By Donella Meadows
–November 12, 1987–
By now we’ve heard hundreds of theories about The Cause of the stock market crash. It was the greed of the yuppies that did it, or the German mark, or the August trade balance. It was program trading. It was the government deficit.
We love single, simple causes, though we know that in this complex world causation usually comes in layers of increasing profundity. On the surface some person or thing, some flaw or rumor may have triggered the crash, like the tiny disturbance that causes a bubble to burst. Knowing exactly which pinprick it was gives us no help in preventing another crash or in picking up the pieces of this one — we will never rid the economic world of pinpricks. We have to look deeper and ask why the market was so distended and vulnerable in the first place. What blew up the bubble?
Causes of market inflation are not hard to find. Tax cuts for the rich that released plenty of cash for speculation. Financial inventions that allowed people to speculate even with money they didn’t have and then to speculate on the speculation. Mindless cheerleading from those in authority, who fabricated reasons for the market to increase when there were none.
Those causes are satisfying, because they allow us to be righteous as well as partly right, but they don’t explain why these inflating forces flourished just now and not in previous decades, when greed and short-sightedness were presumably just as inherent in human nature. To find out why now, why us, we have to look even deeper.
Which brings us to the most fundamental cause of the crash, the one we least want to admit.
Economic ups and downs, panics, booms, depressions, have happened regularly for at least 200 years. The worst downturns have come in the 1830s, 1880s, 1930s, 1980s, no matter whether there was an SEC or an FDIC, no matter whether computers or people did the trading, no matter what party was in power, no matter whether there was a federal deficit. They have happened in every part of the world where there was an industrialized market economy.
We are told, over and over, that the free market is a sort of natural wonder that guides the economy without need for government interference. But in fact the market system is chronically, inherently unstable. All market economies oscillate, with 4-7 year business cycles, with longer cycles of construction and commodity production, and with fifty-or-so-year long waves that bring, among other things, major financial panics.
The oscillations are inevitable because mutual adjustments of supply and demand are very slow. It takes time for producers to respond to shortages or surpluses by adjusting prices, and time for consumers to respond to price changes by buying more or less. It takes even longer for producers to gear up or down, and for those responses to percolate through the system to suppliers, and then to suppliers of suppliers. During the adjustment time — which can be years or even decades — shortages or surpluses go on getting worse, until the corrections begin to take hold.
A huge economy cannot bring itself to a prompt supply-demand balance like the smooth graphs in Economics 101 textbooks. Production and consumption yaw back and forth, seeking equilibrium, overshooting, correcting, under-shooting, in cycles that impact everything from interest rates to opinions about the President to expectations in the stock market.
By the late 1970s the world’s linked market economies had built themselves up to a point of tremendous surplus. Cars, machines, grain, milk, steel, electricity, oil were being produced faster than they could be sold. Mills, mines, and oil wells were producing at only 50-70% of their capacity. There was no point in building more of them. Conservative governments cut taxes and created incentives so investors would shore up the faltering economy. But there were few real investments worth making. So a lot of money went into bubble-blowing.
When the long wave is going up (as in the 1950s and 60s), fancy speculative devices are unnecessary. Savings can be invested in real growth. Not so when the wave turns down. That is when people dream up sterile mergers and acquisitions, investment trusts, junk bonds, stock futures, index arbitrage, anything that can keep apparent wealth swelling though real wealth is stagnant.
Eventually dreams and reality have to be reconciled, and that means some kind of crash. It happened in the 1920s and the 1980s, and it will happen again sometime around 2030, unless we come to understand the economy at its deepest causal layer.
That means putting aside both our eagerness to blame and our knee-jerk ideologies.
If our economic system itself is the deepest cause of the crash, we have no one to blame. Most of us participated joyfully in the ride up. We can minimize the pain only by being compassionate with each other during the slump down.
And if we are serious about understanding our economic system, stabilizing it, and bringing it under some kind of control, we’ll have to start by admitting its imperfections. Doing so does not necessarily throw us from the roller-coaster of untrammeled free enterprise straight into the gray, unproductive prison of central planning. There’s a lot of space in between, in a region that could be called informed, regulated free enterprise. That means no easy labelling of either business or government as all bad or all good. It means finding the right balance between the two.
We can find that balance if we wake up, think, question, reject simple causal theories, and seek to understand at the deepest levels how our economy works. our economic problems.
Copyright Sustainability Institute 1987