Why the World Economy Needs Another Financial Crash – a guest review by Phil Thornton of Clarity Economics

“Those drawing their incomes mainly from City (of London)
activities are relatively few. The devaluation of those claims is a necessary,
if insufficient condition for the quickening of real economic activity and
perhaps even the survival of the capitalist system.”

These words will ring true for many observers of the current
tussle between the UK Government and the big banks. But this was written in
1986 as the conclusion of a prescient article in the Financial Times
explaining why there needed to be a financial crash or a bout of inflation to
purge the system of its excesses. The author, Jan Toporowski, now Head of the Economics Department at the School of Oriental
and African Studies in London, got his wish a year later but also lost his City
job.

Now 25 years later it forms the title essay in a collection of his
subsequent writings on the danger inherent within a “financial era [where]
finance mostly finances finance”. The book, Why the World Economy Needs Another
Financial Crash (Anthem Press; 143pp; £22.95), is therefore not a focused
examination of the causes of, and solutions to the financial crisis, of which
there is a burgeoning bibliography. Instead it is a record of a journey of a
practitioner-turned-student of the era of financial deregulation that he
believes was primed to create an excess of debt that would need to be purged,
either in a controlled fashion or by a shock event that leaves the world with a
period of debt deflation.

His core focus is on the concept of financial inflation, which the
author describes as the “rise in value of the financial sector of the economy
in relation to the value of the rest.” At the heart of the book are two
chapters that form a critique of financial inflation. It is harmful, we are
told, because it changes the way the economy works, by inflating asset prices
and creating a false sense of prosperity until the cycle ends with asset
deflation that in turn can lead to debt deflation.

The book is divided into three sections. The first looks at the
history of modern finance, covering familiar themes such as the end of Bretton
Woods, the run of emerging market crises and the dominance of the Washington consensus
of economic policy but viewed against the backdrop of the battle between
economic liberals and Keynesians over how best to control global finance.

The second looks at the academic and professional culture behind
financial inflation and includes entertaining essays on the “mendacious
courtesy” of goodwill in corporate accounts, and on deleveraging as a conduit
of financial crises. They also include a pertinent pair of chapters looking at
the link between asset inflation and inequality and highlighting the awful
irony that the surge in house prices that made the rich richer encouraged poor
people to over-debt themselves to get on the ladder and fuel the growth in
subprime mortgages.

The third section brings the debate up to data with an analysis of
the causes of the current crisis. It also includes a Woody Allen-inspired
dictionary of “everything you need to know about the crisis but couldn’t find
out because experts were explaining it.”

The book is thoroughly grounded in economic history with references
to the 20th, 19th or even 17th and 18th centuries never far away and steeped
with references to the great economic thinkers. It also uses humour well,
describing financial innovations as being little use to those outside financial
markets “although this will be disputed by anyone who has used a credit card to
cut a cake”.

Ultimately the critique begs the question of what the author would
put in place to replace financial liberalism and so, as Gordon Brown once
heralded, to end the cycle of (financial) boom and bust. Toporowski looks at
the Basel proposals on capital requirements for banks but rejects them as
simply forcing businesses and households to use unregulated financial markets. He
says that a return to the credit controls of the 1950s might curb the credit
cycle but would not end the industrial business cycle, whose downward phase
would simply lead to renewed calls for another bout of credit expansion of
asset inflation. The opening 1986 essay argued that a bout of inflation was
needed to boost wages and prices and reduce the real value of debt. Given that
debts are stratospherically higher now, more extreme measures may be needed.

In case the reader is any doubt about the measures needed
Toporowski closes the book with the statement that what is needed is an
economic system that avoids both financial and industrial instability. “It is
time once more to consider socialism.”

It would have been nice – perhaps for geeks and economic
historians – to have been given details of the time of writing and the outlet
for each article to put the thinking in a context of its time. But that is a
small quibble in what is a timely and amusing contribution.