July 17, 2003

R.I.P. C.P. Kindleberger

Our old teacher Charlie Kindleberger is dead. From the Economist:

A self-confessed "literary economist", Mr Kindleberger, a professor at MIT and the author of more than 30 books, was a critic of the growing reliance of the economics profession on mathematics and on what he regarded as over-narrow rational models of human behaviour. Only a few years ago, his work would have been praised more for its readability than its insights. But he lived to see his best-known book become essential reading on Wall Street and be cited approvingly by younger, more mathematically inclined academics.

In "Manias, Panics and Crashes", Mr Kindleberger provided a comprehensive history of financial crises, stretching back to before the South Sea bubble. He argued, not wholly originally, that several common threads linked these different disasters over the centuries in almost all corners of the financial world. Manias, or bubbles, have typically occurred in the markets following unexpected good news, and so reflect progress of sorts. "New opportunities for profit are seized, and overdone." When this eventually dawns on investors, the financial system may experience distress and often panic.

His book first appeared in 1978, when most economists who studied finance were in thrall to efficient-markets theory, which in its purest form rules out the possibility of bubbles. In so far as it acknowledged past bubbles, the theory blamed them on immature, fraud-prone markets and argued that they were unlikely to occur in sophisticated, well-regulated, modern settings.

The recent dotcom bubble, following such other apparent inefficient-markets events as the 1987 stockmarket crash and the Asian meltdown of 1997-98, changed that, although pure efficient-markets theory was by then already under fierce attack. Mr Kindleberger's work suddenly seemed spot on. Now, studying bubbles is all the rage in academia. There are several schools of thought. "Behavioural" economists, for instance, see recent bubbles as evidence that markets are "irrational", reflecting psychological biases such as over-optimism among investors.

Perhaps more interesting has been the reaction of those most loth to abandon rational Homo economicus . Only a few old believers cling to the idea that the rise in dotcom share prices genuinely reflected likely profits, and that their sudden plunge was caused by regulatory (in)activity. Most prefer to ask why informed, rational investors failed to arbitrage away the absurdly high prices caused by irrational buying, as efficient-markets theory predicts. In a 1997 paper, "The Limits of Arbitrage", Andrei Shleifer and Rob Vishny noted that the cost of shorting--selling borrowed securities in the hope of a fall in price--tends to increase, the further above true value that prices rise. This may discourage arbitrage that would bring the market back to its senses....

Mr Kindleberger believed that "markets work well on the whole", but occasionally "will be overwhelmed and need help" from a lender of last resort. He understood both the danger of inaction by such a lender and the “moral hazard” that its mere existence can create, by encouraging investors to be reckless in the belief that they will be bailed out if all goes wrong. Thus, he argued, a “lender of last resort should exist, but its presence should be doubted.” It should always come to the rescue, but "always leave it uncertain whether the rescue will arrive in time or at all, so as to instil caution." Pulling this off is, he noted, a "neat trick"...

A brief correction. The high priests of MIT mathematical finance--at least those that I talked to--loved Charlie Kindleberger's work. I recall the late Fischer Black saying once that Manias, Panics, and Crashes was one of the ten most important things in finance he had read in the past five years, and something that I needed to read very, very closely. I remember Paul Samuelson saying that a close reading of Manias, Panics, and Crashes was a very good way for youngsters to start the process of generating ideas for their dissertations. And in economic history, of course, Kindleberger's The World in Depression has been a classic for more than a generation. Kindleberger's academic reputation may be a little higher after the Mexican and East Asian crises and the dot-com bubble and crash, but only a little. His reputation was always very high.

I also always found him an immensely charming man, and a wonderful teacher for a young graduate student.

And I would be cranky were I to say that the argument of "The Limits to Arbitrage" is significantly more complex and sophisticated than Economics Focus has the space to say...

Posted by DeLong at July 17, 2003 12:39 PM | TrackBack


The Truman Library had the foresignt to conduct an oral history interview with Professor Kindleberger. A long read, but filled with interesting gems.

At one point Ball got up and said that there was no need to have a Marshall plan at all. What they should have done would be to--following the Henry Hazlittline, "Will dollars save the world?" The thing was to do was to balance the budgets, and reduce the exchange rate to the purchasing power of parity. I figured they need me now, I got it clear what the purchasing power parity is in words of one syllable. I expected Francis Wilcox to run over and start to say, "What the hell is that all about Charlie?" He never did; never lifted a finger. Vandenberg got up and said, "Senator Ball is wrong again." He said, "Senator Ball mentioned the purchasing power of parity doctrine. That's ridiculous, everybody knows the purchasing power of parity doctrine was developed by Keynes. We want no part of it in this country." I was the only guy in the whole room who knew that the purchasing power of parity was devised by Gustav Cassel. It was beautiful.

Posted by: trevelyan on July 17, 2003 12:57 PM

The Truman Library interview with Kindleberger is at:


Posted by: K Harris on July 18, 2003 04:59 AM

Sorry to hear this, his books are well worth reading and learning from.

Posted by: Stirling Newberry on July 18, 2003 07:23 AM

I'm glad that the Economist described Kindleberger as a 'literary economist', since I quoted him in my (literature) doctoral thesis on the South Sea Bubble...

Posted by: nick sweeney on July 18, 2003 03:38 PM

Thanks much K Harris, good reading. Very interesting quote-"The truth is that economists just like generals fight the last war-"

Posted by: northernLights on July 19, 2003 04:50 PM
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