It may seem that economic downturns have only occurred since the creation of modern banking institutions. But in reality, economic “boom and bust” cycles have damaged major economies throughout history. Although the time period and circumstances were different in each of these scenarios, there are common patterns found among most economic downturns. Found below is a time-lapse of major economic crises throughout history.
What Causes Economic Crises?
From the video, it is apparent that there are three common patterns found throughout the history of economic crises: speculation, war and large integrated banks. Speculation usually involves stocks in a company, but it can also include commodities like cotton, oil and precious metals. The price of a stock is based off of both current value and perceived value in the future. The same applies to commodities to a lesser extent. This is called speculation.
In the first few examples, speculation led to overpriced products and stocks. In the case of the South Sea Bubble, the British South Sea company was given a monopoly over trade with South America. Although they dominated all trade in that region for Britain, they failed to realize any profit. It was assumed that the trade monopoly would automatically provide profit, leading to wild speculation which drove the stock price of the company to extraordinary levels. Once people found out there were no profits, the bubble was burst and the company went bankrupt.
Speculation is one of the primary drivers of bubbles, but other factors play a role in crises as well. It is often the case that economies, in particular the economy of the United States, will enter into a recession following a significant war. Looking at the list of recessions, many of them are in the direct aftermath of a war. This happens for two reasons. First, government spending usually cools after a war, meaning the flow of capital and previously inflated sectors of the economy suddenly lose some backing. Second, a large number of soldiers return from war and take time to adjust to civilian life. This usually creates high unemployment in the short term. These factors can reveal weaknesses that exist in an economy, leading to a crisis.
The final, and arguably most significant factor is large banking institutions. Banks are much different than other industries, in the sense that much of their business model does not offer a tangible product. Banks rely heavily on accumulation of wealth. But another factor to consider is the amount of debt that banks are involved with. Most people assume that when a loan is taken or given, it will eventually be repaid. But when debt is created to fund risky ventures, there is a chance that the debt will not be repaid.
In the case of the Danish state bankruptcy of 1813, Denmark funded its wartime efforts with high levels of banknotes (a note payable on demand which can be used as a currency). The excessive issuing of these notes led to high inflation, meaning the value of these notes became increasingly worthless. Many people started demanding gold and silver coins for their banknotes, but the banks simply did not have enough reserve coins to fill the demand. This led to the collapse of both the banknotes and the banks themselves, causing the state of Denmark to go bankrupt.
The core issue with banking institutions is the risk tied to the assets they offer. If certain assets are backed by something worthless and then sold to the public or other banks, those assets are themselves worthless. Once people figure this out, they’ll attempt to get their money back all at once, leading to what’s called a bank run. Because these bank’s values are tied in part to the worthless assets they sold to others, the value of the company disappears quickly, leading to sudden bankruptcy.
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