Typical street scene in Santa Ana, El Salvador. (Photo: iStock)
October 7, 2008
To put the current financial crisis in perspective, IMF Survey magazine spoke to IMF Historian James Boughton about how it compared with previous crises.
Boughton on the crisis: "I think if everybody reacts calmly and wisely in dealing with this crisis over the coming months, it doesn't need to turn into the 1930s" (IMF photo).
HIstorical Perspective
IMF Survey online: How big is the current financial crisis? Can you put it in historical perspective for us?
Boughton: This may well be the biggest financial crisis since the 1930s. But it is important to remember the distinction that it is not as big as the 1930s, which was a horrendous decade in which market activity virtually collapsed for several years, output fell very sharply, and unemployment in the United States was 25 percent. And the economies around the world did not recover for a whole decade. We're a long way from that point right now. But we could get to that point if we're not careful.
I think people tend to forget that we've had other crises that seemed really serious at the time. The United States, for example, has seen three previous, pretty major crises in the postwar period. The dollar was forced off gold in the late 1960s, so that the dollar was no longer backed by a hard asset. Ten years later, in the late 1970s, very high inflation led to a very severe attack on the dollar, and the United States was forced to draw on its reserves at the IMF, for example. It didn't actually have to ask for a Stand-By Arrangement, but if things had gotten much worse, the United States might have had to ask. So that was a very serious crisis. And then, in the late 1980s, the Savings and Loan industry—the thrift industry in the United States—virtually disappeared, and it was then called the savings and loan crisis. It was very expensive, and it could have been even more severe. So each time there's been the potential that you could have a financial, and even an economic, collapse in the country. But it didn't happen; we got through it. And I think there's reason to hope that that will happen this time.
I think what makes this crisis different from some of these earlier ones is that the interlinkages among financial institutions are much greater now than they used to be. This started as a crisis in low-quality mortgage loans—home loans to people in the United States who would have trouble repaying them. But it then spiraled out of control, because the institutions that were making those mortgage loans were dependent on other institutions for the money that they were using to lend. And those institutions were depending on other institutions. So very quickly, this spiraled into a crisis that was affecting financial institutions everywhere. And that wasn't true 10 or 20 years ago, but it is true now, and it's something we need to be very cautious about. So the potential is there. But the good news is that over time, regulators and policymakers have learned lessons from each crisis that we've gone through. For example, the way Sweden handled its banking crisis in the early 1990s is often cited as a good model for regulators to learn from. So I think if everybody reacts calmly and wisely in dealing with this crisis over the coming months, it doesn't need to turn into the 1930s.
IMF Survey online: Some suggest that we have seen the end of laissez-faire capitalism. Do you think this event marks a turning point for the global economy?
Boughton: I don't think it's a real sea change. There's been a debate for quite a while between people who think that markets are perfect, and if you just leave them alone, get the government out of the way, everything will work great. And on the other side, you have people who think that markets are rife with greed and corruption, and we need to have very tight oversight and regulation. And certainly a crisis like this one tips the balance of that argument toward that second view.
But we don't need to go to these extremes, and I don't think we will go to these extremes. I think the fact is that what we need to reach is a point where we can strike the right balance between letting markets work, getting the good effects of free markets, and having proper oversight and regulation of those markets—so that they don't get out of control and so that you don't get too much concentration of power, too much opportunity for greed in markets. It's kind of a middle-of-the-road attitude, and it doesn't make for very good television, but I think it's an important truth that we should keep in mind.
IMF Survey online: Has the IMF ever seen an advanced economy in a crisis of comparable magnitude?
Boughton: Certainly in the postwar period, the closest we've seen to a crisis like this one in the advanced economies was the collapse of the fixed exchange rate system in 1973. You know, there was a period when American tourists in Europe were finding that no one wanted to take their dollars, that they couldn't spend their dollars in shops or restaurants because no one know what the dollar was going to be worth the next day. So that was a major crisis. And that was just one example of how serious a problem that was at the time. And it was a problem that affected all the major countries.
We've also seen some serious economic crises—not really financial crises, but economic crises—in a number of countries. In the late 1970s, both Italy and the United Kingdom had Stand-By Arrangements with the IMF because their economies were suffering greatly under the shock of high oil prices and floating exchange rates. That was the last time that the IMF provided lending to major industrial countries—that was in 1977 and 1978, 30 years ago. But after that, in Japan, we had a major crisis where there was a bubble in real estate prices and when that collapsed, we had stagnation in Japan for a decade.
So we've seen some major crisis, but what makes this one different is the way that it affects all of these major countries, and it's a much more pervasive crisis and has more serious economic potential for a crisis than what we'd seen before. But, as I said earlier, I think it's still too early to make a real judgment about that.
To my mind, what we're seeing right now looks like a very slow train wreck. When a train starts to go off the rails, it can take a little time before it actually tips over. And right now, we're at a point where, on one side, the wheels have come off the track and it's tilting quite a bit. But if you react properly—in that we still have enough forward momentum that we can still try to get the train to right itself and get back on the track—we can prevent things from turning into a total disaster.
Comments on this article should be sent to imfsurvey@imf.org
