. . . Let's learn to like it

October 30, 1997|By Diane Coyle

LONDON -- All the old jokes have been wheeled out here, the ones that start with skyscrapers and end with the punch line: ''It's raining brokers again tonight.''

A financial crisis is always great drama, complete with pictures of panicking, shouting traders and a grave chorus of dark-suited experts punctuating the news bulletins.

But the fact that the reaction to this week's stock market crash has slipped into the familiar routine of criticizing the financial markets as irrational and destructive should not obscure the fact that they play an ever more essential role.

In an increasingly insecure world, we must learn to love the markets, wild, chaotic and tumultuous as they can be.

Let's make no bones about it. A stock market crash is a pain. But it should not turn us against financial markets, any more than you stop loving your toddler just because he's having a tantrum.

This might seem a contrary view to take at a time when even the high priest of financial speculation, George Soros, has been expressing his concerns about global capitalism.

Soros view

In a speech he gave in Hong Kong last month, Mr. Soros warned: ''I cannot believe that the present boom will not be followed by a bust until history has proven me wrong.'' Once again, the Great Speculator got it right.

His speech was billed as a riposte to the anti-market rantings of Mahathir Mohamad, the Malaysian prime minister who had called for a ban on financial trading.

But the arch-speculator agreed with his arch-critic in one thing, saying the instability of the financial markets could cause serious social and economic dislocations.

Mr. Mahathir was voicing the frustration of being unable to connect the funny money of the billions gambled in the markets with the real world effects. ''No real money is involved, only figures,'' he grumbled.

This is the common reaction. It was voiced Tuesday by the great economist John Kenneth Galbraith. Psychology alone drives the stock market.

It has nothing to do with what is happening in the real economy, yet the whims of the traders are allowed to damage the wealth of ordinary investors like you and me. Only up to a point, Professor Galbraith.

The first thing to note is that as stock market crashes go this one is -- so far at least -- a tiddler. In October 1987, Wall Street lost nearly a quarter of its value in a single day and then fell some more.

This 10th anniversary crisis is not over; but although it could match up to 1987's crash eventually, it is nowhere near as severe yet.

Secondly, by October 1988 shares in the United States and in Britain had more or less regained their pre-crash levels, and, until this month, they had gained in value ever since.

The 1997 crash starts from a much higher level of wealth. This has some connection with reality; it reflects the steady economic expansion of the past six years.

Crash ready

Even more relevant is the fact that many professional investors, the anonymous fund managers who look after the money invested in our pensions and insurance policies, have been prepared for a stock market crash for a long time.

It has been clear for at least a year that Wall Street was being inflated by a speculative bubble. Alan Greenspan, the U.S. Federal Reserve chairman, gave clear notice of this when he warned about the markets' ''irrational exuberance'' last December.

Sensible, cautious investment managers -- most of them have caution as their middle name -- have been switching funds out of the overblown equity markets for months.

The growth of mutual funds and the spread of stock options as a component of pay for executives has increased the exposure of individual Americans to the crash.

There are two straws of comfort. One, the lesson of history is that the bigger the boom, the bigger the bust. We should always be grateful for a crash because if it happened later, it would be worse.

Two, the U.S. economy has been growing so fast that the Federal Reserve was poised to slow down spending by raising interest rates. A gentle deceleration would have been preferable to an emergency stop, but the brakes were about to go on anyway.

In the Western world, not since 1929 has stock market crash spelled economic disaster. In his classic history of financial crises, ''Manias, Panics and Crashes,'' Charles Kindleberger concludes that central banks have learned to supply extra credit to the financial system to offset the sudden contraction of share capital.

This worked, if anything, too well in the aftermath of 1987, when credit policy was loose enough to light the touchpaper on the late 1980s boom.

Crises in the financial markets are inevitable but also manageable. They should not distract attention from the fact that financial markets are essential for our well-being. Without them there would be little investment, because it is the stock and bond markets that finance much of it.

Just as important, the markets are a crucial tool for managing risk in an increasingly uncertain world. A crash makes it look as though those yelling traders are the source of financial risk. It's quite the reverse.

Why has the strong pound not yet led to a collapse in British exports? Because many businesses have used the markets to hedge their foreign currency exposure for a year or two.

Financial markets offer the only means we have of insuring against the future, whatever it may hold. The more intertwined the world becomes, the more complex and uncertain, the more we need the global markets.

Those scenes of hysteria in dealing rooms over the past few days are entirely rational, because the traders are taking the risks for the rest of us.

Diane Coyle wrote this for the Independent in London.

Pub Date: 10/30/97

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