Thanks to Will Brown for this piece and for introducing an economist with a very fine name to a slightly wider audience.

Charles P. Kindelberger wrote an authoritative book on the economic chaos following the 1929 stock market crash. His chapter on 1931 was titled ‘Into The Abyss’. It was at this point that rival governments gave up any attempt at a collaborative approach to economic crisis. They started to competitively slash at state spending for fear of being singled out by the capital markets. Are we now in 1931?

Like self-harmers comparing scars, Spain has desperately announced a 5% cut in state wages, only to be rapidly matched by Portugal. Both fear the humiliation and impotency imposed on Greece. Will they now be able to sell their bonds to an intensely nervous market? We wait and see. The implications of this action are not lost on the stock markets. It means seriously deflationary pressure – on sales and profits. European stock markets have fallen heavily in response.

As after the Lehman collapse, there has been a big flight to safety. Investors have sold any assets considered risky. They have bought assets that they will always be able to sell, short of global revolution. These are US dollars, Swiss francs, Japanese Yen and. above all, gold. The gold price has climbed back to pass recent highs. There has been particularly strong demand in Germany – four times normal levels. Confidence in currency is crucial in Germany – with 1920’s hyperinflation seared into popular memory and constitutional law. German and Austrian bank failures were crucial in the 1930’s. Some Germans have already started cashing their bank deposits for gold.

Meanwhile, European bitterness at the behaviour of hedge funds speculating against the Euro in the Greek debacle has fuelled the drive for regulation. Europe is now poised with legislation to control – to some degree at least – hedge fund behaviour. London dominates the European hedge fund scene. The Brown government had fought a stubborn rear-guard action protecting the funds’ freedoms. This struggle has been taken up by the new chancellor, Osborne. European voices are clear, they will now force legislation through. Draft proposals demand greater openness of the secretive hedge world. Specifically, it is proposed to limit the degree to which the hedge funds lever their bets with borrowed money.

Another layer of uncertainty is provided by computers. Half of all market transactions are now made by lightening fast computer programs. They follow algorithms, attempting to profit from miniscule temporary price differentials. In Basildon, a warehouse the size of three football pitches houses machines strapped into the market servers, trading thousands of times a second. The complex is owned by the NY stock exchange. Big falls on Wall Street last week prompted the computers to go hay-wire. The Dow Jones collapsed by 10% before recovering. Without the computers, capitalism seizes. When the computers go bonkers, it looks like Terminator 3.

New Chancellor Osborne is not having an easy start. Britain’s most important company, BP, is on its knees in Washington, desperate to limit action against it for filling the Gulf of Mexico with crude oil. Meanwhile, back home, the last act of the Brown government leaves Stirling vulnerable. Darling refused to contribute funds to support the Euro zone – unlike other non Euro countries such as Sweden. He couldn’t risk Tory and tabloid Euro-hostility. But the lesson has not been lost on the Euro-zone. If Stirling gets into trouble – will Germany and France help bail us out? Get ready for those public sector pay cuts!

Will Brown

Totterdown

Bristol

The World in Depression 1929 – 1939 Charles P. Kindleberger Pelican

‘Algo-trading’ changes speed of the game on Wall Street. FT 8/9 May

‘European banks in bonds plea to ECB as Greece fears rattle markets. FT 8/9May

Debt woes at heart of German poll FT 8/9 May

A currency that’s not just single, but also unloved. FT 12 May

Germans lead gold rush frenzy. FT 15/16 May