Zombie Idea: Creditanstalt Did Not Cause the Depression

Brad DeLong and Barry Eichengreen have written the preface to a new edition of Kindleberger's The World in Depression. It is a very good introduction, except for this part:

Kindleberger’s second key lesson, closely related, is the power of contagion. At the centre of The World in Depression is the 1931 financial crisis, arguably the event that turned an already serious recession into the most severe downturn and economic catastrophe of the 20th century. The 1931 crisis began, as Kindleberger observes, in a relatively minor European financial centre, Vienna, but when left untreated leapfrogged first to Berlin and then, with even graver consequences, to London and New York. This is the 20th century’s most dramatic reminder of quickly how financial crises can metastasise almost instantaneously. In 1931 they spread through a number of different channels. German banks held deposits in Vienna. Merchant banks in London had extended credits to German banks and firms to help finance the country’s foreign trade. In addition to financial links, there were psychological links: as soon as a big bank went down in Vienna, investors, having no way to know for sure, began to fear that similar problems might be lurking in the banking systems of other European countries and the US.

In the same way that problems in a small country, Greece, could threaten the entire European System in 2012, problems in a small country, Austria, could constitute a lethal threat to the entire global financial system in 1931 in the absence of effective action to prevent them from spreading.

I've covered this before, so rather than restate it all I'll just point you to that and mention the gist here. Regarding the first paragraph, Creditanstalt was the largest and most well-connected bank in the Austro-Hungarian empire. Following World War I, it remained one of the most important banks in continental Europe. It was not "relatively minor". More importantly, the Depression was already underway before the Viennese institution went under. The New York Bank of the United States had collapsed several months before along with more than 600 other American institutions. It is just not the case that everything was fine right up until Creditanstalt went under. It is much more likely that the Depression caused the collapse of the Austrian bank and not the other way around.

Why is this important? Because contagion cannot emerge from anywhere. So the ramifications for the present day are not that Greece could destroy the entire European system, as Thomas and I wrote last year in Foreign Policy. The underlying research which motivated that article has now been released in Perspectives on Politics. We were right then, and the same intuition helped us to understand why the Cyprus meltdown was going to remain localized while others were talking about how it could drag down the entire global economy.

This matters because very smart people keep saying that contagion can emerge from anywhere at any time. At the recent International Studies Association annual meeting I heard one of the most prominent scholars in IPE say to a large audience that financial contagion worked like it did in the movie Contagion: anyone can become infected at any time. This was based on no research, just an intuition. Here are some other recent examples (1, 2).

But the intuition is false. This is not how the world works. The fact that the claim keeps being made is evidence that we in the social sciences really do not grasp dynamic complexity well at all. This clearly has major consequences not only for how we view the world, but how we govern it. We need to do better.