History has always given me the greatest comfort in this chaotic world. Understanding the past can help us get ready for new challenges. In this article, I list the significant financial crises that have occurred throughout history and explain their causes and effects.
Tulip Mania (1634 - 1637)
Tulip Mania is one of the earliest market bubbles known to this date. It started in 1634 when the price of tulips ramped up many times their actual value before taking a nose-dive and culminating in a market crash in February 1637.
Causes
Tulips originated in the Tian Shan Mountain ranges and didn't arrive in the Netherlands until the end of the sixteenth century. The vividly coloured petals differentiated tulips from any flower known to Europe at that time.
Another factor contributing to the popularity of tulips is The Dutch Golden Age which took place between 1588 and 1672. During this time, art, science, and military flourished in Holland and the country was considered one of the most influential economies in the world. A group of the new-rich emerged, consisting of merchants, artisans, and tradesmen who wanted to prove their social status by owning luxury items.
The mesmerizing beauty of multicoloured petals and the rise of the independently rich Dutch traders turned tulips into a fashionable trading asset.
The problem is that tulips can't be cultivated year-round. They only bloom between April and May for a few weeks and their dormant phase takes place between June and September when the bulbs can be uprooted and moved to another place.
As a result, the trading of tulips rarely happened on the scene. People would sign contracts to buy tulips during the last months of the year and collect them in the next summer. At its peak, the tulip changed hands a few times before the actual transaction.
Consequences
However, confidence tumbled soon. In February 1637, the bubble burst and prices fell drastically, leading to an economic crash. Many traders had bought the bulbs on credit, hoping to repay when they sold those at a profit. They were left holding a lot of flowers that nobody wanted, leaving them bankrupt. By 1638, tulip prices were back to normal.
The interesting thing is this phenomenon did not critically influence the prosperity of the Dutch Republic, which was the world’s leading financial and economic power during the seventeenth century. The economy did not collapse, but hordes of people who had speculated and participated in the buying and trading became impoverished overnight.
Amsterdam Banking Crisis (1763)
Causes
The Amsterdam banking crisis of 1763 in the Netherlands. At this time prices of grain and other commodities were falling sharply, and the supply of credit dried up due to the decreased value of collateral goods. Many of the banks based in Amsterdam were over-leveraged and were interlinked by complex financial instruments, making them vulnerable to a sudden tightening of credit availability.
Financial activity in late-eighteenth-century Amsterdam was controlled by a group of merchant banking firms. These “bankers” were proprietary firms that dealt in trade goods and that also provided financing to other merchants. These firms were not deposited banks in the English conventional tradition, as deposit taking was viewed as incredibly risky. Since deposits were scarce, financial intermediation was accomplished through a securitization scheme known as the acceptance loan. The building block of the acceptance loan was an instrument known as the bill of exchange which can make a bank have a receivable asset and a payable liability even when no goods were traded, implying a perceived negligible risk.
The high leverage and balance sheet interconnectedness left merchant bankers highly vulnerable to any slowdown in credit availability.
Consequences
On 10 February 1763, the Treaty of Hubertusburg was signed between Prussia, Austria and Saxony. This Treaty marked the end of the Seven Years’ War, a war from 1756 to 1763 that involved all of the major European powers of the period. Berlin then became an emerging market, and Amsterdam’s merchant bankers were the primary sources of credit, with the Hamburg banking houses serving as intermediaries between the two. But early 1763, because of the end of the war, the abnormal high war prices plummeted by 30%; grain lost its value rapidly in May. Two months later more than 30 banking and trade firms went bankrupt with an estimated debt of 10 million Dutch guilders.
British Credit Crisis (1772 – 1773)
British Credit Crisis of 1772 – 1773 was a peacetime financial crisis which originated in London and then spread to Scotland and the Dutch Republic It has been described as the first modern banking crisis faced by the Bank of England. It was perhaps the least well-known financial crises of the eighteenth century. It happened in the interim between the American Revolutionary War’s economic upheaval and the banking crisis of 1763. However, it is just as important historically, if not more so, because it happened at a turning point in the growth of banks, financial institutions, and the world economy.
Causes
From the mid-1760s to the early 1770s, the credit boom, supported by merchants and bankers, facilitated the expansion of manufacturing, mining and internal improvements in both Britain and the thirteen colonies.
Problems, however, lay behind the credit boom and the prosperity of both British and colonial economies: speculation and the establishment of dubious financial institutions. For example, in Scotland, bankers adopted "the notorious practice of drawing and redrawing fictitious bills of exchange in an effort to expand credit”. To increase the supply of money, the bank of Douglas, Heron & Company was established. However, after the original capital was exhausted, the firm raised money by a chain of bills on London. How a chain of bills works? A, say in Edinburgh, drew a bill on his agent B in London, payable in two months. Before payment was due B redrew on A for the same sum plus interest and commission. Meantime A discounted his bill in Edinburgh and before the two months were up he drew another bill on B and so on". This method could only temporarily support economic development, yet it promoted false optimism in the market. The warning signals of the impending crisis, such as the overstocked shelves and warehouses in the colonies, were completely overlooked by British merchants and American planters.
In June 1772 Alexander Fordyce lost £300,000 shorting East India Company stock, leaving his partners Henry Neale, William James and Richard Down liable for an estimated £243,000 in debts. As this information became public within two weeks eight banks in London, and later around 20 banks across Europe collapsed.
Consequences
Economic growth at that period was highly dependent on the use of credit, which was largely based upon people’s confidence in the banks. In June 1772 Alexander Fordyce lost £300,000 shorting East India Company stock, leaving his partners Henry Neale, William James and Richard Down liable for an estimated £243,000 in debts. As this information became public, confidence started ebbing and paralysis of the credit system followed: crowds of creditors gathered at the banks and requested debt repayment in cash or attempted to withdraw their deposits. After the crisis, a dramatic rise in the number of bankruptcies was observed: the average number of bankruptcies in London was 310 from 1764 to 1771, but the number rose to 484 in 1772 and 556 in 1773.
The Great Depression (1929 – 1939)
The Great Depression is the longest and deepest downturn in the history of the United States and the modern industrial economy lasted more than a decade, beginning in 1929 and ending during World War II in 1941.
Causes
The major cause is the Wall Street Crash of 1929, where the Dow Jones Industry Average dropped from 381 to 198 over the course of two months. The stock market rose in early 1930, with the Dow returning to 294 (pre-depression levels) in April 1930, before steadily declining for years, to a low of 41 in 1932. A lot of people suffered severe losses in the stock market and cut expenditure by 10%. Interest rates dropped to low levels by mid-1930, but expected deflation and the continuing reluctance of people to borrow meant that consumer spending and investment remained low. In addition, beginning in the mid-1930s, a severe drought ravaged the agricultural heartland of the U.S, which exacerbated the decline in the U.S. economy.
Then what causes Wall Street Crash of 1929?
The Wall Street Crash of 1929, also known as the Great Crash, the Crash of 29, or Black Tuesday, was a major American stock market crash that occurred in the autumn of 1929. It started in September and ended in mid November, when share prices on the New York Stock Exchange collapsed.
One of the causes is credit boom. In the 1920s, there was a rapid growth in bank credit and loans in the US. Encouraged by the strength of the economy, people felt the stock market was a one-way bet. Some consumers borrowed to buy shares. Firms took out more loans for expansion. Because people became highly indebted, it meant they became more susceptible to a change in confidence.
Another cause is high leverage. People only had to pay 10 or 20% of the value of the shares; it meant you were borrowing 80-90% of the value of the shares. This enabled more money to be put into shares, increasing their value. This left investors very exposed when prices fell.
Also, a mismatch between production and consumption causes disappointing profit results which precipitated falls in share prices.
Consequences of the great depression
Between 1929 and 1932, worldwide GDP fell by an estimated 15%. By comparison, worldwide GDP fell by less than 1% from 2008 to 2009 during the financial crisis. Devastating effects were seen in both rich and poor countries with falling personal income prices, tax revenues, and profits. International trade fell by more than 50%, unemployment in the U.S. rose to 23% and in some countries rose as high as 33%.
What’s next? The causes and consequences Part II
· 1973 OPEC Oil Crisis
· Asian Crisis of 1997 – 1998
· The 2007 – 2008 Global Financial Crisis
· COVID 19 Pandemic
· Summary
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