What are financial panics and crises?

(prepared by Patrick Bond)

A financial crisis typically consummates a period of irrational speculation, in the wake of monetary/credit expansion during a structural stagnation (or even decline) in underlying economic growth rates. Starting with the 1720 South Sea Company bubble, panics occurred in financial, commodity or property markets in 1763, 1772, 1793, 1797, 1799 and 1810. Such panics reflected relatively immature markets, underdeveloped institutions, the uneven expansion of financial systems, the gullibility of investors, and systemic vulnerability to emotion. Wars and geopolitical conflict were often catalysts. The Bank of England and City of Amsterdam performed lender-of-last-resort functions.

More disturbingly, the past two centuries of world capitalism were punctuated by the 1815-48, 1873-96, 1917-48, and 1974-99 episodes of stagnation, speculation and crashes. Such periodic cycles (or `long waves') suggest that a crescendo of financial turbulence may contribute to economic catharsis and renewed capital accumulation (Marx described `violent eruptions... forcible solutions of the existing contradictions which for a time restore the disturbed equilibrium'). Yet discrete crashes are sometimes insufficient to restore conditions for recovery, generating instead `payment-freeze' which in turn makes commerce or investment very difficult to finance in subsequent years. (Thus the past three cycles were interrupted by severe financial panics--1873, 1882, 1890, 1893; 1920, 1929, 1931; and various 1980s-90s crises--which did not immediately rejuvenate growth.)

Even where recovery follows, the panics cause enormous financial, social and ecological harm, often to firms, workers or entire societies which were innocent of speculation. Concedes contemporary speculator George Soros, financial markets `move in a herd-like fashion in both directions. The excess always begins with overexpansion, and the correction is always associated with pain'. Given the late 1990s role of the Bretton Woods Institutions and New York Federal Reserve in baling out emerging-market investors, the asymmetric liability (or 'moral hazard') for the enormous costs associated with financial panic was one important reason for the challenge to `Washington Consensus' economic policy, by even World Bank economist Joseph Stiglitz.

The most recent speculative bubbles and panics--to some extent offset by limited bailouts, but generally destroying a third or more of the value of financial assets--included the dollar crash (1970s), gold and silver turbulence (1970s-80s), Third World debt crisis (1980s), farmland collapse (1980s), energy finance shocks (mid 1980s), crashes of international stock (1987) and property (1991-93) markets, and the long fall (from 1973- 99) in non-petroleum commodity prices and related securities. Emerging markets offered spectacular late 1990s examples of financial panic, including Mexico (early 1995), South Africa (early 1996 and mid-1998), Southeast Asia (1997-98), South Korea (early 1998), Russia (periodic but especially mid- 1998) and Brazil and Ecuador (early 1999). Other examples of investment gambles gone sour included derivatives speculation, exotic stock market positions, and bad bets on currency, commodity and interest rate options, futures and swaps, with specific victims covering enormous losses: Long-Term Capital Management ($3.5 billion)(1998), Sumitomo/London Metal Exchange (1.6 billion pounds)(1996), I.G.Metallgessellschaft ($2.2 billion)(1994), Kashima Oil ($1.57 billion)(1994), Orange County, California ($1.5 billion)(1994), Barings Bank ((900 million pounds)(1995), the Belgian government ($1 billion)(1997), and Union Bank of Switzerland ($690 million)(1998).