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Anatomy of a Crash

18 Nov 2019

 

Every crash is different. That’s why there is a crash. If everyone knew that markets would plummet, we would all prepare, and therefore nothing would ever happen. Which is why drawing lessons from history is to be taken with a pinch of salt. We may be able to figure out the reasons that led to a financial crisis, but that doesn’t mean we will know when it will happen again. In the history of financial markets, there really are only three great crashes we can look at: 1929, 1987 and 2008. I know there was this tulip crisis, which allegedly was the first bubble since records began, but that was in 1637 and the data is somewhat sketchy. So, with apologies to the purists, let’s look at the more recent history and see what lessons we can draw.


Many people forget that the period between the great wars actually went rather splendidly, and the economies of the world were booming. So much so, that people thought we had entered a new age of enlightenment, peace and prosperity. Then came the bill and over speculation finally led to a correction in the markets, which turned into a panic and when the last person had sold all they had, the damage was everywhere. The resulting great depression wiped out many a great fortune and forced many millions into poverty, with far reaching consequences. It took the financial markets more than 26 years to recover the losses of the great crash.


When you have nowhere to go but up, it is no wonder we experienced the great economic miracle that started in the fifties and continues to this day. Modern passenger air travel was born, productivity in manufacturing grew almost exponentially and the service sector developed, not least of which by entertaining the masses as television started a new era. The world was growing again, the middle classes became the baby boomers and it seemed like the good times would last forever. Then came the eighties and along with bad hair and shoulder pads, also came financial engineering. The capital markets were vast and powerful, as they benefitted from the global boom (some say facilitated, but that is another discussion). And as leveraged buyouts, junk bonds and financial derivatives just began to take hold, we had a mighty reminder that money doesn’t grow on trees. The crash of 1987 was unprecedented in its scale, and globalisation ensured that it was felt everywhere.


But it took much less time to recover this time around. The wall came down, East and West seemingly made friends, the internet was created, and the world traded more goods on a larger scale and with more money than at any time in the history of mankind. The nineties and the noughties were immensely prosperous decades and created more wealth for so many that it really seemed like this time around, we had finally made it. There were signs, of course, that it couldn’t last. I know it was allegedly all due to sub-prime housing, but really was the crash of 2008 not all about commodities? I mean oil traded at $150 for goodness sake. Over excitement, speculation, and ridiculous expectations that we could simply grow forever all caused the S&P 500 to drop more than 50% before it rebounded from a level of 666 (yes, the sign of the devil truly made its most distinct of marks on the US stock market).


What are the consequences of all these crashes? Few will argue that the rise of Hitler and the second world war would have happened had it not been for so many with nothing to lose, that chose the ultimate evil. Undoubtedly, every crash causes major social and political changes. Most recently, the far right and extreme left have been the major electoral beneficiaries as a result of so much wealth being redistributed, so unevenly. So, what are the lessons hence? For one, given that we’ve only had 3 crashes in a hundred years, I wouldn’t worry about it too much. Two, a crash always seems to happen when we least expect it. And three, every crash has far reaching and long-term repercussions that alter the world forever. Clearly, the effects of the great crash of 2008 are not yet over, and we shall see if this time things changed for the better.

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