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History of Economic Calamities

In: Business and Management

Submitted By Striker09
Words 1690
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As far as we know, there were more than five economic and financial crises during the recent 200 years. Society was suffering from such downturns, because each of them had its own characteristics and consequences which affected the whole economic world. In the next passages I would like to tell you about the history of financial crises and about the solutions made by governments and departments which helped to reduce the bad effects of it.
Not a single year has gone by in the past two centuries where there was not a financial crisis somewhere in the world (see figure 1). Arguably, the world witnessed its first international financial crisis in 1825. The opening up of Latin America after the overthrow of the Spanish empire led to the opening up of international trade between England and the Latin American republics. The result was massive capital flows from London to finance infrastructure, mining and government spending. But once the capital outflows impinged on the Bank of England’s (BoE) gold reserves, the policy rate was raised, leading to a banking crisis. A sudden stop of capital flow from London resulted in banking panics in the US and currency crashes across Latin America. Figure 1: The history of financial crises Indeed, the crisis in 1825 marked the first of seven clusters of sovereign defaults in the period 1800 to 2010
In the first cluster of defaults, which happened during 1824-1834, 13 Latin American countries defaulted.
The following period (1835–1866) was relatively tranquil. But a lending boom developed in this period, which soon resulted in a new series of default episodes. The global crisis of 1873 started with the collapse of a property boom in Germany and Austria, then spread through the continent and affected the US as European investors dumped US railroad stocks . The US had a major panic associated with a corporate governance scandal in the railroad sector. Subsequently, the crisis spread to Latin America via a sudden stop of capital flows as the Bank of England raised its policy rate once again to offset gold outflows (компенсировать отток золота). This led to a series of debt defaults across the region. In the period 1867-1882 (the second cluster of defaults), 13 Latin American countries defaulted once again.
In the 1880s, the Western European countries started exporting capital to the Latin American countries for infrastructure investment. Major recipients (aims) of these funds were Argentina, Brazil and Uruguay. The associated land boom financed by generous bank lending conditions ended in a bust once more when the Bank of England and European central banks began raising their policy rates to stem losses in their gold reserves. The sudden stop of capital flows led to banking crises in Latin America

The crises in the 20th century
As soon as we stepped foot into the 20thcentury, the advanced countries were hit by the panic of 1907, which started in the US after the stock market fell close to 40% from its peak (end-1906). As a result, banks in France, Italy, Denmark, Sweden, Japan, Canada and the US entered a crisis. Almost a decade later, the world witnessed another major financial crisis.
The crises at the end of World War I reflected the attempts by central banks around the world to unwind the inflation that had built up during the War. For example, in Germany at the beginning of 1920s inflation was so high that money went down in value during the ten hours. Disinflation impinged upon the balance sheets of many European countries leading to banking crises Scandinavian countries and many South European countries.
Then came the mother-of-all-financial-crises – the Great Depression. This episode was preceded by stock market booms that crashed in the US and UK in the late 1920s. A series of banking panics in the US beginning in October 1930 were not successfully allayed (смягчать, подавлять) by the Federal Reserve System and this turned the situation from bad to ugly. The depression was transmitted around the world by two main reasons:
1. the fixed exchange rate links of the gold exchange standard
2. and numerous protectionist measures. Many advanced countries were finally hit by banking crises (see figure 3). The period 1931-1940 also marked the fifth cluster of defaults as 26 countries defaulted on their sovereign debt, of which 9 in Europe and 14 in Latin America.

After World War II, the world economy entered a period of relative calm. This was primarily due to the Bretton Woods (BW) system . In this era, exchange rates were kept fixed, capital controls were widespread and financial regulation was strictly designed to prevent a reoccurrence of the financial chaos of the interwar period.
We also need to stress that most developing countries had completely lost access to the international capital market after the War. As a consequence, there were very few financial crises until 1970.
Once the Bretton Woods system broke down in 1971, the global economy reopened and capital flows surged again. In specific, lending to developing countries exploded after the oil shock of 1973, which created the need for recycling the earnings of oil-producing countries. Against this backdrop, financial crises made an unfortunate comeback. Banking crises erupted in both advanced and emerging countries in the 1970s. But neither of these events was considered to be a classic banking crisis. In the emerging countries there were scores of currency crises.
By the end of the 1970s, the advanced countries shifted to a very tight monetary policy to break the back of inflation. Tight monetary policy and the ensuing recession in the West led many countries in Latin America and elsewhere to default on debts built up in the preceding inflationary era.
Already in the late 1970s and the 1980s, there were 33 sovereign defaults throughout the world. They were in Latin America, Africa and Europe. The Latin American debt crisis triggered financial difficulties for banks in Canada, the UK and the US. Eventually the defaulted bank loans in Latin America were restructured and a new lending boom started in the 1990s.
Therefore, the last decade of the 20th century was full of crises. In the early part of the 1990s, Sweden and Finland experienced a property boom. The bust was triggered by the breakdown of the Soviet empire. These forces produced the Nordic financial crisis. Banks also failed in Norway. In 1994, the tight policy of the Fed triggered a massive devaluation by Mexico, which led to a banking crisis. This crisis is widely known as “Tequila crisis”. The contagion resulted in other Latin countries (Argentina, Brazil) suffering from a banking crisis.
The Russian crisis also managed to push Longterm Capital Management, an American hedge fund led by two Nobel laureates in economics, towards bankruptcy as it was greatly exposed to Russian debt. Declining productivity, an artificially high fixed exchange rate between the ruble and foreign currencies to avoid public turmoil, and a chronic fiscal deficit were the background to the crisis. We will speak about the Russian crisis in the last chapter of this work.

The crises in the 21st century
As soon as we entered the new millennium, several European and Asian countrires experienced a banking and sovereign debt crisis. Then we entered a tranquil period (2003-2006), which gave way to an enormous surge in global credit expansion. The result was the credit crisis that initially started in the US subprime mortgage market. After Lehman’s bankruptcy, the financial crisis turned truly global. Of all the 22 advanced countries in our sample, only eight countries (Australia, Canada, Italy, Japan, New Zealand, Norway, Finland and Sweden) did not experience a banking crisis during the Great Recession. Interestingly, none of the major emerging and developing countries in our sample, with the exception of Hungary and Russia, experienced a banking crisis in this period..
Lessons to be drawn from history
To sum up, we have ended a extensive overview of the history of financial crises and it gives us an opportunity to understand where and why crises occurred and what were the consequences of the crisis. From the history of financial crises we can draw two important conclusions.
First, financial crises are very common phenomena and no region is secured from it. Latin America has been the region with the highest number, more than hundred) of default episodes and Europe with 61 episodes remains a distant second. Meanwhile, Europe holds the number one position in banking crises (149 episodes) while Latin America with 68 episodes remains second. This is because the advanced countries, with their more ‘mature’ financial markets, have been more susceptible to banking crises (see figure 4).

Figure 4: Banking and sovereign debt crises
To this end, it is very difficult to reconcile why market participants always suffer from the ‘this time is-different’ syndrome – the belief that financial crises are things that happen to other countries at other times because the countries they invest in have the right policies and are built on sound fundamentals.
Apparently, market participants always tend to believe that the lessons learnt during the past crises no longer hold in the present context. Let’s not forget that public debt of all advanced countries was considered ‘risk-free’ before the eurozone debt crisis erupted in 2009. Ever since, investors started realising that sovereign risk, which was a non-issue after WWII, is still very relevant in the industrialised world.
Second, financial crises are usually started in temporal and regional clusters, which correspond to boom-bust cycles in international capital flows. Lending booms among decreases and increases in global capital mobility, serve as a useful early warning indicator for impending crises. As such, countries experiencing a large expansion in credit become highly vulnerable to financial crises. In specific, countries which posted relatively large current account deficits (i.e. were ‘living beyond their means’) faced severe financial crises during the Great Recession.
Of course, many of the capital exporting countries (e.g. Switzerland, Germany and Austria) also suffered from a crisis because their financial institutions were heavily exposed to crisis-prone countries. So the relationship is not as straightforward as one would hope.

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