In a fascinating article published in the Atlantic Monthly in January 1987, economist and Roosevelt Institute co-founder John Kenneth Galbraith takes note of the parallels he sees around him with the year 1929. He speculates that the markets are in for another crash and draws lessons from the 1920s to indicate why he thinks this is the case.
Galbriath bases his conclusions on three relatively simple observations—or parallels—with the economic climate of the late 1920s that resonate well with the current economic crisis. The first has to do with the basic nature of the stock market itself and what he terms “the dynamics of speculation”—the tendency of reckless and overly optimistic investors and institutions to drive share prices up to a level of unreality so that the prices achieved “no longer have any relation to underlying circumstances.” Once the market has entered this realm, a collapse, he insists, is inevitable.
A second and equally compelling parallel—especially for our own day—stems from the “seemingly imaginative, currently lucrative, and eventually disastrous innovation in financial structures.” Here, Galbraith is referring of course to the many investment trusts and holdings companies that sprang up in the unregulated environment of the 1920s that conducted “no practical operations” yet were the “financial marvels of their time.” These legalized pyramid schemes used borrowed money to leverage their holdings in ever-expanding layers, which even some of the financial titans of the time said they did not fully understand. One consequence of all of this financial activity was the vast proliferation of debt, which, when called in by the market collapse, quickly brought these investment trusts and holding companies to ruin.
The third parallel—and what Galbraith calls one of the great constants of capitalism—is the tendency for it to mete out its “most ostentatious punishment” to those “on whom it once seemed to lavish its greatest gifts.” By this, Galbraith infers that those involved in the current speculative trading schemes would suffer the same fate as the great financiers of the 1920s—public humiliation before Congress; termination of their positions and income; even prison. Galbraith turned out to be exactly right, of course, about the financial climate in 1987, as October 19 of that year brought in the largest one-day percentage decline in stock market history. He is also right to call attention to the first two parallels with 1929. But, sadly, one wonders if the third parallel will hold true: Will the financial titans who brought us the current economic collapse have to answer for their reckless and irresponsible behavior before Congress, the law, and the public? Or will they simply reinvent themselves and carry on as usual, taking in huge salaries and bonuses in the process? Galbraith himself hints at this possibility when he muses at the close of the article that: “History may not repeat itself, but some of its lessons are inescapable. One is that in the world of high and confident finance little is ever really new. The controlling fact is not the tendency to brilliant invention; the controlling fact is the short-sightedness of the public memory, especially when it contends with a euphoric desire to forget.”
David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute.