Zombie Idea: Creditanstalt Did Not Cause the Depression

Brad DeLong and Barry Eichengreen have written the preface to a new edition of Kindleberger's The World in Depression. It is a very good introduction, except for this part:

Kindleberger’s second key lesson, closely related, is the power of contagion. At the centre of The World in Depression is the 1931 financial crisis, arguably the event that turned an already serious recession into the most severe downturn and economic catastrophe of the 20th century. The 1931 crisis began, as Kindleberger observes, in a relatively minor European financial centre, Vienna, but when left untreated leapfrogged first to Berlin and then, with even graver consequences, to London and New York. This is the 20th century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously. In 1931 they spread through a number of different channels. German banks held deposits in Vienna. Merchant banks in London had extended credits to German banks and firms to help finance the country’s foreign trade. In addition to financial links, there were psychological links: as soon as a big bank went down in Vienna, investors, having no way to know for sure, began to fear that similar problems might be lurking in the banking systems of other European countries and the US.

In the same way that problems in a small country, Greece, could threaten the entire European System in 2012, problems in a small country, Austria, could constitute a lethal threat to the entire global financial system in 1931 in the absence of effective action to prevent them from spreading.

I've covered this before, so rather than restate it all I'll just point you to that and mention the gist here. Regarding the first paragraph, Creditanstalt was the largest and most well-connected bank in the Austro-Hungarian empire. Following World War I, it remained one of the most important banks in continental Europe. It was not "relatively minor". More importantly, the Depression was already underway before the Viennese institution went under. The New York Bank of the United States had collapsed several months before along with more than 600 other American institutions. It is just not the case that everything was fine right up until Creditanstalt went under. It is much more likely that the Depression caused the collapse of the Austrian bank and not the other way around.

Why is this important? Because contagion cannot emerge from anywhere. So the ramifications for the present day are not that Greece could destroy the entire European system, as Thomas and I wrote last year in Foreign Policy. The underlying research which motivated that article has now been released in Perspectives on Politics. We were right then, and the same intuition helped us to understand why the Cyprus meltdown was going to remain localized while others were talking about how it could drag down the entire global economy.

This matters because very smart people keep saying that contagion can emerge from anywhere at any time. At the recent International Studies Association annual meeting I heard one of the most prominent scholars in IPE say to a large audience that financial contagion worked like it did in the movie Contagion: anyone can become infected at any time. This was based on no research, just an intuition. Here are some other recent examples (1, 2).

But the intuition is false. This is not how the world works. The fact that the claim keeps being made is evidence that we in the social sciences really do not grasp dynamic complexity well at all. This clearly has major consequences not only for how we view the world, but how we govern it. We need to do better.

Agreeing and Disagreeing with Kindleberger (and Delong and Eichengreen)

This post is basically to point to the new preface by Brad DeLong and Barry Eichengreen to Kindleberger's The World In Depression 1929-1939. I'm glad the book is being reprinted, and I am in agreement with all of DeLong & Eichengreen's intro. Except this part:

Kindleberger’s second key lesson, closely related, is the power of contagion. At the centre of The World in Depression is the 1931 financial crisis, arguably the event that turned an already serious recession into the most severe downturn and economic catastrophe of the 20th century. The 1931 crisis began, as Kindleberger observes, in a relatively minor European financial centre, Vienna, but when left untreated leapfrogged first to Berlin and then, with even graver consequences, to London and New York. This is the 20th century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously.

I don't think this is "arguable". First things first... Creditanstalt was decidedly not a "relatively minor" institution; as Ben Bernanke has noted it was one of the largest (and most well-connected) banks in Europe. Moreover, it wasn't the first major bank to fail. To give just one example, the Bank of the United States (a private bank located in New York) failed in December, 1930 -- one of the largest bank failures in U.S. history, which occurred months before the collapse of Creditanstalt. Indeed, in his monetary history of the U.S. Milton Friedman considered the collapse of the Bank of the U.S. as the pivotal moment that tipped the U.S. from recession into depression. In general, financial instability in the U.S. seemed to precede financial instability in Europe from 1929 on.

The U.S. and much of Europe was already in depression before the collapse of Creditanstalt. Indeed, chronology suggests that Delong & Eichengreen have causality reversed: the Depression (combined with the fallout from losing WWI, including reparations) caused the collapse of Creditanstalt, not the other way around. U.S. industrial production had fallen by nearly 25% before Creditanstalt's collapse. Farms prices were down by 40%. The financial system was decimated. Trade was collapsing. The signal events occurred in 1929, not 1931. By the latter date we are talking about knock-on effects, not first causes.

My view is not particularly controversial. The collapse of Creditanstalt exacerbated a pre-existing panic, but it did not generate one sui generis.

Contagion is powerful, but it tends to operate from the center outward rather than from the periphery inward.* The best read of the collapse of Creditanstalt is that it was evidence of contagion rather than the epicenter of it.

That said, Kindleberger's book is very good in general, as is the new Delong/Eichengreen intro.

*We've blogged about this before, and we have a piece that will hopefully be forthcoming soon that makes this case explicitly. For a simplistic precis see this Foreign Policy piece that Thomas and I recently placed.

P.S. While thinking about this I stumbled across this piece from a 1952 issue of Time which gets nearly every detail wrong in its first paragraph. For starters: Creditanstalt collapsed in 1931, not 1929; it was not controlled by the Rothschilds until after that collapse; Hitler persecuted the bank during Anschluss for that reason, so it not quite fair to say that the bank "served" Hitler. The rest of the article is blocked to nonsubscribers so I (mercifully) can't read it.