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Economics

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Intro to Economic Thought (ECO 105)
Robert Ellmann
Financial Crises
Irina Sterpu
__________________________________________________________________________________

OUTLINE











Introduction into the topic and its origins
The Great Depression 1929-1939
German Hyperinflation 1918-1923
The Great Recession 2008
1973 Oil Crisis
European Sovereign Debt Crisis 2009, onward
Ruble Crisis 1998
Black Monday 1987
Conclusion
References

Financial crises – definitions and origin

The majority of economists and monetarists define financial crises as a manifestation form of banking crises, with an impact on financial stability and reaching the state of collapse of the financial infrastructure in the absence of central bank‟s intervention. Financial collapse which affects most of the companies generates quickly problems over the banking system as the following consequences: the panic of the clients, inability to distinguish between the efficiency and the difficulty of banks, deposit withdrawals. Jack Reed, an American politician mentions: “The financial crisis is a stark reminder that transparency and disclosure are essential in today's marketplace.” In economic literature, the problems in the banking system are the main sources of the financial crises. All the economic collapses require injections of liquidity or public financial funds, in some cases, private funds from banks and international institutions.
Financial crises have usually as a consequence the unemployment because labor markets are globally rigid, the currency is in devaluation, and people usually enter into a "forced leave". Therefore, the most important crises that marked the population at an individual and global level, in a top of seven, were: the
Great Depression during 1929-1939, German Hyperinflation between 1918 and 1924, the Great
Recession in 2008, 1973- Oil Crisis, European Sovereign Debt Crisis from 2009 and onward, Ruble
Crisis from 1998, and Black Monday in 1987.

The Great Depression 1929-1939
Causes:
According to Smiley Gene (Rethinking the Great Depression, 2002) “The Great Depression is often called a „defining moment‟ in the twentieth-century history of the United States. Its most lasting effect was a transformation of the role of the federal government in the economy.” After WWI, the US was recovering and its economy was in a new era. The unprecedented development of technical and scientific innovations during the war and immediately after, has created a gap between the industry's ability to generate competitive products and the ability of employees to buy them, while the savings rate of the population with above-average income was higher than the increasing of investment opportunities, which led to an unprecedented rise in prices of stocks and real estate assets.
Consequences:
The immediate effect of the Great Depression was unprecedented human suffering. People found themselves in inability to find jobs, the stock market collapsed, the panic in the banking sector and other financial market disruptions in other countries have resulted in decreased productivity and prices. The
Great Collapse from 1929-1939 lit a fierce race for gold deposits and forced the Federal Bank to raise interest rates in terms of slump. Roosevelt created the New Deal plan which has managed to reconcile the American society dismantled by the crisis, to define a new balance of political, economic and social powers, finally anticipating a redefinition of the American capitalism.

German Hyperinflation 1918-1923
Causes:
After World War I, through the Treaty from Versailles, Germany was obliged by the winning countries to pay in rates, war damages worth 132 billion gold marks (about 200 billion dollars in current money), the annual rate of 2 billion gold marks plus 26% of the export value. These penalties were huge, representing far more than the total gold and currency held by Germany. The situation calmed down at the end of 1923 when it was currency reform in Germany by introducing Rentenmark.
Consequences:
The effects of German Hyperinflation were inevitably the anticipation of the supremacy of the National
Socialist Labor Party and the “chancellorship of Adolf Hitler in 1933” (German Hyperinflation 1922/23:
A Law and Eonomics Approach, Wolfgang Chr Fische, 2010). Finance Minister Dr. Luther, seconded by
Reichsbank president, Dr. Schacht has managed to give Germany a strong currency. Germany began a period of economic regeneration, marked by the evacuation of Ruhr through the use of the Dawes Plan
(designed to solve the problem of war compensations) for damages of war and especially by the influx of
American capital borrowed, allowing German industry, still affected by unemployment to modernize and reorganize; production in 1928 exceeded a quarter that of 1913.

The Great Recession 2008
Causes:
The crisis of 2007-2008 has its source in mortgage credit expansion, encouraged by repeated interest rate reduction by the FED in banking legislation amendment (Glass Steagall Act of 1933) and in lending to low-income population for the purchase of homes, according to the law Community Reinvestment.
Basically, the most important “factors can be identified as: interest rates, global imbalances, perceptions of risks and regulation of the financial system” in the United States (Sher Verick and Iyanatul Islam, The
Great Recession of 2008-2009: Causes, Consequences and Policy Responses, 2010).
Consequences:
In the existing global financial system with its critical aspects were felt following consequences: the collapse of steep and long of the market values of assets; deep decline of the economy and of the employment simultaneously with a high jump of the debt value. The crisis worsened in 2008 as the world's stock markets have collapsed or have entered a period of acute instability. A large number of banks, lenders and insurance companies went bankrupt in the following weeks. Until now there can be felt globally the consequences of the crisis such as the unemployment and governments that struggle to take back the control over their finances.

1973 Oil Crisis
Causes:
The Oil Crisis of 1973 is the first major one which took place as a result of the Yom Kippur War. The
USA and other well-developed countries decided to support Israel in the given conflict, therefore the

Arab states from the OPEC (as well as Egypt and Syria), as counteraction and punishment for this, enforced an embargo, ceasing to deliver oil to the involved international actors.
Consequences:
The effects of the Oil Crisis of 1973 were totally devastating for the world economy, as most economic drops led immediately to an increase in oil prices, which becomes a counter value of a single global currency, studies showing even as a growing of $10 per barrel of oil would cause a global economic contraction. Oil shock from 1973 was long felt in the whole world; it was the moment awareness of the value of oil, of the power decision which it holds by reorganizing the hierarchy of major world powers.
Another consequence of the oil embargo of '73 which is felt today is that the last oil deposits were discovered in the 60s and began to run out, for example the giant oil fields of Saudi Arabia. In addition, it is speculated that the attacks of 11 September 2001, once with the falling of the towers of the World
Trade Center, were going to unleash a war of oil that Americans declared to Iraq in order to administer the large deposits found there.

European Sovereign Debt Crisis 2009, onward
Causes:
The main reason that led to the European debt crisis was the financial crisis of 2008 – 2009. In addition, the building of real estate bubbles in several countries such as Greece, Iceland, Ireland, and Portugal had an impact on the crisis (L. Story, L. Thomas Jr. and N. D. Schwartz,2010). The culmination of the crisis was when Greece revealed that its government has underreported its budget deficit, a violation of the EU policy, which led to fears of the euro collapse and caused credit rating agencies to downgrade the ratings of several Eurozone countries (Greece‟s rating was downgraded to „junk‟ status at one point).
Consequences:
The crisis led to several Eurozone countries requiring bailout, including Ireland, Italy and Spain, along with Cyprus in 2012. The debt crisis led to the implementation of severe fiscal reforms and austerity programs in most of the countries and even though the recovery from the crisis is still underway, most countries managed to exit the bailout programs. However, the crisis still leads to debates over the monetary policy regulation in the Eurozone and some countries, such as Greece, are still coping with the aftermaths. Ruble Crisis 1998
Causes:
From 1991 until 1998 Russian economy seemed to be on a strong path of recovery after the collapse of the Soviet Union, however, in 1998, a year after the Asian crisis, the Russian government defaulted on debt and devalued the currency. The external factors such as the Asian crisis and the decline of commodity prices are among main factors that led to the Ruble crisis in 1998. However, most important causes that caused the crisis in Russia were internal. After the fall of the Soviet Union, which had already been in a weak economic situation, Russia was stockpiling debt from foreign creditors, but soft administrative and legal constraints made it difficult to repay the debt. After the drop in oil and nonferrous metal prices, Russian FX-reserves have been also affected. In this way, the Russian government

has declared a moratorium on foreign debt on August 17, as the income to the budget was incapable of covering even the interest payments on the foreign debt, which amounted to $24 billion at the time of the crisis. Consequences:
On the back of the crisis, the inflation in Russia reached 84%. Several banks have been closed, and the agricultural sector was affected significantly, as the crisis led to a drastic cut in subsidies (Agricultural
Outlook, 1999). The crisis also had some effects on the political system as it led to the weakening of
Boris Yeltsin‟s power and the replacement of Prime Minister Viktor Chernomyrdin with Yevgeny
Primakov. Following the crisis, Russian government has managed to tighten its control over the political and social life and the country has recovered on surging oil prices in the following decade after 1998.

Black Monday 1987
Causes:
A popular opinion, including the one that was shared by the Securities and Exchange Commission, thought that program trading (any trade involving fifteen or more stocks with an aggregate value in excess of $1 million) was one of the main reasons for the crash. (Dean Furbush, 2002). However many economists dismissed the importance of program trading in the 1987 market crash. Another reason is the overvaluation of the market in the months prior to October 19, 1987. As Richard Sylla, a Professor of
Economics at New York University's Stern School of Business said in an interview to the Wall Street
Journal, the market was not moving significantly for several years before 1987 and then the market moved rapidly as inflation declined and the economy was improving under the presidency of Ronald
Reagan. The advancements in financial technology, such as the introduction of futures, index futures, portfolio insurance also played an important role in the crash. Among the external reasons are cited the international disputes, primarily between the US and European countries about foreign-exchange rates and interest rates in October.
Consequences:
The Federal Reserve continued to require banks to lend money on usual terms, although it was often done at a loss as it would be discovered later. The Fed‟s reaction provided investors with more security in the upcoming years that the central bank is capable of dealing with major downturns. However, a more important move that was made after the crash was an overhaul of trading regulations, such as allowing exchanges to halt trading in case of major declines in large indices, such as the Dow Jones
Industrial Average.

Conclusion
In most of the countries the crises were followed by drastic changes what concerns banking regulations; with the exception of the small banks crisis in Great Britain. Following the concerns of national authorities to develop more effective bank regulation, it was set on a international scale a new capital agreement, in Basel, called the "International Convergence of Capital Measurement and Capital
Standards".

References
1. Financial Crisis Quotes , Jack Reed; URL: http://www.brainyquote.com/quotes/keywords/financial_crisis.html 2. Smiley Gene, “Rethinking the Great Depression”, 2002; URL: http://www.econlib.org/library/Enc/GreatDepression.html 3. Wolfgang Chr Fische, German Hyperinflation 1922/23: A Law and Eonomics
Approach, 2010;
4. Sher Verick and Iyanatul Islam, The Great Recession of 2008-2009: Causes,
Consequences and Policy Responses, 2010; URL: http://www.southbaylawfirm.com/blog/upload/Financial-Crisis-Overview.pdf 5. LOUISE STORY, LANDON THOMAS Jr. and NELSON D. SCHWARTZ, 2010,
Wall St. Helped to Mask Debt Fueling Europe‟s Crisis; URL: http://www.nytimes.com/2010/02/14/business/global/14debt.html?pagewanted=all 6. Economic Research Service/USDA, Agricultural Outlook, 1999; URL: http://webarchives.cdlib.org/sw15d8pg7m/http://ers.usda.gov/publications/agoutlook/jun 1999/ao262c1.pdf
7. Richard Sylla, 2007, Looking Back at Black Monday: A Discussion With Richard
Sylla by ANNELENA LOBB; URL: http://www.wsj.com/articles/SB119212671947456234 8. Dean Furbush. "Program Trading." The Concise Encyclopedia of Economics. 1993.
Library of Economics and Liberty. URL: http://www.econlib.org/library/Enc1/ProgramTrading.html

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