Wednesday, October 15, 2008

Yom Kippur and the credit crunch

The Yom Kippur war of 1973 caused the credit crunch and collapse of the world financial system in 2008.

Let me explain. The Yom Kippur War was initiated on 6th October 1973, the holiest day in the Jewish calendar, when Syria and Egypt jointly attacked Israel. It was only the support of the United States, which sent $2 billion of arms, that enabled Israel to repell its assailants. However, the support that the United States provided to Israel triggered OPEC, the Arab oil-production cartel, into raising oil prices and cutting oil production, and this caused the worldwide oil crisis of 1973-1974.

Prior to the crisis, the average rate of economic growth in the West had been around 5 percent; after the crisis, growth reduced to zero, and inflation rose to around 10 percent. The late 1970s, then, was an era of stagflation, and its consequence was to destroy the Keynesian economic consensus, with its belief in the importance of government taxation and expenditure. In its place, as Thatcher and Reagan came to power in 1979 and 1980, were the economics of Milton Friedman, with its emphasis on low taxation and the unregulated free market. This belief in the unregulated free market permitted the growth of financial derivatives capable of hiding debt, and this ultimately led to the collapse of the world financial system in 2008.

And the role of sub-prime mortgages in the USA? Well, the problem with the growth of financial derivatives is that they created an unstable system, and as Professor Peter Cox pointed out in High Anxieties: The Mathematics of Chaos, when an unstable system collapses, the particular eddy which causes it to collapse is not really relevant, it is the instability itself which is the culprit.

16 comments:

Nick Caulfield said...

I think that some of the themes explored in Critical Mass by Philip Ball are similar to what you quote Prof Cox as saying

The Dandy Highwayman said...

I've been quite confused by the response to the recent crisis. The standard response seems to be something like this: "Well, this is what happens when you deregulate the free market and let it go wild."

But such an analysis assumes that the financial markets over the last few years have been unregulated. This is hardly true. Would any of this subprime nonsense have occurred without the Community Reinvestment Act?

More to the point, would any banks have messed around with complicated CDOs if they hadn't been deprived of conventional investment schemes? Central banks have kept interest rates artificially low for many years, so it's hardly surprising that financiers have been looking for ever more exotic investment vehicles to get a decent return on their money.

However, I do like your point that the exact cause of the collapse is irrelevant - the interesting claim is that the system is itself unstable.

So, what's your evidence that free markets are unstable?

Gordon McCabe said...

To clarify, I don't think that free markets are intrinsically unstable, but they are clearly capable of entering unstable states.

The massive worldwide domino effect which has resulted from some people in the USA defaulting on their mortgage re-payments, attests to the fact that the financial market had entered an unstable state; a small external perturbation had a massive effect.

The Dandy Highwayman said...

OK, but now the interesting question is what caused it to enter this unstable state? Was it the immoral (or perhaps merely irresponsible) behaviour of actors within an unregulated market, or was it the immoral (or perhaps merely mistaken) actions of regulators?

Your original post suggests that you believe the instability was caused by Reagan/Thatcher-style belief in free markets. I am in no way an expert, I have only ever worked on the periphery of the financial industry, but I think it is more likely that the instability was caused by fans of Keynes than by fans of Adam Smith.

Gordon McCabe said...

The belief in the unregulated free market permitted the growth of financial derivatives capable of hiding debt and risk, but didn't inevitably lead to it. Some combination of responsibility must be shared between the regulators and actors, but I've tried to suggest in my latest post above what the underlying causes were, within the established context of the belief in the minimally regulated free market.

The Dandy Highwayman said...

Fair enough. Your latest post does answer my query quite effectively.

I suppose my motivation for bothering to question your post in the first place was my desire to discover the correct solution to the problem.

Many people seem to believe that the problem was caused by deregulation and that therefore the solution is greater regulation. I think this is too simplistic and that greater regulation is likely to prolong the misery rather than cure it. This is much like how FDR's New Deal, contrary to established myth, actually exacerbated the Great Depression.

It would be a shame if a remediable situation was turned into a worldwide recession by the ignorant application of interventionist policies.

Then again, quite what a few comments on the world's only philosophy-physics-motorsport blog have to do with world governance I don't know...

Gordon McCabe said...

I hear that Stanford are thinking of introducing a joint honours philosophy/physics/motorsport degree.

Clare Dudman said...

Brilliant, Roger! I have not heard such a succinct description of recent events before - and to me seems to make much sense.

Clare Dudman said...

Sorry, I've called you Roger, again! I'm so sorry - it seems to be fixed in my head for some reason.

Gordon McCabe said...

You trying to Roger me again Clare?

The Dandy Highwayman said...

I would emigrate for a course like that.

Also, there's an article at the Washington Post that may interest you. Apparently it's all China's fault.

elberry said...

An interesting idea, Gordon, but what i think you're really saying here is that Jesus is God, yes? Am i right, yes, yes?

Gordon McCabe said...

"The Logos was made flesh." John 1-14.

This is often interpreted as a reference to Christ, but in fact is actually a reference to Niobe's craft in the Matrix Reloaded and Matrix Revolutions.

The Dandy Highwayman said...

No, no, no. This myth has been perpetuated for long enough already without you joining in too. It wasn't Logos at all. That's just a typo.

Clare Dudman said...

I couldn't possibly! :-)

Gordon McCabe said...

Genius! A Lego-illustrated Bible!

Which reminds me: do anti-reductionists believe that a Lego spaceship possesses emergent properties which are not reducible to the properties of the individual bricks and the relationships between them?