The headline could have come from a hundred places any time in the last hundred years. “Market has gone wild”, it read. The accompanying news report explains that the price of a crucial financial asset is in “free fall”. Traders and businessmen are calling on the government to step in.
The asset in question could be peripheral euro zone government debt today, global equity markets in early 2009. The wild market could have been soaring rather than falling: the stocks of 1929 and 1999, the house prices in Florida or London in the 2000s, or the supposedly safe government bonds today.
The actual headline comes from a Hong Kong newspaper in 1983, when investors in the then British colony began to fear the worst from a Chinese takeover. The UK’s Minister of State told the locals to “have confidence in yourselves”, but, as today’s Spanish and Italian politicians can ruefully confirm, such rhetoric is not enough to stop an investor stampede. A few weeks later, the Hong Kong authorities did indeed take the matter out of traders’ hands – they fixed the exchange rate between Hong Kong and U.S. dollars.
Under the leadership of Alan Greenspan, the U.S. Federal Reserve took the opposite approach. With a few dramatic exceptions, it trusted the ultimate wisdom of markets. That laissez faire faith was a mistake. If the Fed had intervened to limit house price increases a decade ago, the current economic malaise might well have been avoided.
Interventions are helpful because wild financial markets are one of the worst aspects of the modern economy. Financial asset prices can move fast for no good reason. When they rise too high, they provide misleading signals, which misdirect the flow of investment. When prices fall too far, the damage to the real economy of goods and services can be severe and long lasting. Damage to factories and roads is relatively easy to repair; it only took a few months for the global supply chain to recover from 2011’s severe Japanese earthquake. The damage from the financial crisis of 2008 still lingers.