Fifteen years after the Global Financial Crisis: Recessions and Business Cycles in the History of Economic Thought

From Edimburg to Cambridge : Kindleberger Revisiting Smith on Financial crises.

Leloup Sandrine, Université Bretagne Sud
Emmanuel Carré, Université Bretagne Sud

It is not self-evident to make a connection between Kindleberger, a specialist in financial crises, and Adam Smith, the author of the invisible hand. Yet, in many of his contributions on financial crises, Kindleberger mentions Smith. The way Kindleberger does this is original, in that he summarises Smith's approach to crises in simply three terms: 1) overtrading, 2) revulsion and 3) discredit. These three stages of the crisis are indeed present in Smith in different books in the Wealth of Nations (1776). Overtrading is present in Book II in relation to the behaviour of bankers. The expression is also found in Book IV about foreign trade, for which the profit is higher than ordinary. Revulsion only appears in Book IV, about investments in the colonies. This lucrative but risky business echoes the foreign trade. Discredit is present in Book II about banks financing risky operations. The term refers to the loss of reputation through bankruptcy. In Smith's view, this loss of reputation is more painful, than the bankruptcy’s material loss. Thus, the link between the three stages of the crisis is clear. At the beginning, there is a commercial activity that specializes in risky operations. These will generate discounting and rediscounting of bills of exchange, which will cause an excess of credit, a source of financial crisis. A typical example is the Ayr Bank. This financial institution is known for its imprudent liberal management, with the financing of dubious investments. Those in the colonies are among them. This article has two main goals: on the one hand, we will see how it is possible to reconstruct a Smithian theory of financial crises, based on the triptych overtrading-revulsion-discredit and, on the other hand, the influence that this Smithian approach had on Kindleberger. In Kindleberger's view, these three terms form the sequence of the dynamics of the crisis. The crisis starts with overtrading which can have three origins: i) speculation, ii) overestimate and iii) gearing. Revulsion corresponds to a diversion of capital: investment is made in sectors with high expected profit but high risk. Finally, discredit echoes the failure of financial institutions. While Kindleberger is well known as a theorist of financial crises, Smith is less well known. Therefore, we will highlight the originality of Smith's approach. His theory of financial crises is part of his moral philosophy: unlike Kindleberger, who insists on the role of rationality and anticipation, Smith's theory focuses on the passions.

Area: Eshet Conference

Keywords: financial crisis, Kindleberger, Smith, overtrading, revulsion, discredit

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