The subtitle is Two Cold Wars and a Thirty-Year Journey Through Romania and Beyond and the author is Robert Kaplan (2016).
It is very much a travelogue and trip down memory lane for the author, who first visited Romania (and surrounding countries) in the midst of the Cold War. His visit again in 2013 and 2014, as the situation in Ukraine was heating up, confirming the existence of an ongoing dispute between East and West that did not truly dissipate just because the Berlin Wall came down. This region is simply the center point for that tug of war.
Friday, August 26, 2016
Monday, August 1, 2016
Legislating Instability
The subtitle is Adam Smith, Free Banking, and the Financial Crisis of 1772 and the author is Tyler Beck Goodspeed (2016).
Adam Smith is the dupe in this read. As a Scot, but also as a critic of unregulated banking, certain events in his own backyard challenged his theory and supported a tale of how a system of finance can be self-correcting when left to its own devices. The focal point is Scotland and how, in the midst of over a half-century of robust economic growth, its banking system did not sway too hard despite a fixed exchange rate, large external debts, large capital account deficits, and generally volatile political and economic times across the Continent.
The secret sauce was seemingly a system of truly free banking, where there were not high barriers to entry, and therefore new competitors could enter the fray and market discipline would ferret out the characteristics that did not work. In the period from 1716 to 1845, the Scottish banking system was generally able to withstand the forces around it and remain as resilient as any in the world. The significant exception was the great crisis of 1772 – a moment in time where Adam Smith spoke up and largely represented a view that misdiagnosed the problems and called for changes that had ultimately caused the problems in the first place.
Specifically, a systemically important institution, Douglas, Heron & Co., failed under the weight of a London-based bank going under. With hindsight, Smith and others suggested that the problems might have been avoided with usury laws, bans on small denominations, and a prohibition of contingent liability banknotes – except that all those ideas were part of the Scottish Bank Act of 1765, the first regulations on the banking system. Largely a result of lobbying by the very largest Scottish institutions, the legislation raised the barriers to entry, reduced competition, and allowed the existing participants to grow in scale. As they say, the numbers don’t lie – and following the Bank Act’s introduction, over the next 7 years, the average starting capital for a bank grew nine-fold, the number of partners in an institution grew six-fold, and, most tellingly, the number of bank failures in that period was more than ten times the total between 1716 and 1765, even though leverage levels were actually lower (that last almost contradictory data point stemmed from lower profitability due to higher reserve requirements, which triggered a move towards riskier loan portfolios to compensate). In other words, as the scale of the individual players increased, so too did the fragility of the overall system.
And a crisis they got. Ultimately, the saving grace was another feature of free banking that preceded the changes in 1765 – joint and several liability for the partners of these firms. In the end, creditors and depositors were paid back because the shareholders had liability beyond just the value of their interests in the banks. The unlimited liability mechanism was prevented from serving its full utility a bit with the increased scale of the banks, as they became too large and cumbersome to properly monitor – but this feature nevertheless allowed the Scottish economy to recover fairly quickly, as the resulting credit crunch did not go on interminably – mostly because, in a certain sense, the partners of failed institutions served as the lender of last resort.
Adam Smith is the dupe in this read. As a Scot, but also as a critic of unregulated banking, certain events in his own backyard challenged his theory and supported a tale of how a system of finance can be self-correcting when left to its own devices. The focal point is Scotland and how, in the midst of over a half-century of robust economic growth, its banking system did not sway too hard despite a fixed exchange rate, large external debts, large capital account deficits, and generally volatile political and economic times across the Continent.
The secret sauce was seemingly a system of truly free banking, where there were not high barriers to entry, and therefore new competitors could enter the fray and market discipline would ferret out the characteristics that did not work. In the period from 1716 to 1845, the Scottish banking system was generally able to withstand the forces around it and remain as resilient as any in the world. The significant exception was the great crisis of 1772 – a moment in time where Adam Smith spoke up and largely represented a view that misdiagnosed the problems and called for changes that had ultimately caused the problems in the first place.
Specifically, a systemically important institution, Douglas, Heron & Co., failed under the weight of a London-based bank going under. With hindsight, Smith and others suggested that the problems might have been avoided with usury laws, bans on small denominations, and a prohibition of contingent liability banknotes – except that all those ideas were part of the Scottish Bank Act of 1765, the first regulations on the banking system. Largely a result of lobbying by the very largest Scottish institutions, the legislation raised the barriers to entry, reduced competition, and allowed the existing participants to grow in scale. As they say, the numbers don’t lie – and following the Bank Act’s introduction, over the next 7 years, the average starting capital for a bank grew nine-fold, the number of partners in an institution grew six-fold, and, most tellingly, the number of bank failures in that period was more than ten times the total between 1716 and 1765, even though leverage levels were actually lower (that last almost contradictory data point stemmed from lower profitability due to higher reserve requirements, which triggered a move towards riskier loan portfolios to compensate). In other words, as the scale of the individual players increased, so too did the fragility of the overall system.
And a crisis they got. Ultimately, the saving grace was another feature of free banking that preceded the changes in 1765 – joint and several liability for the partners of these firms. In the end, creditors and depositors were paid back because the shareholders had liability beyond just the value of their interests in the banks. The unlimited liability mechanism was prevented from serving its full utility a bit with the increased scale of the banks, as they became too large and cumbersome to properly monitor – but this feature nevertheless allowed the Scottish economy to recover fairly quickly, as the resulting credit crunch did not go on interminably – mostly because, in a certain sense, the partners of failed institutions served as the lender of last resort.
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