Review of "Nuclear folly, a new history of the Cuban missile crisis" and lessons for financial policy

August 12, 2022

I just read Nuclear folly, a new history of the Cuban missile crisis by Serhii Plokhy. It’s an excellent book, not only telling the story from the Soviet side for the first time but also with many lessons for those interested in central banks and financial stability.

There is a lot of research on the Cuban missile crisis, but everything I have read so far tells the story from the US side. Historians simply didn’t have access to Soviet documents. Harvard historian Serhii Plokhy has now rectified this in his recent book Nuclear folly, a new history of the Cuban missile crisis.

I have an indirect personal interest. My parents lived in New York City then, and New York was certainly within the range of the Soviet missiles in Cuba and likely to be hit. I was born a year after the crisis.

There is always a tendency to paint the other side as a monolithic evil, the Soviet man that threatened our way of life. Serhii shows us how silly such analysis is. The arguments and politics and egos and dysfunctionality on the Soviet side were so similar to that in the US. Even if one was a democracy and the other a communist dictatorship. Plenty of food for thought for those thinking about China and Taiwan, and the US.

Serhii’s book has many lessons for those interested in inflation, financial stability and systemic risk.

One person has to make the ultimate decisions in a crisis. You cannot delegate that to a committee (or AI). On both the Soviet and the US side, all the men (and they were all men in 1962) surrounding the two leaders represented one part of the government (like diplomacy, espionage, military, politics, global relations, PR), and their advice was coloured by where they came from. Some advisors wanted war, some may even have wanted nuclear war, and Castro apparently wanted a Soviet nuclear attack on the US. Serhii maintains that the determination of Kennedy and Khrushchev to avoid that eventuality was key to bringing both sides to the negotiating table.

It is the same in financial policy. The senior decision-makers work on macropru or micropru or inflation, the economy or… This means their advice is likely coloured by where they come from. Someone has to arbitrate.

So who runs the central banks today? Is it the person (type A) who has deep knowledge of the most important problems, inflation and systemic risk, or (type B) someone chosen because they were trusted and familiar, or a political compromise ? Type B seems to be much more common. How does such a governor pick what advice should be followed in crisis? One governor of a major central bank of type A is Elvira Nabiullina of the Bank of Russia.

Decision-making is strongly affected by what happened when they were young. Both the American and the Soviet decision-makers in the Cuban missile crisis were shaped by World War II, as Serhii illustrates so well. Then, the lesson from the Cuban missile crisis was that the US and the Soviet Union had no choice but to cooperate, helping to bring about decades of agreements preventing nuclear proliferation and test bans. Only after those young in 1962 retired did the leaders of the US and Russia scrap these agreements.

It is the same in the financial system. The lesson from the 19th century was laissez-faire. Then, the impact of the Great Depression was to create a highly regulated financial system because nobody wanted a repeat. When those people were retired by the early 70s, the Bretton Woods system was scrapped, and deregulation and openness ruled the day. The decision-makers coming up then tend to like free and open markets. Then we got 2008, and those who came of age then are pushing for much heavier government interventions. Like after the Depression.

Information about what is happening in a crisis is very inaccurate and confusing. The US generals who wanted to invade Cuba did not know that the Soviets had over 40,000 soldiers in Cuba, armed with tactical nuclear weapons they were authorized to use if attacked. We would not be here today if the US generals had their way, simply because they did not have the proper information.

The financial system is the most complex of all human constructs. There is no way for the central banks to have anything but a superficial overview of what is happening. Why crises happen and we suffer inflation. But the central banks monitor the financial system intensively, and while the risk of mistakes is not of the same degree as if the US generals had their way in 1962, there are real consequences.

One way this manifests itself is how we regulate by the rearview mirror. Preventing past crises while it is axiomatic that the next crisis will happen when no one is looking. The information needed to regulate effectively in order to prevent crisis just isn’t there.

There is a tendency to imbue the other side with incorrect attributes. We might think the private sector institutions are profit-maximizing and rule breaking entities ruled by evil geniuses. The reality is much more prosaic. Incompetence and bad luck is much more likely explanation for when things go wrong. The employees are not maximizing the profits of the institution, they are maximizing the chance of them keeping their jobs and only after that the bonuses.

The central banks are not staffed by anti-capitalists who hate private sector firms or geniuses that are able to find the appropriate social balance between risk and return. Instead, just like in every other organization, the central bankers are terrified of making mistakes that threaten their careers.

So as in my recent book, Illusion of control, I argue that while the financial authorities believe they have the system under control, they don’t. There is a better way.