Thursday, 21 May 2009

Book Review and Giveaway: The Cost of Capitalism by Robert J. Barbera

The cost of capitalism is repeated market mayhem, bubbles and crashes caused by financial system excesses, according to Robert Barbera, an economist with one foot in the practical world as a long time economist with investment banking firms and the other foot in the theoretical world as an academic professor.

This slim volume of 200 pages expounds the central idea with a series of fascinating, even entertaining vignettes of the bubbles and crashes of the last 30 years - the 2008 crisis and its current aftermath (the book was completed in January 2009), the 2000 tech bubble, the Japanese real estate bubble and subsequent lost decade, the 1998 Asian currency crisis. It is a book of economics for the non-economist, with no jargon and simple, but precise explanations of events, illustrated by pertinent graphs. The writing and language is engaging and flows smoothly, perhaps the by-product of Barbera being obliged to communicate constantly with non-economists in his job.

The author exhorts us to heed the ideas of Hyman Minsky, who stated that people's attitude towards risk changes with stages in an economic cycle: with prolonged good times in the recovery and growth phases, individuals get complacent and believe that the good times will continue forever, leading them to take on ever-increasing risk and leverage, goaded on by the financial system, till a typically small negative event, which he calls a "Minsky Moment", pricks the bubble and the violent slide destroys wealth, at which point everyone gets very (too) risk-averse. The financial system itself, as the holder of all the "cannot be paid back" debt, then has to be bailed out by the government. As he puts it, "Thus, government rescue operations are an inescapable part of capitalism."

There is a brilliant example on page 31 contrasting a homeowner with a conservative mortgage and one with a very large mortgage predicated on rising house prices to sustain affordability, such as was common in the USA in the years leading up to the housing crash there. The easy-to-follow table shows how a small rise in interest rates or a small decline in house prices will cause catastrophe for the large mortgage holder. This example is then extended to explain to show how the risky mortgage default effect can cascade into the general economy through financial institutions and create havoc even for those home buyers who have been cautious, or for completely unrelated companies and sectors.

Barbera thinks that destructive capitalism of most businesses benefits society by cleansing bad businesses with better ones but he says that the financial system is an exception and must be prevented from failing to prevent destructive deflation such as happened in the 1930s - thus he severely criticises the decision to allow Lehman to fail in September 2008. Barbera has an ax to grind and that ax is what he believes is the mis-perception by governments, central bankers and the mainstream of economic thinking on how the financial system works to create recurring bubbles.

Overall the book is a highly engaging and well-argued essay on what ails capitalism and the financial system. Barbera advocates that central banks should be mandated with controlling not just inflation but also asset bubbles to nip them in the bud before they grow too large and wreak havoc. He does not want to see overshoot on the regulatory side in reaction to the 2008 crisis, saying that the huge engine of wealth that is capitalism should not be hobbled too much - one might characterize it as "as much new regulation as necessary but only as much as necessary".

What is the value of this book for an individual investor?
  • a cautious attitude - understanding that bubbles are inherent and inevitable in our system makes one cautious and on the lookout for the next one; that is a powerful message of this book
  • awareness of bubble signs - it helps to know some signs to monitor since bubbles originate from the financial system, like high and climbing levels of debt and leverage; once a bubble exists it is impossible to predict when it will collapse as a slight seemingly innocuous event starts the fall
  • awareness of calamity indicators - if financial institutions do start failing whether due to government neglect or powerlessness, then it really is time to look for escape and safety, certainly financially and perhaps even physically
My rating: four out of five stars

Giveaway! The publisher McGraw Hill has kindly provided me with a copy to give away. So leave a comment on this post with some kind of unique name, i.e. not "anonymous", by closing date of midnight EDT Thursday May 28, 2009. If the fancy strikes you, in your comment say what you think will be the next bubble - green tech, gold, oil ... I will do a random draw to pick a winner and then I'll need to get a postal address from him/her to mail it. Good luck everyone!!

20 comments:

Frog of Finance said...

Sounds like an interesting read. Count me in for the giveaway. :o)

The next bubble? If I knew that, I would be rich. Likely candidates are water, infrastructure, green tech and health care.

ASHVIN said...

Count me in for the Giveaway..!

Nathan said...

Interesting book. Please add me to the contest.
Next bubble? Tech will likely have one. Traditional means of serving users of technology will change soon, in a significant way.

Just Another Guy said...

Next bubble will be in China or India.
Count me in, I'm always open for winning.

Traciatim said...

I'm not so sure I can pick the next bubble, but count me in on the give away.

Jordan said...

Sounds like a very interesting read, if I win I'll write a review as well

Jack L said...

...count me in for the giveaway...

Not sure about the 'next' bubble but a future bubble will be WATER.

X's said...

Not sure about the 'next' bubble but a future bubble will be WATER.

(sorry for the double post, didn't log in the first time)

phasor said...

Aren't banks really quasi-government institutions and thus be heavily regulated? I'm interested in reading this book.

The next bubble, electric cars.

Dan said...

I think the next bubble will be either food related (wheat, rice, corn etc.) or energy.

Please include me in your draw, thanks

Erick F said...

Sign me up! Next bubble? I'd guess infrastructure.

as said...

Next bubble(s)? Well, I'm just preparing for a bath myself...

Tony said...

Green tech, specifically hydrogen fuel and hybrid cars.

Francois said...

Sounds like a good book, count me in for the draw!

As far as the next bubble goes, I'd say either green tech or something related to cloud computing...

zaman said...

Count me in for the draw. My guess for the next bubble is green tech and infrastructure.

uberben said...

Looks like an interesting read. Count me in.

cannon_fodder said...

I'd expect there will be at least 3 bubbles in the future before I die, so knowing the warning signs could prove very useful.

Patrick said...

Hum, The next bubble? food or alternative energy.
Food commodities because it is now very financialized which etf and derived products.

Alternative energy, because so many people think it will be the next thing and for all the money going into the field.

Doug said...

I find it fascinating how you mention in the article that ‘climbing levels of debt and leverage’ are signs of a bubble. This immediately made me think that the next bubble that will exist and eventually burst is with the Fed itself. Its balance sheet has already ballooned, er bubbled, to previously unknown levels, which leads me to believe that the next bubble is already here, and when it bursts it will gradually transfer the wealth of the US capitalistic system to other nations, most notably China. The belief was that tech stocks would never crumble and the Internet would destroy brick and mortar; the belief was that housing prices would always increase; and now the belief is that the US government is the only organization strong enough to own toxic assets. How long will it be before that belief is likewise proven to be baseless? The last fifty years have been fantastic, but lost faith in the US financial system and markets are going to be a difficult thing to regain, and be a source of significant economic pain during the next fifty years.

Count me in as well on the giveaway – your blogging is much appreciated.

CanadianInvestor said...

Jordan, congratulations!! You are the winner of the giveaway. Send me an email with your name and address and the book will be on its way.

Thanks to everyone else for taking part. There will be another giveway in a few weeks.

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