Wednesday, June 1, 2011

The Australian Business Cycle in the 19th Century

The trade/business cycle was clearly seen in Australia before 1840s. There appears to have been a commercial crisis from 1810–1813, a financial crisis in 1826, which appears to have contributed to the recession of 1827–1828 (Butlin 1994: 223).

Moreover, the Australian depression of the 1840s was comparable in severity to the disastrous depressions of the 1890s and 1930s (Butlin 1994: 223).

In the 19th century Australia had two severe depressions, and mild to severe recessions in 1867 (0.42% GDP decline), 1870 (GDP fell by 3.32%), 1878–1879, and 1885–1886.

One of the worst downturns in the business cycle was the depression from 1890 to 1893, exacerbated by the financial crisis of 1893 (see Hickson and Turner 2002). Australia had a massive property bubble in the 1880s under a gold standard and a free banking system. Before 1893 there was a speculative boom, in real and financial assets, fuelled by inflows through the capital account, mainly from Britain. Then came the collapse of the asset bubble in 1889/1890:
“In Australia, GDP fell for four years running, from 1890 through 1893 ... Unemployment rose sharply. Immigration slowed and tentatively reversed direction. Social disorder spread, led by protesting sheep shearers, dock workers, and miners. Post-1893 recovery, if it may be called that, was slow and uneven” (Adalet and Eichengreen 2007: 233).
In Australia, real GDP fell by around 10% in 1892 (Kent 2011), and by 7% in 1893, and deflation occurred from 1891 to 1897. After 1895, growth returned but the economy was mired in what we can call a chronic underemployment disequilibrium, just as many countries were in the 1930s.

Australia in the 1880s is an example of a system that probably came closest to a libertarian free banking system than any other nation in the past two centuries. The disastrous failure of that system is empirical evidence that free banking is not the best or ideal system imagined by libertarians.


BIBLIOGRAPHY

Adalet, M. and B. Eichengreen. 2007. “Current Account Reversals: Always a Problem?,” in R. H. Clarida (ed.), G7 Current Account Imbalances: Sustainability and Adjustment, University of Chicago Press, Chicago. 205–246.

Butlin, N. G. 1962. Australian Domestic Product, Investment and Foreign Borrowing 1861–1938/39, Cambridge University Press, London.

Butlin, N. G. 1994. Forming a Colonial Economy, Australia 1810–1850, Cambridge University Press, Cambridge.

Glasner, D. and T. F. Cooley (eds). 1997. Business Cycles and Depressions: An Encyclopedia, Garland Pub., New York.

Haig, B. 2001. “New Estimates of Australian GDP: 1861–1948/49,” Australian Economic History Review, 41.1: .

Hickson, C. R. and J. D. Turner. 2002. “Free Banking Gone Awry: The Australian Banking Crisis of 1893,” Financial History Review 9: 147–167.

Kent, C. J. 2011. “Two depressions, one banking collapse: Lessons from Australia,” Journal of Financial Stability 7.3: 126–137.

Simon, J. 2001. “The Decline in Australian Output Volatility,” RBA, Research Discussion Paper 2001–2001.

10 comments:

  1. I read one part twice, just to make sure I read it right.

    A speculative boom before 1893? While there was a depression between 1890 and 1893? So a speculative boom was happening till the end of a depression?

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  2. In case it is not clear:

    Actually, the asset bubble burst in 1890, causing the familiar debt deflationary spiral. This is essentially the same pattern as America in 1929-1933.

    By 1893 there was a financial crisis, which was a further pro-cyclical diaster that deepened the depression.

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  3. "Actually, the asset bubble..."

    ... because of inflow of large amounts of English capital.

    Yet, this is not a market failure. There was a massive government intervention, which led to a real, and general crisis.

    http://analyseeconomique.wordpress.com/2011/06/19/the-experience-of-free-banking-kevin-dowd/

    One might note too that there was no indiscriminate running of financial institutions; there was instead a ‘flight to quality’ in which depositors withdrew funds from institutions perceived as weak to re-deposit them in stronger institutions such as the big banks, and it is significant that at no time were the big three banks — the Australasia, the New South Wales and the Union — ever in serious danger.

    The bungling attempts of the Victorian Treasurer to pressurize the Associated Banks in to bailing out the weaker banks backfired at a critical point and needlessly undermined public confidence. The Victorian banking holiday had a similar impact.

    You can read this entire book here :
    http://ebookee.org/The-Experience-of-Free-Banking_584623.html

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  4. "The bungling attempts of the Victorian Treasurer to pressurize the Associated Banks in to bailing out the weaker banks backfired at a critical point and needlessly undermined public confidence. The Victorian banking holiday had a similar impact."

    And that and Dowd are refuted here:

    Hickson, C. R. and J. D. Turner. 2002. “Free Banking Gone Awry: The Australian Banking Crisis of 1893,” Financial History Review 9: 147–167.

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  5. I cannot find the article you pointed out. But ...

    "...according to Kevin Dowd (1992) was a unique experience of a major banking collapse (1893) within a free-banking system9. Rather than being a consequence of a lightly regulated banking system, Dowd argues that this crisis was the result of a real supply shock and Government intervention. A quite different explanation is proposed in two recent papers by Hickson and Turner (2002, 2004). They argue that the crisis could have been avoided if the banks had been more regulated. The lack of regulation resulted in low capital and cash and banks over-holding risky assets."

    Well, well...
    Have you check the link I posted above ? I guess not.

    Check this link, and read it closely. Selgin refuted the quotation above.
    http://analyseeconomique.wordpress.com/2011/06/19/the-experience-of-free-banking-kevin-dowd/

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  6. You don't seem to want to read and discuss the book here, certainly because you're keynesian. So I'll make it clear for you :

    The suspensions were also prompted by government intervention. In Victoria the government imposed a five-day banking holiday from 1 May.

    The two banks’ willingness to remain open shored up public confidence in them, and the withdrawals they faced soon abated. The Bank of New South Wales re-opened the next day, and also stood the storm, but the remaining banks that had closed had effectively lost public confidence and were consequently unable to reopen (Butlin 1961:303–4).

    One of the key issues here is the banks’ liquidity and Merrett goes on to argue that the ‘inescapable conclusion is that the long decline in liquidity standards seriously undermined the banks’ ability to cope with the growing problem of higher risks’ (1989:77). However, as George Selgin points out

    « the facts tell a different story. Merrett (1989, p. 75) reports that the aggregate reserve ratio … fell from .3217 in 1872 to .2188 in 1877; but his figures for later five-year intervals show no further downward trend … . Even the lowest figure compares favorably to those from other banking systems, both regulated and free. It is much higher than Scottish bank reserve ratios for the mid-nineteenth century … and about the same as ratios for free Canadian banks in the late nineteenth century and for heavily regulated US banks today. »
    (Selgin 1990a: 26–7)

    He also notes that

    « Pope’s annual data, presented graphically … are more plainly inconsistent with [the falling reserve] hypothesis … in the seven years preceding the crisis … the average ratio of the thirteen suspended banks rose steadily from about .15 to .16 … . Pope’s reserve figures also show a minor difference only — perhaps two percentage points — between the reserve holdings of failed Australian banks and those that weathered the crisis. This also suggests that ‘overexpansion’ was not the root cause of the banking collapse. »
    (Selgin 1990a: 27)

    And note, finally, that the difference between the capital ratios of banks that were to fail and banks that were not is relatively small — under 3 percentage points, and usually considerably less — and shows no tendency to grow as the dates of the failures approach (1989: figure 8).

    One might note too that there was no indiscriminate running of financial institutions; there was instead a ‘flight to quality’ in which depositors withdrew funds from institutions perceived as weak to re-deposit them in stronger institutions such as the big banks, and it is significant that at no time were the big three banks — the Australasia, the New South Wales and the Union — ever in serious danger.

    … the claim that banks’ risks were becoming more concentrated only receives very weak support. Pope’s figure 8 indicates only a barely perceptible increase in the suspended banks’ risk-concentration, and the fact that the risk-pooling variable always has an insignificant coefficient in Pope’s estimates (1989:20) indicates that it had little effect on the bank failures anyway.

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  7. Your beliefs about Australia have been completely destroyed. But hey, nice try;D

    http://books.google.com/books?id=VfTSxZsKKCUC&lpg=PP1&dq=Laissez-Faire%20banking&pg=PA115#v=onepage&q&f=false

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  8. Anonymous,

    You're right, but "the experience of free banking" (Kevin Dowd) is much better. Check the link in my post above.

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  9. LK,

    I think your criticism of free banking needs a bit more work. Meng Hu links seem to undermine your argument that you've made above. I just came across this article and thought you might find something useful although I'm pretty sure you've read it.

    http://findarticles.com/p/articles/mi_qa5437/is_n1_v31/ai_n28685180/?tag=content;col1

    Steve

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  10. I have another good link for you, Lord Keynes.
    http://menghusblog.wordpress.com/2012/02/21/empirical-evidence-for-free-banking/

    "Is Our Current International Economic Environment Unusually Crisis Prone? – Australia: 1893 Banking Crisis" from Bordo and Eichengreen.

    In New South Wales, bank notes were given legal-tender status to ease access to means of payment, and the government declared a 5 day bank holiday. Some banks never reopened their doors. Tens of thousands of depositors had their claims extended — for four years and more & before any withdrawals could be made, and in some cases claims were converted into stock and preference shares. Bank share prices fell heavily. The banks retrenched, withdrawing from the business of long-term lending. The “depression” of the 1890s followed.

    Dowd challenges the conventional wisdom about this crisis, noting that the fall in the loans to capital ratio from 20 per cent in 1880 to 12.5 per cent in 1892 was not representative of the condition of most banks. He dismisses a domestic credit crunch on the grounds that advanced did not actually decline in the period of failures. He argues that the big banks had already adjusted their portfolios by holding less speculative assets by 1890. In conclusion he argues that the crisis was mainly caused by inadvisable government intervention in the financial sector. The bank holiday, he concludes, was unnecessary and damaged confidence. Consistent with his view, the standard historical statistics do not show much of an output decline.

    Fluctuations in Real GNP Growth Rates (in percentage points)

    Year // Crisis-(-1) // (Crisis)-Avg (-5) // (Crisis)-Avg(-3) // Avg (+1)-(Crisis) // Avg (+3)-(Crisis) // Avg (+5)-(Crisis)
    1893 // 8.0 // 0.0 // 2.0 // 0.0 // 1.0 // 4.0

    Kevin Dowd was right, after all...

    ReplyDelete