Abstract. This paper provides a historical and theoretical overview of the mechanisms leading up to financial crises and financial bubbles. It suggests that the potentially explosive growth of the financial sector at the expense of the real economy fed by compound interest has – since before ancient Mesopotamia under the rule of Hammurabi – represented a real threat for such crises. A more modern and additional factor that builds up crises is Joseph Schumpeter's observation of the clustering of innovations. Carlota Perez has more recently developed Schumpeter's vision into a theory of technoeconomic paradigms which – about midway in their trajectory – produce the build-up to financial crises. The theories of Schumpeterian economist Hyman Minsky, describing the mechanisms producing the collapse of financial bubbles complete the overview. The paper ends with recommendations to bring the West out of the present crisis by – once again – putting the real economy rather than the financial economy in the driver's seat of capitalism.

Keywords: Financial crises, innovations, Hammurabi, Joseph Schumpeter, John Maynard Keynes, Hyman Minsky, Carlota Perez.

Introduction

Financial crises occur when the relationship between the real economy (the total production of goods and services) and the financial economy (money in the widest sense) comes out of balance in such a way that the financial economy no longer primarily supports the real economy, but takes on an independent life of its own in such a way as to damage the real economy. Today's economics (neoclassical economics, standard textbook economics, mainstream economics) accepts such an imbalance between the real economy and the monetary sphere when it comes to inflation (rising price levels) and deflation (decreasing price levels), but not when it comes to financial crises. This is in sharp contrast to other kinds of economics – the experienced-base type of economics I refer to as the other Canon – which traditionally have understood and still understand crises, but which have been marginalized.

Financial crises represent imbalances which – in contrast to inflation and deflation – are not immediately visible in the consumer price index as rising or falling prices, but rather in the form of asset inflation and debt deflation, which in sum have very important impacts on income distribution. The assets in which massive incomes from the financial sector are invested, will experience an asset inflation.