Lessons of the past tell us that a financial crisis is rarely a short-lived, isolated event but more a series of traumas that merge together when history is written years later. A fitting analogy is that of a volcano, such as Iceland’s Eyjafjallajokull. It erupts dramatically but then, rather than subsiding immediately, volcanic activity continues, further eruptions follow and more ash is spewed out.
“If a volcano has died down, does that mean it is not going to reappear?” says Andrew Milligan, head of global strategy at Standard Life. “Would you expect crises during this recovery phase? Absolutely.”
A brief history of crises suggests that multi-year market turmoil is nothing new — and neither is contagion.
THE GREAT CRASH, 1929
The bull market on Wall Street began in 1923 and led to an unprecedented period of share trading. However, by 1929 there were signs of instability. The bubble finally burst on Oct. 24, 1929 — Black Thursday. A then record 13 million shares were traded, and newspapers reported losses as high as US$5 billion. Commentators were quick to say the worst was over, but Black Monday followed, on Oct. 28, when US markets went into freefall and the contagion spread around the world. A Black Tuesday followed as investors tried to sell all their stocks at once, and the market recorded US$14 billion in paper losses. Millions of people lost their savings. Despite large stock purchases by the US’ financial elite to shore up confidence, the sell-off continued. It was not until July 1932 that the market reached the lowest point of the Great Depression. Global unemployment rose for years following the Great Crash, and it took 23 years for the US market to recover.
THE ASIAN CRISIS, 1997
What began in Thailand in the summer of 1997 soon spread to become the Asian crisis and, a year later, a global financial crisis as Russia and Brazil saw their currencies tumble. Like many developed countries today, some countries in Asia had large current account deficits at the onset of the crisis. Many also had fixed exchange rate regimes that effectively meant their currencies were overvalued. The situation sparked a rash of overseas borrowing at lower rates than could be found at home, but when it became clear to the world that Asian currencies would have to devalue, those foreign currency debts became acutely painful. Thailand was first to let its currency, the baht, float, cutting its peg to the dollar. Other Asia countries soon saw their currencies weaken sharply, their stock markets fall and other assets devalue. By the autumn, the Asian crisis was rattling confidence, and markets, in Japan and the US. The troubles transferred to Russia and Brazil as markets made the link to those countries’ own overvalued currencies and large foreign debts. The contagion did not stop there. As spreads widened between those assets seen as safe and those seen as risky, they defied the expectations of the huge and highly leveraged hedge fund Long Term Capital Management (LTCM). Its bosses, among them two Nobel laureates, had expected such bond yields to converge. With the fund in a perilous state, its many lenders were forced to write off big losses while the US Federal Reserve, deciding LTCM was too big to be allowed to collapse, coordinated a bailout to save the integrity of the markets.
THE DOTCOM BUBBLE, 2000
The Internet bubble grew as stock markets fell in love with online companies through the late 90s, but began to burst in the spring of 2000. In Europe, the panic was sparked after the disastrously unsuccessful flotation of pan-European internet service provider World Online, a scary contrast to the usual pattern of madly popular flotations and soaring share prices. Jitters about overvalued technology stocks — and about companies built on buzzwords rather than business plans — began to spread and markets around the world were rattled. Companies started to go under.
The technology recession persisted for several years and the contagion spread to related sectors such as communications infrastructure. Sentiment was hurt the world over as the “new economy” boom unraveled, dotcom millionaires lost their fortunes and IT specialists lost their jobs. The financial chaos was subsequently intensified by the terrorist attacks of Sept. 11, 2001.
THE CREDIT CRUNCH, 2007
Now we have a crisis that began with worries about sub-prime mortgages, leading to a credit crunch as liquidity dried up, central bank intervention on a massive scale, bank collapses and government bailouts of struggling financial institutions. With the private sector’s problems now shifted to the public sector, two questions loom. First, if the burden cannot be passed on again, how will the problems be unraveled? Secondly, who foots the bill? That sovereign debt issue, it would appear, is the latest phase in a crisis that started almost three years ago.
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