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The Origin of Financial Crises: Central Banks, Credit Bubbles, and the Efficient Market Fallacy (Anglais) Broché – 29 octobre 2008


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1.1 Lopsided Policy
The first years of this millennium were marred with a corporate credit crisis; this being the hangover of a credit binge associated with the stock market boom of the late 1990s. Just as this crisis ebbed we found ourselves engulfed in a housing boom and, sure as night follows day, this boom has now morphed into its inevitable credit crunch. The proximity of these boom-bust cycles has fuelled the popular perception that financial crises are becoming larger and more frequent. The following chapters will explain why this popular perception is correct.

Toward the end of the book I make some policy suggestions that, it is hoped, could begin to dampen the current chain of overlapping boombust cycles. The overall thrust of these suggestions is that avoiding the financial tsunamis comes at the price of permitting, even encouraging, a greater number of smaller credit cycles. And also at the price of requiring central banks to occasionally halt credit expansions. That is to say, the central banks must be required to prick asset price bubbles. Key to the success of any such policy will be a political climate that accepts the need for symmetric monetary policy; excessive credit expansion should be fought with the same vigour as is used to fight excessive credit contraction. As things stand neither politicians nor voters are ready for such tough love and central bankers have neither the stomach nor inclination to deliver it. In large part this is because economists have taught us that it is unwise and unnecessary to combat asset price bubbles and excessive credit creation. Even if we were unwise enough to wish to prick an asset price bubble, we are told it is impossible to see the bubble while it is in its inflationary phase.We are told, however, that by some unspecified means the bubble's camouflage is lifted immediately as it begins deflating, thereby providing a trigger for prompt fiscal and monetary stimulus.

In recent years this lopsided approach to monetary and fiscal policy has been further refined into what has been described as a “risk management paradigm”, whereby policy makers attempt to get their retaliation in early by easing policy in anticipation of an economic slowdown, even before firm evidence of the slowdown has been accumulated. This strategy is perhaps best described as pre-emptive asymmetric monetary policy.

To followers of orthodox economic theory, based on the presumption of efficient financial markets, this new flavour of monetary policy can be justified. Yet, current events suggest these asymmetric policies have gone badly wrong, leading not to a higher average economic growth rate, as was hoped, but instead to a an unsustainable level of borrowing ending in abrupt credit crunches.

1.2 Efficient Markets More Faith Than Fact
The bare outlines of a competitive profit-and-loss system are simple to describe. Everything has a price — each commodity and each service. Even the different kinds of human labor have prices, usually called 'wage rates.'

Everybody receives money for what he sells and uses this money to buy what he wishes. If more is wanted of any one good, say shoes, a flood of new orders will be given for it. This will cause its price to rise and more to be produced. Similarly, if more is available of a good like tea than people want, its price will be marked down as a result of competition. At the lower price people will drink more tea, and producers will no longer produce so much. Thus equilibrium of supply and demand will be restored.

What is true of the markets for consumers' goods is also true of markets for factors of production such as labor, land, and capital inputs.
Paul A Samuelson

Who could possibly argue with the above passage? It was written by one of the world's most respected economists and is no more than a statement of the common-sense principle of supply and demand. When the demand for a particular product goes up, so does its price, which is then followed by an increase in supply. According to this theory, prices jostle up and down keeping supply and demand in perfect balance.With just a little more thought we can stretch the argument further and convince ourselves not only that this process generates a stable equilibrium state, but that it also ensures the best possible arrangement of prices, leading to the optimal allocation of resources; if a better, more-economically productive, allocation of resources could be achieved, then those able to make better use of the resources would be able to pay more for them, causing prices to change accordingly. Naturally, if markets tend toward an optimal arrangement of prices, with the most productive allocation of resources, this configuration must also be a stable equilibrium situation. The upshot of all of this is what is known as the laissez-faire2 school of economic theory, which argues that market forces be given free rein to do as they choose. The logic of the laissez-faire school being that, if free markets naturally achieve an optimal equilibrium, any interference with market forces can at best achieve nothing, but more likely will push the system away from equilibrium toward a sub-optimal state. The prevailing laissez-faire school therefore requires the minimization, even elimination, of all forms of interference with the operation of market processes.

It also follows from the efficient market philosophy that only external adverse shocks are able to push markets away from their natural optimal state, as, by definition, an equilibrium-seeking system cannot internally generate destabilising forces able to push it away from equilibrium.

1.3 A Slight Of Hand
Now re-read Samuelson's passage, only this time look out for the slight of hand in the final sentence:

What is true of the markets for consumers' goods is also true of markets for factors of production such as labor, land, and capital inputs.

The passage provides a convincing explanation of how equilibrium is established in the marketplace for goods, but when it comes to the markets for labour, land and capital inputs, there is no explanation of the mechanisms through which equilibrium is established. For these markets we are offered nothing better than proof by assertion. This logical trick is pervasive in economic teaching: we are first persuaded that the markets for goods are efficient, and then beguiled into believing this to be a general principle applicable to all markets. As the failure of Northern Rock and Bear Stearns show it is unsafe to assume that all markets are inherently stable.

1.4 The Market For Bling
We can easily find a counter example to Samuelson's well-behaved supply-and-demand driven markets. In the marketplace for fine art and luxury goods, demand is frequently stimulated precisely because supply cannot be increased in the manner required for market efficiency: Who would pay $140,000,000 for a Jackson Pollock painting if supply could be increased in proportion to demand? The phrase “conspicuous consumption” was coined by the economist Thorstein Veblen to describe markets where demand rose rather than declined with price. Veblen's theory was that in these markets it was the high price, the publically high price, of the object that generated the demand for it. Veblen argued that the wealthy used the purchase of high-priced goods to signal their economic status.3 Veblen was the original economist of bling — if you've got it you want to flaunt it.

Fortunately for the high priests of market efficiency, Veblen's observations can be dismissed as minor distortions within an overall economic environment that responds in a rational manner to higher prices. That is to say, even at a price of $140,000,000, the market for Jackson Pollock paintings is irrelevant to the wider economy.

1.5 When The Absence Of Supply Drives Demand
While the markets for bling can be dismissed as economically irrelevant, there are other much more important markets which also defy the laws of supply and demand, as described by Samuelson. While Veblen identified the rare conditions in which high prices promoted high demand, we can also consider the much more common situation in which low or falling supply promotes high demand.

Today's oil markets are a case in point, where constrained supply is prompting higher speculative demand. While consumers of oil are reducing their oil purchases in response to supply constraints and higher prices, speculators (investors) in oil are moving in the opposite direction and increasing their purchases.

This simple observation of how consumers and speculators respond in different ways to supply constraints gives us the first hint that a fundamentally different market mechanism operates in the markets for assets to that which dominates the markets for goods and services. This effect is not confined just to today's unusual oil market: Who would invest in the shares of a company if that company were in the habit of issuing more stock whenever its share price rose above a certain level?

As a rule, when we invest we are looking for an asset with a degree of scarcity value, one for which supply cannot be increased to meet demand. Whenever we invest in the hope of achieving capital gains we are seeking scarcity value, in defiance of the core principle that supply can move in response to demand.

To the extent that asset price changes can be seen as a signal of an asset becoming more or less scarce, we can see how asset markets may behave in a manner similar to those of Veblen's market for conspicuous consumption goods. In Veblen's case it is simply high prices that generate high demand, but in asset markets it is the rate of change of prices that stimulates shifting demand.

Frequently in asset markets demand does not stimulate supply, rather a lack of supply stimulates demand. Equally price rises can signal a lack of supply thereby generating additional demand, or, conversely, price falls can signal a glut of supply triggering reduced demand.

1.6 Introducing The Efficient Market Hypothesis
To economists the importance of efficient markets lies not in the markets' pricing mechanism directly, but rather in the ability of the pricing mechanism to maximise economic output via an optimal allocation of resources. To financial professionals the emphasis is more directly on the pricing of the items being traded. Financial theory has refined and extended the implications of market efficiency into an additional set of laws describing how markets must behave as a consequence of their being efficient.

The key message of the Efficient Market Hypothesis is that asset prices are always and everywhere at the correct price. That is to say, today's market prices, no matter what they are, correctly reflect assets' true values, based on both current economic conditions and the best estimate of how those conditions will evolve in the future. According to this financial theory any asset price movement must be generated by external “shocks”. To the efficient market school the constant price changes observed in financial markets are the result of those markets responding to a constant stream of new information.

The Efficient Market Hypothesis has no room for asset price bubbles or busts; under this theory the wild asset price swings commonly referred to as bubbles are nothing more than markets responding to changing fundamentals. People outside of the world of economics and finance may be amazed to know that a significant body of researchers are still engaged in the task of proving that the pricing of the NASDAQ stock market correctly reflected the market's true value throughout the period commonly known as the NASDAQ bubble. To these researchers the NASDAQ Composite Index was correctly priced at 1,140 in March 1996, also correctly priced at 5,048 in March 2000, and again correctly priced when, in October 2002, it had returned to a price of 1,140. The intellectual contortions required to rationalize all of these prices beggars belief, but the contortions are performed, none the less, in the name of defending the Efficient Market Hypothesis.

The idea that markets are always correctly priced remains a key argument against central banks attempting to prick asset price bubbles. Strangely, however, when asset prices begin falling the new lower prices are immediately recognised as being somehow wrong and requiring corrective action on the part of policy makers.

Another interesting result of the Efficient Market Hypothesis is that it can be used to infer the manner in which asset prices move, which in turn allows for the calculation of the entire probability distribution of potential future asset returns. Sadly, these theoretical distributions tend not to fit with the reality of financial markets, which in practice tend to generate extremes of both positive and negative returns that simply cannot be explained with the statistical models derived from the Efficient Market Hypothesis. The clash between the theoretical statistics predicted by efficient markets and those observed within real financial markets is known as the “fat tails” problem.5 One recent example of the fat tail problem occurred with huge losses in one of the world's largest hedge funds. These losses were apparently described by the firm's chief financial officer as resulting from the fund suffering adverse “25-standard deviation events, several days in a row”. It is difficult to convey just how improbable a pair of back-to-back 25-standard deviation losses really is, but by my estimate its probability is roughly:
0.00000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000000001.

Statistically speaking, a pair of 25-standard deviation events is not an example of bad luck; it's an example of bad statistics and bad science. Improbabilities such as these properly belong to the realm of Douglas Adams.

Were these claimed 25-standard deviation events unique, it would be possible to gloss over the inconsistencies between real life and theoretical forecasts, but in finance statistical impossibilities are quite literally an everyday occurrence. Each and every day financial markets move in ways that simply cannot be explained by our theories of how these markets work.

Nevertheless, despite overwhelming evidence to the contrary, the Efficient Market Hypothesis remains the bedrock of how conventional wisdom views the financial system, the key premise upon which we conduct monetary policy and the framework on which we construct our financial risk systems.

Revue de presse

“A must-read on the origins of the crisis.”
The Economist

“A well written book. . . . Cooper's most novel doctrine is that investors do not have to be irrational to generate bubbles. . . . Mr. Cooper traces present difficulties to the rapid growth of credit encouraged by the Fed's ultra-cheap money policy of a few years ago.”
Financial Times


Détails sur le produit

  • Broché: 208 pages
  • Editeur : Vintage (29 octobre 2008)
  • Langue : Anglais
  • ISBN-10: 0307473457
  • ISBN-13: 978-0307473455
  • Dimensions du produit: 13,1 x 1,4 x 20,3 cm
  • Moyenne des commentaires client : 5.0 étoiles sur 5  Voir tous les commentaires (3 commentaires client)
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1 internautes sur 2 ont trouvé ce commentaire utile  Par Malek-farzad Nuban le 11 février 2009
Format: Relié Achat vérifié
This book is simply excellent. Very easy to read but full of intelligent meaning for one who wants to understand our debt financed growth and why all this financial mess has come around. As The Economist has told, really a Must Read.
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0 internautes sur 1 ont trouvé ce commentaire utile  Par Billy Durant le 9 février 2011
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Un des désavantages de Minsky, c'est que c'est pénible à lire et parfois brumeux. Et donc l'avantage de son prophète Cooper, c'est que son ouvrage est limpide, se lit tout à fait aisément, que les raisonnements paraissent des évidences. Ce livre compte parmi le meilleur de ce que l'approche systémique keynésienne de la finance peut offrir. Et il y a même des anecdotes et des exemples totalement originaux (l'eurofighter, les régulateurs de Maxwell... mais où a-t-il été dénicher tout cela ?). Bref, passionnant, un must-have comme ils disent.
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0 internautes sur 1 ont trouvé ce commentaire utile  Par Betty Cordenier le 28 juin 2013
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Very good book about the evolution of the monetary system and the appearance of crises! It's simple, concise, precise! It's a must-read for people reflecting about the origin of financial crises.
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120 internautes sur 127 ont trouvé ce commentaire utile 
Well-written critique, but affirmative points less convincing 2 décembre 2008
Par A. J. Sutter - Publié sur Amazon.com
Format: Broché
There's a lot to like in this book. George Cooper (GC) provides one of the most lucid and concise descriptions of the role of central banking you're ever likely to encounter. He carefully distinguishes among the philosophies of different central bankers, such as between the Federal Reserve and the European Central Bank. His critique of the Efficient Market Hypothesis (or "fallacy", as he prefers to call it) is trenchant and clear, as is his analysis of why the "fundamentals" of a stock aren't fundamental. He highlights the heterodox theories of Mandelbrot and Minsky, which are closer to the truth than the orthodox ones Ben Bernanke used to teach at Princeton. And he writes with a wry sense of humor, including a nice one-liner about boom-bust cycles that I'm surprised other reviewers haven't mentioned: "The invisible hand is playing racquetball" (@105).

That said, this book won't give you the whole story in understanding the current financial crisis. For one thing, GC never mentions credit default swaps or other derivatives, which in the aggregate dwarf the "real" economy. Even when GC describes why balance sheets are misleading, he doesn't mention any off-balance sheet instruments, of which derivatives are one category.

For another, GC tends to be overly accepting of microeconomics, and even of the diligence of lenders. For example, he says, in a kind of defense of bond ratings analysts, "When ratings analysts are assessing the quality of a loan, ... or the mortgage broker is assessing the safety of a mortgage, they evaluate each loan against the prevailing market prices for the loan's corresponding assets. In this procedure the tacit assumption is that the asset in question can be sold to repay the loan. At the micro level this is always a reasonable assumption" (@115). GC's point is that there is a "fallacy of composition" in reasoning from the micro scale to the macro -- the macro-level reality is not simply the sum all the micro transactions. OK. But why is the assumption he mentions *always* reasonable at the micro level? And why doesn't GC mention that in the current financial crisis, ratings agencies, mortgage brokers et al. did NOT follow the careful procedures he describes? (to say nothing of explaining *why* they didn't). The recent books by George Soros, Charles Morris and especially the fantastic "Structured Finance and Collateralized Debt Obligations" (2nd. ed. 2008) by Janet Tavakoli will tell you much more about this aspect of the story.

GC rightly points out that many economists' arguments operate on the principle of "proof by assertion" (@6), but he doesn't entirely avoid this trap himself. For example, GC's simplified descriptions of the history of finance are mostly based on "toy model" analogies, such as bakers and farmers selling their wares in a town square (Chapter 3). This picture isn't entirely historically accurate; e.g., when he asserts that central banking was necessary for the development of venture capital "in the truest sense of the word," whatever that means (@55), he overlooks the venture investments of the Medici during the medieval period, as well as many forms of Islamic financial transactions. None of those investment structures relied on central banks. This gave me the feeling that other aspects of his explanation might be a bit too pat, as well, especially when he says that some particular institution or practice led to or enabled another.

As he shifts his argument to a more constructive point of view, GC invokes an ingenious analogy (Chapter 6) to 19th-Century physicist James Clerk Maxwell's mathematical theory of mechanical "governors" (gizmos that kept machines from spinning out of control; Maxwell's original paper is reproduced as an appendix). Ingenious, but problematic. Most of standard neoclassical economic theory is based on ingenious analogies to physics, too (see especially P. Mirowski's 1989 book, "More Heat Than Light"). Some of those analogies, such as to "equilibrium" in supply and demand for consumer goods, sound at first blush as plausible as GC's analogy to Maxwell: ask any mainstream economist. But that plausibility doesn't mean that any of the theories are right -- and indeed, in the neoclassical case, the theory is wrong. GC doesn't use any empirical data stronger than anecdotal evidence to show that his Maxwell analogy is apt to the real world. Nor does he provide evidence that the policy recommendations he deduces from that analogy are feasible.

GC's failure to enagage with the derivatives issue is pertinent in this context too. One of GC's main constructive ideas is that central bankers should "prick" asset price bubbles as soon as they can identify that they've begun. (BTW, GC uses the word "asset" not as you might have learned if you took an accounting class, but in the finance pro's narrow sense of referring to stocks, bonds and other financial instruments.) If this sends the economy into small cycles of good times and tougher times, so be it -- in GC's view, that's better than the long ride up and crashing ride down we've experienced so often under Greenspan and his successor. However, GC says *the* key macroeconomic variable for identifying bubbles is the rate of credit creation (@125). Many derivatives contracts, like the ones that made trouble for A.I.G. in autumn 2008, are a form of credit creation -- just like bets placed with a bookie, any form of gambling creates debts. But derivatives are notoriously non-transparent: it's hard to know how many of these contracts are out there at any time. In that case, the visible data (mainly loans, bonds, etc.) might understate the amount of credit in the economy and also understate the rate of credit creation. So how's a central banker supposed to know the right time to prick? Since GC doesn't show how this approach has worked in the past, it's a matter of faith as to whether it might in the future.

This is a clear, witty book from which you can learn a lot. And some of GC's recommendations aren't so controversial, such as his suggestion for using a different form of statistical analysis (e.g., à la Mandelbrot) for looking at financial markets. But ultimately, the book is stronger when criticizing current practice than when proposing new policy.
41 internautes sur 47 ont trouvé ce commentaire utile 
Review in "The Economist" 16 septembre 2008
Par J. Foti - Publié sur Amazon.com
Format: Relié
FYI--this book receives a good review in "Credit and blame: a must-read on the origins of the crisis," The Economist 388(8597), 13 September 2008:79.
"The [credit] crunch has lasted long enough to spawn its own publishing mini-boom, as authors have raced to give their diagnoses in print. George Cooper, a strategist at JPMorgan, an investment bank, has produced by far the best so far, skewering both academic orthodoxy and central bank policy in the process...Mr Cooper's book is by far the most cogent and reasoned of the modern-day 'credit excess' school."
37 internautes sur 43 ont trouvé ce commentaire utile 
COOPER HAS WRITTEN A READABLE MASTERPIECE 5 octobre 2008
Par Amazon Customer - Publié sur Amazon.com
Format: Relié Achat vérifié
I completely agree with the positive recommendations of The Economist Magazine and the reviewers. George Cooper has combined a strong technical and practical investment background to produce a modern thoughtful study of how to best manage our complex economy. However, I disagree with Brady on its readability, I feel Cooper opens this subject up to any thoughtful investor {regardless their background) by writing in down-to-earth English. He uses everyday examples, like a baker making and selling bread. His clear understanding of the material and deep sympathy for the reader motivate him to use such everyday examples to completely dispense with mathematical equations. He still maintains the needed precision.
I was persuaded that economic crises are inevitable, and enjoyed his ideas on how we might deal with them. I want to encourage every investor and student who is curous about how we can improve our economy to read Cooper's clear, cogent presentation.
44 internautes sur 53 ont trouvé ce commentaire utile 
Disconnected from the historical data. Unrealistic recommendations 12 janvier 2009
Par Gaetan Lion - Publié sur Amazon.com
Format: Broché Achat vérifié
Cooper covers the same subject as Kindleberger's Manias, Panics, and Crashes: A History of Financial Crises (Wiley Investment Classics); and that is Hyman Minsky theory that the credit cycle exacerbates both asset bubbles and crashes. Credit is too plentiful when the price of the collateral goes up; and too restrictive when the price of the collateral goes down. By doing so, creditors fuel both bubbles and crashes.

But, Cooper and Kindleberger treat the subject very differently. While Kindleberger develops an encyclopedic model of crises since the 1600s, Cooper obsesses in using Minsky's theory for rebutting the Efficient Market Hypothesis and blaming the Fed for not pricking bubbles. But, Cooper over reaches.

Cooper overlooks that his remedy (pricking bubbles) has been tried. And, the track record is scary. Two central bankers did it. One exacerbated the Great Depression. The other caused a 20 year deflation cycle in Japan.

He does not factor that the inflation/deflation risk trade off is asymmetric. It is easier to curb inflation (raise interest rates) than getting out of deflation (can't lower rates below 0%).

Cooper overlooks that a central bank mission is to manage inflation and GDP growth by responding to macroeconomic shocks. Also, asset prices (stocks, real estate) are often negatively correlated to GDP growth and inflation. For the Fed, this would mean having a single set of breaks for four different cars running in opposite directions. Thus, if the Fed was to preempt various asset bubbles, it would run into a constant policy paradox. Does it preempt a bubble and risk a dangerous deflation cycle or not? To avoid this situation, the Fed instead focuses on inflation targeting.

Another area where Cooper and Kindleberger diverge is who to blame for excess credit expansion. Kindleberger sticks closer to Minsky's theory and blames partly the banking sector that is too happy to lend on their rising collateral value. Instead, Cooper blames mainly the Fed. Meanwhile, the data shows that even throughout the housing bubble in the first half of this decade the growth in the money supply was moderate. And, the Fed increased the Fed Funds rate from 1.00% to 5.25% between May 2004 and July 2006. So it was not an expansive monetary policy that caused the housing bubble. It was an outdated regulatory framework. Cooper blames the Fed for running a chronic expansive monetary policy that causes inflation. But, he ignores the data. Since 1987, the money supply has grown at a moderate pace combined with a low inflation rate. Low inflation has also been supported by the emerging World's savings glut as elegantly explained in Wolf Fixing Global Finance (Forum on Constructive Capitalism).

In chapter 7, Cooper takes an excursion in Mandelbrot's fractal geometry from his book The Misbehavior of Markets: A Fractal View of Financial Turbulence to rebut the Efficient Market Hypothesis (EMH). (I invite the reader to read my review on this interesting book). The problem with Mandelbrot is that he comes up with a model that is even less robust than the EMH. Mandelbrot mentions a long term memory embedded in the markets regarding price and volatility. But, when looking at monthly data of S&P 500 returns since 1950 this memory is no where to be seen for both price change and price volatility. Meanwhile, such data does fit a Normal distribution fairly well even though the data is less disperse than the Normal distribution (positive Kurtosis). So much for the fat tail problem. Cooper states that our risk management problems are due to our not picking the correct distribution. I wonder if the problem is more that we don't go back far enough to fully capture the volatility in the data. This was the case for Long Term Capital Management failure as well reported by Lowenstein in When Genius Failed: The Rise and Fall of Long-Term Capital Management.

Cooper's recommendations are as controversial as his analysis. He suggests that the Federal Reserve abandons managing inflation, as he believes that goods and services operate within efficient self-stabilizing markets (unlike assets). He wants the Fed to solely focus on managing credit creation so as to prevent asset bubbles. He also wants the Federal Reserve to have control of both monetary and fiscal policy.

Reviewing Cooper's recommendation, we observe that the Fed has been very successful at managing inflation and somewhat successful at managing money supply growth. The latter is only one component of credit creation. The latter depends on many other factors beyond the Fed's control. This is especially the case for the Budget Deficit (fiscal policy). His proposal that the Federal Reserve control fiscal policy is politically unrealistic.
27 internautes sur 32 ont trouvé ce commentaire utile 
well written but not convincing 5 décembre 2008
Par Read and think - Publié sur Amazon.com
Format: Broché
This book is well written. It is very well organised and structured, engaging, easy to read, clear and interesting.

According to the author, one can hold one of 3 views:
1) one can think that the markets are efficient (auto-equilibrating) and believe the central banks are required (mainstream thinking). According to the author, this is logically untenable because if the markets are efficient, then logically one would not need a central bank to correct desequilibria as they would not occur.
2) one can think that the markets are efficient and therefore no central banks are required (Friedman). According ot the author this is more logical but empirically false as reality shows that markets are inefficient and severe crisis do occur on such a regular basis as to invalidate the theory of automatic auto-regulation of the markets
3) one can think that the markets are inefficient and that we needed an interventionist central bank. This is the point of the author. In one chapter, the author recommend a strategy of "monetary regulation" copied from Maxwell's "governors" in physics: this is required precisely because (again according to the author) markets are as inherently instable as the Eurofighter plane is (the plane though is this way by willful design for manoeuvrability purpose and the instability is corrected electronically by a "governor").

There can be little argument against discarding 1).

So the difficult part is deciding on between 2) and 3).

Let's say we go along with the author and choose 3). Then we are facing with a nightmarish situation. You would need to have always a very competent (actually a genius) economist to direct the "governor" of the central bank. Although it needed not be perfect (and the author make it seem almost easy to design), most people can express doubt about this and the actual result. And then consider what happens when one day a president names his loyal (but incomptetent) friend (of course, this could never happen in the real world!) at the helm of the central bank and this friend is seated on the cockpit to pilot the "inherently unstable" eurofighter/economy! You guess it... we might not enjoy a soft landing but a terminal crash! Scary prospect. No wonder there is a market for gold, even nowadays.

Let's now consider option 2). Like another reviewer I was stunned when the author discarded the option by merely writting (p. 55):

"It soon became apparent through repeated waves of financial crisis, that this new credit generation system was highly unstable. However it was equally apparent that this new system was also leading to dramatic economic expansion, wealth generation and improving living standards. Going backward to a world before depository banks and credit creation was not an option. The process of credit creation had opened up a whole new channel for economic growth and prosperity. Venture capital in the truest sense of the word was now possible. Equally the new banking system permitted channels by which risk could be pooled and shared; larger ventures became feasible."

Wow! We are to take this at face value! Lots of details follow as to why the instability occurs but zero further explanation why the credit generation system is required and is the actual cause of the prosperity. It is supposedly "self-evident". This is like my mathematical teacher would say: the weak point in an argument is always the line where someone writes the disputed "obviously formula xyz applies in all case" and then spend all the rest of the article explaining, at great length, the obvious. In this case, the author spend virtually the entire book trashing the efficient market hypothesis, and zero line defending the most contentious point!

Indeed, there is a growing number of very knowledgeable economist who do believe that the central bank is not necessary and that fractional reserve banking not only is the no 1 source of instability of the system, but should be abandonned.

Now let's respond to the author point by point:

1) "venture capital in the truest sense of the word was now possible". Hummm. It ALWAYS had been possible. People have always pooled their money and give it to an adventurer going to India or America; people have always pooled their money to give to the inventor to create a new machine. You don't need a fractional reserve bank AT ALL to do this.
MOREOVER, without a fractional rerve banking system, you remove the main instability: if the endeavor/project fails, only the venture capitalist lose and they had themselves accepted the risk, no surprise. In a fractional reserve system, either the bank disappear (about 9,000 failed in the 30's in the USA...) destroying hard-earned savings of people who never thought their money was used for risky endeavor, or, the central bank is used to save the bank (2008 situation) and its risk-takers (or plain gambling as it now the case with derivatives the extent of which I doubt not even 0.1% of the population is aware of) at the expense of the entire unwitting population.

2) "the new banking system permitted channels by which risk could be pooled and shared": this is almost the dictionary definition of an insurance company! You don't need any fractional banking system for this! Again, with an insurance company in a world of fractional banking system it only worsens: they are rendered more instable and can only be resuscitated by a central bank otherwise the entire economy will collapse (think AIG). In a non-fractional banking reserve system, only the insurance company collapse - it is isolated from the rest of the economy penalising only its imprudent shareholders and customers.

Fractional reserve banking leads to instability and require a central bank. I think everybody agrees on this.
THE controversial point is: can the author show us why we NEED the (inherently unstable) fractional reserve banking? Why?

I am quite open to contrary viewpoint and could even change my mind about the subject.

Indeed I'd be delighted (and without a doubt, many others would also be) to purchase and read a book from the author titled "Why we need a fractional reserve banking system and its ensuing economic instability that can then only be rendered rendered stable by a eurofighter style "governor" piloted by a agile central bank".

It would especially be a delight reading that new book because I do enjoy the author's clear and well organised writing style. And I would love to write a review of that new book on Amazon!

I'll be patiently waiting...
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