Navigating the Financial Crisis Again

It is often said: "Failure is the mother of success."

However, in many instances, this statement is incorrect.

Most of the time, small successes are more likely to motivate people to keep trying and working hard, while sudden failures only bring about a sense of frustration.

In many cases, success might actually be the mother of failure.

People also often mention that only by learning from history and drawing lessons from it can we avoid making mistakes in the future.

Regrettably, people are not always able to draw the right lessons from history; they are more likely to misinterpret history or only have a one-sided understanding of it.

A historian once mocked Napoleon's invasion of Russia: Napoleon did study history, but he learned history only to better make the same mistake a second time.

The renowned economist Barry Eichengreen's new book, "Hall of Mirrors," tells the story of how people recognize and misinterpret financial crises.

The Great Depression from 1929 to 1933 and the global financial crisis from 2008 to 2009 are the two most significant financial crises we have experienced.

These two crises are extremely similar in many aspects.

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It is natural for people to associate these two financial crises.

What's more coincidental is that during this global financial crisis, the Federal Reserve's helmsman Ben Bernanke, and the Chair of President Obama's Council of Economic Advisers, Christina Romer, had already studied the history of the Great Depression when they were young.

Now that we have the lessons of the Great Depression, can decision-makers do better this time?

Decision-makers certainly can do better.

Before the Great Depression, there was no mature macroeconomics, and people's understanding of financial crises was naive and crude.

For the decision-makers and economists of that time, the market economy was a law of nature, like the arrival of storms and tsunamis, which cannot be resisted by human power.

The international gold standard welded the economies of various countries together.

At that time, decision-makers did not value the autonomy of macroeconomic policy.

In order to maintain exchange rate stability, they could calmly accept prolonged economic recession and soaring unemployment rates.

They believed that corporate bankruptcies during the financial crisis were a good thing, which was necessary for "survival of the fittest."

In the words of Andrew Mellon, the Treasury Secretary during President Hoover's time, bankruptcy was necessary to "cut out the rot."

The central bankers of the time believed in the real bills doctrine.

They thought that central banks could only provide credit that matched the needs of economic activity.

When the economy was booming, the central bank would provide more credit, and when the economy was shrinking, the central bank would reduce the supply of credit.

They believed that the nature of bank failures and corporate failures was the same, and the government had no obligation to rescue financial institutions.

The government must strictly adhere to fiscal discipline; fiscal deficits are a sin.

Even if the economy is in crisis, the government must tighten fiscal expenditure.

This political philosophy, mixed with the harshness of Puritanism and the ruthlessness of social Darwinism, led decision-makers to be indifferent and indifferent when facing an unprecedented financial crisis.

After the situation became uncontrollable, they turned to hysterical panic.

In order to cover up their incompetence and mistakes, politicians made other countries the scapegoats, and the "trade wars" and "currency wars" with the policy of beggar-thy-neighbor ultimately dragged countries into the abyss of World War II.

This time, decision-makers did indeed do better.

Having learned the lessons of the Great Depression, they avoided the worst outcome.

After the collapse of Lehman Brothers, they acted decisively, not afraid to save capitalism in a "socialist way," injecting a large amount of liquidity into financial institutions, and almost turning systemically important financial institutions into "state-owned financial institutions."

After the economy hit rock bottom, they united to adopt expansionary fiscal and monetary policies, especially implementing unprecedented quantitative easing policies to stimulate economic growth in unconventional ways.

Developed countries invited important emerging market countries to join the G20, and governments resisted the temptation of beggar-thy-neighbor policies, strengthening coordination and dialogue, showing a rare unity.

These policy responses are very different from the countermeasures during the Great Depression in the 1930s.

Although the global economy inevitably fell into a long-term slump after the crisis, the pain people felt is much less compared to the Great Depression in the 1930s.

In 2010, the unemployment rate in the United States reached a peak of 10%, but this number is still far lower than the 25% unemployment rate during the Great Depression.

However, while decision-makers successfully avoided the worst outcome, they also "successfully" made a series of new mistakes.

In Professor Eichengreen's view, the reason why decision-makers made these new mistakes is precisely because they thought they were very successful in dealing with this financial crisis.

They focused too much on the lessons of the Great Depression and ignored the new changes around them.

Since the Great Depression was mainly a crisis caused by bank bankruptcies, decision-makers naturally focused on commercial banks when dealing with the financial crisis from 2007 to 2008.

They ignored shadow banks and also ignored hedge funds, money markets, and real estate loan financial institutions.

Perhaps, it is precisely this mistake that prevented decision-makers from realizing the huge disaster brought about by the collapse of Lehman Brothers.

After all, Lehman Brothers is not a commercial bank, and it does not accept public deposits.

Decision-makers did not fully consider that there are countless connections between financial markets.

The collapse of Lehman Brothers directly triggered panic in the money market because many money market funds held short-term bills issued by Lehman Brothers, and the panic in the money market quickly spread to investors' runs on investment banks.

Dominoes fell one by one.

In 2010, the European economy was still in a slump, and the European Central Bank hastily decided to exit unconventional policies.

In the spring and autumn of 2011, the European Central Bank raised interest rates twice.

This seems to be an inconceivable thing, and the result is self-evident: Europe did not usher in a recovery but fell into a second recession.

Why did the European Central Bank act in this way?

This is largely due to Germany's concern about inflation.

In 1923, Germany experienced hyperinflation, and many historians even believe that this hyperinflation led to public dissatisfaction with the Weimar Republic, turning to support Hitler, leading to the rise of the Nazis.

Germany has a huge influence on the European Central Bank, and at that time, the Frenchman Trichet, who was the head of the European Central Bank, was eager to show that he was as noble as the Germans, and he was more radical than the Germans.

This is another misinterpretation of history.

Even if there has been a heart-wrenching history like the Great Depression of the 1930s, people can only learn half of the lessons.

The Federal Reserve's quantitative easing policy was fiercely condemned by Congress, and politicians attacked the zero-interest-rate policy, which would lead to a new round of asset price bubbles.

The U.S. Congress opposed financial bailouts, opposed expanding public spending, and opposed raising taxes.

In 2012, Europe made a large cut in budget deficits, regardless of the fact that the European economy had fallen into recession again.

The United Kingdom did not join the euro zone and has its own central bank and independent currency, but the United Kingdom is also busy cutting government spending.

This kind of policy flip-flopping and indecisiveness is one of the main reasons for the global economy to fall into a long-term slump.

The same mistakes also occurred in financial regulatory reform.

After the Great Depression, the U.S. financial regulatory system underwent a huge change.

The Glass-Steagall Act required commercial banks and investment banks to be isolated from each other, the deposit insurance system was born, and the U.S. Securities and Exchange Commission was officially established.

But after this global financial crisis, although the Dodd-Frank Act of 2010 tried to propose a series of reforms, it still did not touch the root.

Eichengreen mentioned that it is precisely because decision-makers believe that they have avoided the worst situation that they have lost their determination to reform resolutely.

Success once again became the mother of failure.

One cannot step into the same river twice.

One cannot cross two different rivers in the same way.

Each stream of financial crisis has invisible vortices: this time is really different.