea bubble of 1720. The American experience with such wholesale crises began in 1819.

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The next three big panics -- in 1857, 1873 and 1893 -- fed off railroad development accompanied by currency and stock speculation. Every boom fed the dreams of small-town boosters, that one more mile of shiny rails would buy them a seat at the rich man's table. Each panic squeezed out the excess but also cut to the bone of subsistence for men and women who lived from payroll to payroll. In the speculators' game, the hammer always falls, but rarely on those who deserve it.

In the 20th century, we erected safeguards against these devastating cycles. In 1913, our Federal Reserve system was established to rescue banks from such sudden crises of confidence. Still, the Crash of 1929 yielded a worldwide Great Depression. New Deal reforms -- especially the Glass-Steagall Act of 1933, which created the FDIC and barred commercial banks from Wall Street speculation -- helped limit the effect of panics on ordinary people. But capitalists always invent new ways to cheat on the rules, like the now-infamous "credit default swaps." Beginning in the 1980s, the enemies of New Deal policies stripped away regulations and allowed speculators to take outrageous risks that former Fed Chairman Alan Greenspan claims he could not have imagined. Too bad he never looked in the rearview mirror!

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Panics expose how the game of chance can ruin the core economy. These days, we cannot retreat into semi-subsistence, grow our own food and sit tight under our own vine or fig tree -- advice freely given in 1819. Still, there is no reason to submit to absurd abuses by self-serving gamblers who toy with the people's welfare. The history of panics ought to remind us that independence was the first objective of America's founders. A market economy can be made to serve the common good, but when you license it to make a killing, you just might get killed.