With the recent US Presidential election, and Brexit just months earlier, the world is hushed amidst worries about another global financial crisis. Concerns are widespread about President Trump’s inauguration and the new era it will herald. As history dictates, a financial crisis in the American economy creates a domino effect across the globe.
WHAT IS A FINANCIAL CRISIS?
A financial crisis relates to circumstances where the value of assets within a particular organization unexpectedly drops on a massive scale. Each crisis, however, varies so there is no general solution on how they could be completed avoided.
A “banking crisis” occurs when banks experience an unpredicted surge of customers who withdraw money, within a similar time frame, as opposed to over a prolonged period. In instances where banks are able to foresee these events, they may become stringent with minimizing loans, in which case it becomes a “credit crunch”.
When a “speculative bubble” happens, people buy more stocks while over-estimating the profits with the intention of selling at a later date for a higher price. It is however, notoriously difficult to predict whether the cost of stocks is the same as the stock’s value.
A “currency crisis” is where a nation’s currency is undervalued as a result of either a speculative attack or due to an inability to make debt repayments.
Two of the world’s biggest global recessions, occurred because of a dip in the American economy. The first was the Great Depression.
The Jazz Age post the Great War was a period of prosperity and indulgence in the world’s economy. The “Roaring Twenties” was a magical era; it heralded a boost in the economy after the ravages of the war and the Russian Revolution. The prices of shares in the US stock market soared. Between 1923 and 1929, the valuation on shares climbed by 400%, especially pursuant to the “gold rush”.
By August 1929, shares had reached its peak in the US stock market. In a turn of events, agriculture was growing too rapidly, causing a decline in prices and increased debts for farmers. By September, stocks had dropped at such an alarming rate, it caused mass panic and speculation.
By October 29th, 16,000,000 shares were sold with disastrous consequences, causing the stock market to crash to a ground-breaking halt. The Federal Reserve Board responded with disastrous policy miscalculations, which exacerbated the situation by stemming the supply of money even further.
As a result, unemployment and debts soon spread like wildfire throughout America, seeing almost 14 million people become unemployed. Millions scoured the country with the hopes of finding work to no avail.
Across the globe, economies quickly became infiltrated with debts as stocks continued to plummet with the knock on effect of the American economy. In no time, the entire world was waking up to the black horror that was the Great Depression.
By 1933, nearly half of the banks in America had fallen into liquidation. The ramifications of escalating debts paved the way for many political upheavals. The most significant was Adolf Hitler’s ascension to Nazi power in 1933 as extremism grew amidst the people’s struggles through suffrage.
In a curious twist of events, this period ended ten years later because World War 2 helped to provide jobs and revitalise economies.
By mid 2007, another global financial crisis occurred that even mainstream macroeconomics failed to predict. Things all came to a boiling point when in 2008, Lehman Brothers bank caused a catastrophic credit crunch that toppled the world’s financial system like a house of cards. It culminated in one of the worst recession that the world had seen since the Great Depression.
The crisis itself was perpetuated be various contributing factors. The first culprit came in the form of the financiers themselves, who advocated a faulty method of lowering risk, when they had in fact, simply increased it.
America witnessed a spate of negligent mortgage loans to borrowers with low credit ratings, who then strained under the repayments. These were then transferred to larger banks that in turn “pooled” them into larger “low risk” figures. But things came to a blundering standstill when a nationwide crash occurred in the property market.
These “pools” were then used in conjunction with collateralised debt obligations (CDOs), which were converted to tranches assigned with good credit ratings by rating agencies (paid by the banks). With the misperception that these were safe investments, investors and banks worldwide eagerly purchased these trenches.
Demand for these investments increased due to lower interest rates and false lucrative returns, with the presumption that the yields would overcompensate the borrowing. Unbeknownst to investors, this was a catalyst that created a chain effect from the American property market to the greater money market.
By 2007, financial institutions started to crumble. Consequently, it led to an increase in loans, which only served to worsen the problem. The regulators permitted Lehman Brothers to file for bankruptcy, which only perpetuated the mass hysteria that had infiltrated global banking.
Due to the failure by certain governing bodies such as the Federal Bureau and the European Bank to address these problems properly, a wave of financial instability expanded internationally.
WHAT CAN WE EXPECT FOR THE WORLD’S ECONOMY IN 2017?
There is a famous economic saying: “When the US sneezes, the world catches a cold.” It is safe to say that the American economy remains at the epicenter of the world’s global markets. Any major shift in finances would inadvertently have a worldwide chain reaction.
As President Trump takes on the reigns, speculations are high about what his new policies may spell, and indeed, if it could lead to another crash. Yet even the greatest economist will admit, with the unpredictability of the economy and politics in recently times, only time can will.