HARVARD GAZETTE ARCHIVES

Economist John Kenneth Galbraith on ...
World Financial Markets: How Stable Are They?

By Alvin Powell
Contributing Writer

The Asian turmoil, the Russian meltdown, and the U.S. stock market crash and recovery have made it a wild year in the financial world.

Though the U.S. stock market has headed up again, Harvard economist John Kenneth Galbraith, the Paul M. Warburg Professor of Economics Emeritus, advises caution. He stops short of making a prediction, but says all good things must come to an end.

With 1998 drawing to a close and 1999 looming ahead, the Gazette recently discussed the market and the economy with Galbraith. He is the author of The Affluent Society, The New Industrial State, and The Great Crash -1929, which has been in print since it first appeared in 1954.

With the U.S. stock market rebounding from its recent decline and talk resurfacing of the Dow Jones Industrial Average hitting 10,000, what is your view of the market? Is sustained growth on the horizon, or could the speculative bubble burst?

Everyone should bear in mind that there's a good deal of speculative content in the market at this time. The notion that the American financial world stands as a pillar of strength among the weakening economies in Asia and Russia is pure nonsense.

We still have people and institutions that think the market is going up and who respond by buying. That puts the market up and the cycle repeats itself. The speculative bubble - it never comes quietly to an end. Every sensible person should be cautious.

How important have the Federal Reserve's interest rate cuts been in the market's recovery and growth?

The modern economy and its management is a very complex thing. Nothing is more satisfying to investors and the economic world at large than the notion that the whole problem can be delegated to the Federal Reserve and to Alan Greenspan.

Alan Greenspan is the economic world's most esteemed figurehead.

But isn't perception almost the same as reality in the financial markets? Isn't the perception that the Federal Reserve has done something dramatic as important as the concrete effects of its actions?

Perception as distinct from reality is very important in the financial world. What we call financial genius is a rising market and it comes to an end when the market falls.

Wall Street, if it had gravestones, would be filled with memorials to the fallen financial geniuses.

How important is it that people investing and working in the market today understand the history of previous booms?

I recommend a strong sense of financial history to all in the financial world. The pattern goes back to the 17th century, to the great tulip mania in Holland. One of the prime speculative marvels of the South Sea Bubble [in the 18th century] was a company that was to drain the Red Sea and recover the treasure left by the Israelites. It was a very popular stock. The modern example is Long-Term Capital Management. [The hedge fund, featuring some of today's brightest financial minds, lost half a billion dollars in one day last August and was given a $3.625 billion bailout by a consortium of Wall Street firms in September.]

Have there been structural changes that have kept the market from a prolonged crash despite the turmoil in Asia, Russia, Brazil, and the collapse of Long-Term Capital Management?

There have been some improvements since 1929. There is a little more fear of leverage. We don't see quite the kind of corporate excesses of 1929.

What we don't know is whether the summer's events are a warning or whether they'll be looked at as a passing episode. If people take them as a warning we may be saved a repetition. Otherwise, the bubble could continue to inflate.

In 1929, in the spring, there was a sharp market [decline] after adverse comments about speculation by Paul Warburg, one of the most distinguished financial figures of that time. In September, there was another quite bad break in the market, the Babson break. That we had a break in August shouldn't give us a sense of security.

What do you see as the impact on the financial markets of the increasingly global economy?

It's a long-term trend, and one, on the whole, I applaud. In the past, committed nationalism has been the cause of the greatest tragedy: war.

Now international companies operating in different countries and in the world do not stir up animosity. IBM and Microsoft are, in general, peacemaking forces.

In my lifetime, I've seen two world wars and I'm prepared to applaud anything that diminishes that threat.