The author, George Cooper states "My aim is to bring an understanding of financial instability and central banking to as wide an audience as possible in the hope that this will bring with it an informed discussion of how macroeconomic policy should be reformed". The central thesis is that the financial system does not behave according to the Efficient Market Hypothesis [EMH] and consequently a better model is needed.
Financial Instability Hypothesis
Analysis and evidence is presented to discount the EMH model and the author points to another model that is closer to what is observed in the market - the Financial Instability Hypothesis by Hyman Minsky who credits many of his ideas to John Maynard Keynes. The key and fundamental difference between these models is that EMH postulates that market price movement is from external changes whilst Minsky suggests that it can be from internal market forces. These internal forces can cause waves of credit expansion and asset inflation followed by waves of credit contraction and asset deflation.
Central Banks
To place all of this into context, the history behind central banks and their purpose is explored and with some deft analysis the author explains:
- A concise history of barter, gold and money
- Private credit creation
- First banking crises and the response - central banks to act as the lender of last resort
- Financial crises happen with and without a gold standard and moral hazard
- Bretton Woods and then the later separation of money from the gold standard
- Conflicted central bank objectives such as promoting credit creation for demand management and restraining it for financial stability
Stable and Unstable Markets
A simple "market story" is used to explain the difference between price action and supply and demand for goods and services versus assets. Building on this foundation the author investigates modern macroeconomic policy and credit creation and how bubbles can happen without irrational investor behaviour. This analysis demonstrates that markets can have periods of stability and internal market forces can lead to instability. The key to identifying that instability and potential bubble is credit growth.
Central Bank Governors
Drawing on the insights of James Maxwell in 1868 in On Governors and the work of Hyman Minksy and Benoit Mandelbrot the author explains how a better hypothesis can be formulated that more closely fits the evidence from the markets than the EMH. This new hypothesis would discard consumer price targeting and instead focus on aggregate credit creation.
Origin of Financial Crises
The author proceeds in a series of simple, clear arguments that are easy to understand and follow, and these show that the EMH model does not reflect reality. A better alternative model is presented that also indicates how markets should be governed. This is an insightful, clear and compelling book, which The Economist described as "A must read".
The Origin of Financial Crises: Central banks, credit bubbles and the efficient market fallacy by George Cooper. Harriman House 2008. ISBN: 978-1-905641-85-7.
Roger Lever - Early career was in Treasury Banking and this led to my interest in financial investment, especially the stockmarket. Enjoy reading widely ...
