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Speculative bubbles that we’ve seen in housing, equity and commodity markets have helped cause financial crises.And there have been repeated calls for policies that would control the markets.
But a speculative bubble is a social epidemic that is contained by price movements in the free market, according to Robert Shiller.
In a new Project Syndicate piece Shiller writes that social epidemics have been even worse in the absence of financial markets, and points to The Great Leap Forward, a socio-economic campaign in China from 1958 – 1961 as an example.
Shiller writes that even if it was ordered by a totalitarian regime, this devastating social epidemic had all the key aspects of a bubble:
“China’s Great Leap Forward in 1958-61 was a market-less investment bubble. The plan involved both agricultural collectivization and aggressive promotion of industry. There were no market prices, no published profit-and-loss statements, and no independent analyses. At first, there was a lot of uninformed enthusiasm for the new plan. Steel production was promoted by primitive backyard furnaces that industry analysts would consider laughable, but people who understood that had no influence in China then. Of course, there was no way to short the Great Leap Forward. The result was that agricultural labour and resources were rapidly diverted to industry, resulting in a famine that killed tens of millions.
…The recent and ongoing world financial crisis pales in comparison with these events. And it is important to appreciate why. Modern economies have free markets, along with business analysts with their recommendations, ratings agencies with their classifications of securities, and accountants with their balance sheets and income statements. And then, too, there are auditors, lawyers and regulators.
All of these groups have their respective professional associations, which hold regular meetings and establish certification standards that keep the information up-to-date and the practitioners ethical in their work. The full development of these institutions renders really serious economic catastrophes – the kind that dwarf the 2008 crisis – virtually impossible.”
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