History of Financial Disasters 1763-1995 Book Review

HOW CAN YOU AVOID financial disaster? First of all, it helps to understand the nature of disaster. What is a disaster, after all? People use the word “disaster,” but what does it mean? And of course, if you want to avoid a financial disaster, it would help to know what a financial disaster looks like as well. If your goal is to avoid something whose effects are not good, it certainly helps to know what that particular something looks like, or at least to understand its nature. Then at least you can get your money off the table and get yourself out of the way when it is headed in your direction.

In this review of a new and brilliant three-volume set of books entitled History of Financial Disasters 1763-1995, I will talk about just these subjects: disaster and financial disaster. And I will give you a unique opportunity to obtain an insider’s view of what happens when the proverbial roof caves in on your financial house.

The Nature of Disaster

WHAT IS A DISASTER? The Latin roots of the word are “dis” and “astro.” Literally, the two combined words mean “ill-starred.” In ancient times, if you offended the gods, the deities would align the stars against you and bring a bad set of events down upon your house, if not upon your head. So the word itself has come to mean, according to the Oxford English Dictionary, “a sudden or great misfortune; an event of ruinous or distressing nature; a calamity; complete failure.” Let’s look at some examples, just to illustrate the point.

Everything Was Destroyed

In classical times, there was hardly a more disastrous event, or an event with more calamitous outcome, than the Athenian invasion of Sicily in 415 B.C. This disaster was chronicled by no less than Thucydides in his classic work, The Peloponnesian War . The short version of the story is that the Athenians had been fighting the neighboring Spartans for many years and eventually decided to attempt to break what had turned into a military stalemate. The Athenians determined to outflank their enemy by sending an army halfway across the Mediterranean Sea to Sicily and raising a threat to Sparta’s rear.

But talk about offending the gods? Someone sure did. (Thucydides said that it was Alcibiades, but who really knows?) The Athenians were filled with hubris at the prospect of their own success. But their distant expedition met with trouble from the outset, encountering almost every form of problem that a distant military campaign could have. And once the Athenians had landed on the shores of hostile Sicily, things went from bad to worse. After losing a major battle at the Sicilian town of Syracuse, the Athenians were thrown into headlong retreat. Eventually, the soldiers of Syracuse caught up with the main body of Athenians at the Assinarus River, on the southeast coast of Sicily. There, according to Thucydides, the thirsty Athenians were slaughtered in droves as they trampled each other trying to get to the water.

Thucydides summed up the expedition to Sicily in sad words, but words that still convey the sense of total loss. In the end, he wrote, “They were destroyed, as the saying is, with total destruction, their fleet, their army, everything was destroyed, and few out of many returned home. Such were the events in Sicily.” Now there is a disaster for you.

Every Man for Himself

Let’s take a look at another disaster, the sinking of the steamship Titanic on the night of April 14-15, 1912. It is a familiar story in many respects. You may have seen the 1997 award-winning movie, or read one of the many good books that chronicle the event. Titanic was a big, expensive ship that was constructed according to the highest levels of naval architecture of the age. The captain of the Titanic, a skilled mariner named E.J. Smith, once said, “I cannot conceive of any vital disaster happening to this vessel. Modern shipbuilding has gone beyond that.” But what Capt. Smith did not appreciate is that the steel used in constructing the ship was brittle, and that the steel became even more brittle when it was chilled to freezing temperature in the cold waters of the North Atlantic.

When Titanic scraped its side along the fateful iceberg on the night of April 14, 1912, the brittle steel of the ship fractured in many places. Also, the force of the ice moving along the side of the hull literally scraped the rivet heads off the outside of the vessel. Within moments, Titanic suffered thousands of small penetrations in its hull due to the popping of rivets, each small rivet hole allowing seawater to pour into the ship. Titanic was doomed.

So the good Capt. Smith could “not conceive of any vital disaster happening” to his vessel? “Modern shipbuilding has gone beyond that”? Talk about offending the gods. There is some more of that hubris for you.

On the night of April 14, 1912, a star of ill fate must have shone down from the heavens upon the glassy sea, because Capt. Smith was heard to say something quite different. Toward midnight he gave an order: “Prepare the lifeboats.” And later, in the wee hours of the morning of April 15, he shouted as the water lapped over the bridge: “Every man for himself.” And then the cold sea took Capt. Smith and he was never seen again. So things change, don’t they? Disasters occur.

Major Malfunction

“But mankind has moved beyond these sorts of things,” some people still say. Yes, of course. Except that we humor ourselves when we say such things. The same sorts of calamities still occur. We suffer from the same sense of hubris that doomed the Athenian army and the good ship Titanic and its captain. Mankind still has that almost willful blindness to exercising the vision to forecast and avoid disaster in the making.

For an example of a modern disaster, no one who was around at the time could ever forget the famous words broadcast from NASA’s Mission Control on Jan. 28, 1986, perhaps the understatement of the age: “It appears we have had a major malfunction of the vehicle.”

“A major malfunction?” Space shuttle Challenger had just exploded, less than two minutes after liftoff. The vehicle was destroyed. The crew was killed. Debris rained down from the sky, falling into the blue sea offshore Cape Canaveral. And it was all on television, live and in color, no less.

The immediate cause of the Challenger disaster was a faulty device called an “O-ring,” part of an otherwise tight seal between two sections of one of the solid rocket boosters. When cooled to a freezing temperature, as had occurred on the cold night before the deadly launch, the rubber in the O-ring lost its resilience and became somewhat brittle. (Brittle due to the effects of the cold? Where have we heard of something similar?) During the stress of launch, the exhaust from the solid rocket booster literally burned through the O-ring, causing the rocket booster to shift from its proper position in flight, resulting in a sequence of failure events that led directly to the explosion that destroyed Challenger and killed the crew.

Common Features of Disaster

So can we really say that a disaster results from just the single triggering event? Of course, every disaster has its penultimate cause. In Sicily, the Athenians lost a battle at Syracuse. The rivet heads of the Titanic were shaved off. And the O-ring on one of Challenger’s booster rockets burned through. But is this the end of how to think about it? Not by a long shot. Thucydides, for example, writes his history but does not shirk from detailing a chain of errors and misjudgments on the part of the Athenian leaders who sent their army to its doom in Sicily.

And in the case of the lost Titanic, as fate would have it, a man named J. Bruce Ismay, one of the directors of the White Star Line that owned the vessel, was aboard when disaster struck. Ismay survived the Titanic’s sinking by leaping into one of the last lifeboats that dropped from the doomed vessel into the freezing ocean. Later on, Ismay was greatly criticized from almost every quarter, because he survived the sinking when over 1,500 others did not.

One of the most trenchant critiques of Ismay came from the U.S. Navy’s Rear Adm. Alfred Thayer Mahan, the great historian, strategist, and visionary of sea power. Mahan was more than critical of Ismay’s retreat to the lifeboats. Despite his position as an owner of the sinking vessel, Ismay took to a lifeboat and abandoned hundreds of passengers and crew to death by drowning in the freezing sea. Mahan wrote:

“We should be careful not to pervert standards. Witness the talk that the result is due to ‘the system.’ What is a system, except that which individuals have made it and keep it? Whatever weakens the sense of individual responsibility is harmful, and so likewise is all condonation of failure of the individual to meet his responsibility.”

In the case of the Challenger explosion, no less a mind than Richard Feynman, physicist and Nobel Laureate, noted that the source of the explosion was a pervasive cultural disease within the institution of NASA. Feynman noted that NASA had evolved away from its roots as a scientific and engineering agency within the U.S. government to become a vast bureaucracy that allowed safety standards to slip, and which permitted grievous errors to go unnoticed for years at a time. To paraphrase Mahan, NASA had become a “system” that allowed its bureaucratic nature to “pervert standards.”

History of Financial Disasters

Now that we have discussed a few examples of famous disasters, let’s take a look at the idea of “financial disaster.”

“What is a financial disaster? The phrase brings to mind images of panicked merchants huddled around an exchange waiting for the latest news to arrive via post, telegraph, or computer, of stock market crashes, of unemployment and charts showing a precipitate drop in the price of shares, indexes, or currencies.”

The foregoing comes from the introduction of a remarkable three-volume set of books entitled History of Financial Disasters 1763-1995, released in April 2006 by the London-based firm of Pickering & Chatto.

As the title implies, these three volumes review the origins and consequences of the Western world’s most important financial crises in the past quarter millennia. The editors have chosen to highlight and delve into 19 seminal economic crises between 1763-1995. Rare public and private papers, offering trenchant firsthand accounts from some of the principal insiders, offer rich source material and penetrating background on the events that occurred. In addition, the editors have culled the stacks of academic literature to assist the reader in interpreting these events and in drawing conclusions and lessons for our own time.

There are only a few people in the economic world that could have assembled this type on insightful collection. The general editor of this important historical review is Mark Duckenfield, an accomplished economist and historian at the London School of Economics. With the able assistance of co-editors Stefan Altorfer and Benedikt Koehler, also accomplished economic historians, Dr. Duckenfield has cast a broad net to gather what are among the best source materials that could be found in the world.

In general, the editors follow the definition of “financial crisis” established by the great analyst Charles Kindleberger. That is, financial crises are “associated with changed expectations that lead owners of wealth to try to shift quickly out of one type of asset into another, with resulting falls in prices of the first type of asset, and, frequently, bankruptcy.”

Alterations of Expectations

Thus, according to the editors, financial crises are a product of sudden alterations of expectations, rooted in reality or imagination. If you are looking for a way to avoid financial disaster, this is the key level of understanding. The impending alteration of people’s expectations sends a glaring signal to which you should train your mind to react.

In these three volumes, and for each of the financial crises that bears examination, the editors provide the reader with a look beyond the immediate crisis itself, and a view of the series of events that constituted the whole disaster. Here is the true value of this set of books.

The editorial approach is similar to the way that one might view the onshore wreckage caused by a hurricane, and from which natural disaster the recovery efforts can take years to come to fruition. In other words, the landside wreckage is only the most visible feature of a natural phenomenon that had its origins far out to sea. To avoid the impact of the storm, you should learn to forecast the weather. And then prepare yourself for the hit, if not just plain get out of the way.

Origins and Consequences

The editors use a broad conception of financial disasters that includes objectively describing the origins and resultant consequences of the phenomena. But the editors go many steps further as well by presenting information about how each disaster related to broader themes of the times. This includes providing the reader with fascinating information about the historical context, changes in the view of government intervention in the economy, the development of broad economic thought, the role of the media, and the openness (or what we now call “globalization”) of markets.

Each of the three volumes in this series looks at events in which sudden changes in market expectations led to either large-scale insolvency or an inability to pay. Of course, many events lead to changes in market expectations, and the editors provide examples to illustrate the points and put each event into its own context.

Large-scale changes could be triggered by the dawn of a realization that a government’s currency policies were highly inflationary. As an example, the editors review both the French Assignat inflation of the 1790s and German Weimar hyperinflation of the 1920s, and what followed when people came to realize that their currency was plummeting to worthlessness. Or people may begin to perceive that a government might have less political stability than had previously been thought, such as occurred with the Mexican peso crisis of 1994. On occasion, the financial meltdown begins not with overt monetary inflation, but with the pricking of a credit balloon and associated asset price bubble, such as the New York crashes of 1929 and 1987. Or there could be a herd mentality when investors respond to rumors and fears of insolvency, as with the collapse of the British entity of Overend & Gurney in 1867.

Often, a financial disaster is triggered through the confluence of several factors, rather than one defining cause. A combination of fraud, contraction of credit, shipwrecks, and a bumper year for agricultural output in Europe contributed to the Ohio Life Crisis of 1857. This financial disaster had its own broader effects on the U.S. economy, and helped to precipitate the U.S. Civil War.

Likewise, in 1931, German and Austrian banking failures undermined confidence in Britain’s financial institutions, while at the same time a minority Labour government in Britain proved unable to balance the budget through cuts in social benefits or indirect taxes. The efforts of the successor National government to do so triggered a near-mutiny in the Royal Navy that further spooked currency markets and forced Britain off the gold standard.

From the standpoint of an American reader, the history of the financial disasters in the U.S. during its formative, post-Colonial years offers great insight, particularly by way of comparison with current times. The editors do an excellent job of illustrating the circumstances of the Second Bank Crisis of the U.S. in 1818, as well as the devastating Panic of 1837. Each of these events had much to do with both the economic and political evolution of the U.S., to include pushing the nation down a path that sharpened sectional divisions and rivalries, eventually steering the nation toward its Civil War. (It is far too facile just to say that the U.S. Civil War was “all about slavery.”)

In addition, no one can consider himself or herself knowledgeable about the origins of modern monetary policy, and, in particular, the role of the U.S. Federal Reserve, without a solid grounding in the events of the Crisis of 1907. This section alone ought to be required reading for anyone who wants to understand the Fed and its origins, as well as its future direction as the U.S. dollar continues its century-long decline in value.

The Roots of Disaster

Every disaster has its proximate cause, the roots whence it grows. The Athenians lost a battle at Syracuse. The Titanic hit an iceberg. The O-rings of space shuttle Challenger became brittle in the cold. But as we discussed, there were deeper causes and origins, not to neglect the general human affliction of hubris.

In this same vein, History of Financial Disasters 1763-1995 is a treasure chest of historical perspective on the subject of economic and monetary disasters, and a valuable tool in your personal workbench of financial and historical knowledge. These books give you insight into the origins and consequences of financial disasters.

As I said at the beginning of this review, if your goal is to avoid something whose effects are not good, it certainly helps to know what that particular something looks like, and to understand its nature. Then at least you can get your money off the table and get yourself out of the way when it is headed in your direction. You could not do better than to read these three outstanding volumes and work to acquire the financial insight that might make all the difference in the world to you and to your family when the economic ship hits the next iceberg.

This Is a Limited Opportunity

“Limited opportunity?” Sure, you say. You hear that all the time. OK, suit yourself. But believe me. There is a limited number of copies of History of Financial Disasters 1763-1995 in print. This is a publishing opportunity, and it is not for everyone. If you have that certain hunger for knowledge, and the driving desire for financial success in the midst of some future disaster that may (no, will) come down the road, History of Financial Disasters 1763-1995 is your kind of reading. On the level of scarcity and value alone, purchasing this set is a unique opportunity.

The information in these volumes is priceless. If you attempted to do your own research on these topics, to develop the perspective that you will find in this publication, you would spend months combing the stacks of a very good university-level library. So if the publisher, Pickering & Chatto, was to set a figure of thousands of dollars on the content of the product, it could be worth every cent.

And ask yourself this “bottom-line” sort of question: What would these volumes be worth to you if they alerted you to the signals of the next financial disaster that will perhaps make the pages of “Vol. 4” of this so-far three-volume set? Forewarned is forearmed. What is it worth to be just a few steps ahead of the crowd when the roof starts to cave in?

The publishers have set the price of these fine volumes at $395, or less than the daily fluctuation in value of a very modest brokerage account. And if the books are shipped to you within the U.S., that price includes the cost of shipping and handling.

Until we meet again…
Byron W. King

March 14, 2007