Financial crises are not like your average recession or corporate fraud. They involve firms and people overborrowing, usually to speculate on shares or real estate. They turn legitimate economic booms into gluttonies of lazy assumptions, hucksterism, and recklessness. Because they’re based on debt, the loss of confidence in one specific area of trouble quickly reverberates. Presto, credit dries up for everybody.
The earliest crises were about the currency. The invention of coins and then paper money led governments to overprint and eventually trigger inflation and ruin their finances.
1. Debasing coins
Ancient Rome’s economy was based on coins which emperors since Nero diluted to the point of worthlessness by the third century. Cue debilitating financial crises in the face of barbarian threats.
2. Paper money
A similar phenomenon happened in China, which invented paper money in the ninth century. Emperors came to rely on printing fiat backed simply by the power of the sword, an “alchemy” that astonished Marco Polo. Fiat money fueled China’s vast, growing economy until the Ming Dynasty overprinted so badly that it invented hyperinflation.
3. Tulip bulbs
As societies turned more capitalist, crises became matters of speculation. The Dutch tulip bulb craze over something intrinsically worthless ended with a bang in 1631. Although punters were wiped out, their share buying was not based on debt, so the economic damage was limited.
4. Mississippi Company
Not so for France’s Mississippi Company, a joint-stock company supposedly reaping lucre from Louisiana. Not only was it a scam, but its shares were backed by French government guarantees, based on the state’s issuing paper money. When the company’s stock collapsed in 1720, it bankrupted the government.
5. Panic of 1907
The US became the center of booms and busts. The American Revolution had been financed purely on fiat paper money that turned worthless, embedding a hostility to finance or a central bank. The Panic of 1907 was so severe that a private individual, JP Morgan, had to bail out other banks.
6. Great Crash of 1929
Then came the biggie: the 1929 Wall Street Crash, which ushered in the Great Depression. The US by now had a central bank, the Federal Reserve, but it didn’t lend to troubled institutions. The crash was worsened by the rampant borrowing to speculate in Roaring Twenties stocks.
7. Emerging market crises
Reforms such as the 1932 Glass-Steagall Act, and then the post-war settlement, ushered in a period of stability. This ended when the US left the gold standard in 1971 and all currencies floated.
A series of credit-driven financial crises boiled: the Latin American “lost decade”; the Japanese real-estate and stock bubble of the 1980s; the Asian Financial Crisis of 1997; Russia’s default in 1998.
Most of these events involved Western banks recklessly lending to equally foolish companies and governments in emerging markets: these loans were in dollars so when a local currency crashed, the size of the debt mushroomed beyond what could be paid.
8. Japan’s bubble
In Japan’s case, US pressure for it to devalue the yen in 1985 led to speculative inflows and a credit binge in stocks and real estate; the party stopped in 1989 when the Bank of Japan tried to cool things off. The BoJ then chose to prop up wounded banks, creating a lost decade of zombie companies, zero interest rates, and the first example of a central buying securities (“quantitative easing”).
9. Global Financial Crisis
Despite these multiple crises, most people in the US and Europe assumed these were other people’s problems: the Atlantic world was in go-go mode, shrugging off its own stock market crashes. Regulatory shackles on banks from the Great Depression were loosened. US banks lent to homeowners with the aim of selling these loans to Wall Street to repackage them as securities, which were in turn sold on to global financial institutions.
These mortgages were soon being lent on the basis of smoke and mirrors. When the music stopped, investment banks like Lehman Brothers were holding the bag and all lending suddenly stopped. Only radical intervention by the Federal Reserve prevented the worst – but the crisis of 2008 devastated consumers and businesses across the US and Europe.
10. Eurozone crisis
It also revealed debt problems in the eurozone. Greece’s admission to cooking its books touched off the eurozone crisis, ending in yet more QE. The eurozone crisis nearly destroyed the European Union, and although “Grexit” was prevented, the sour taste of the crisis led to a populist backlash that fed the flames of “Brexit” in 2016 – and saw the US elect Donald Trump.
Although the West had begun to recover, 2020 ushered in the deepest crisis yet, triggered by the coronavirus pandemic. This is not yet a financial crisis: it’s a traditional, if terrible, recession. But it is so deep that a financial crisis may yet lie in the cards.
This guide has been written exclusively for ByteStart by Jame DiBiasio, author of Cowries to Crypto: The History of Money, Currency and Wealth illustrated by Harry Harrison and published by OANDA, a global leader in online multi-asset trading services. It is available on amazon.co.uk, priced at £19.99.