financial collapse

2019 may very well be the year the economy suffers a significant financial collapse, according to centuries of past history.

In a study published last week, International Monetary Fund economist Jihad Dagher analyzed ten of the most famous booms and busts since the 18th century, and found that financial meltdowns are most often preceded by governments applying a laissez-faire approach to economic regulations and undoing rules put in place to rein in financial markets. The paper is a chilling reminder that the U.S. is on the same path, given the hands-off approach the Trump administration and the Republican Congressional majority employ for financial regulations.

“Financial booms, and risk-taking during these episodes, were often amplified by political regulatory stimuli, credit subsidies, and an increasing light-touch approach to financial supervision,” Dagher wrote in the summary of his paper. “Post-crisis regulations do not always survive the following boom… History suggests that politics can be the undoing of macro-prudential regulations.”

While the 2008 housing market crash and resulting recession would be the most recent economic meltdown in the United States, Dagher’s paper showed that the consistent pattern with bullish markets and sudden economic crashes was the repeal of government regulations put in place following a sudden financial collapse.

Speculation-fueled financial collapse in 1720

One case study was what happened following the South Sea Bubble of 1720, when the South Sea Company’s (SSC) stock price was inflated by speculators hungry by a scarcity of available stock — given that the highly profitable East India Company shared a smorgasbord of dividends with its small club of just 499 investors. However, unlike the East India Company, SSC was poorly run, with exports reportedly decaying in ports rather than going to Central and South America, according to Investopedia. Nevertheless, SSC was eager to sell high-priced stock to willing buyers, reportedly re-issuing stock certificates to anyone who wanted to invest.

When company managers realized their stock was essentially worthless and propped up only by speculation, they offloaded it en masse in 1720. While SSC stock was trading at as much as 1,000 British pounds (unadjusted for inflation) per share, investors quickly panicked once the company’s failure became public knowledge, and rushed to sell their shares, rendering the stock worthless. The only reason banks didn’t go belly-up was due to the British Empire’s bailout of financial markets. The government responded by outlawing the issue of stock certificates.

Political corruption leads to another financial collapse

The legendary Panic of 1825, in which approximately 70 banks across England closed, was preceded by British politicians loosening financial regulations put in place following the South Sea Bubble, according to Dagher. Before the panic, the British Empire enjoyed an unprecedented boom following the Napoleonic wars of the early 1800s and the decline of the Spanish Empire, when newly independent states in Central and South America were seeking European investors to jump-start their own economies.

Similar to the South Sea Bubble, economies boomed due to lax financial regulations enabling speculators to make high-risk, high-return investments in both the stock and bond markets. South American mining companies joined the London Stock Exchange, which was the dominant capital market of the time, according to Dagher (PDF). Whenever investors questioned the legitimacy of “increasingly bewildering schemes,” British members of parliament who sat on the boards of the companies being traded — who appointed them to director positions to curry political favor — clamped down on any talk that would slow the flow of investment.

“Even the prime minister, Lord Liverpool, was appointed president of a company that sought to revive the silk industry,” Dagher wrote. “Scottish adventurer Gregor McGregor arranged to successfully float a £600, 000 loan to Poyais, his fictitious small country on border of present-day Nicaragua, through the offices of a former Lord Mayor of London.”

The subterfuge didn’t last — by the end of 1825, England was reeling from “spectacular collapse,” according to a 1998 study issued by the St. Louis Fed. As economist Larry Neal wrote in the report, the British government instituted a number of new financial regulations that stabilized the nation’s economy for the better part of a century:

“The policy changes that affected the monetary regime—the exchange rates, the structure of the banking sector, the role of the Bank of England and the management of the government’s debt—while minor in each particular and slow to take effect, were cumulatively effective in laying the basis for Britain’s dominance in the world financial system until the outbreak of World War I.”

British forecasting firm predicted financial collapse under Trump’s watch

If past history is any indicator, the U.S. economy is likely headed for a similar meltdown if the Trump agenda continues to steamroll its way through Congress. British financial services firm Legal & General (L&G) — which was founded just 11 years after the Panic of 1825 — predicted that President Trump’s agenda of simultaneously cutting corporate taxes and pouring $1 trillion into new infrastructure and military spending will result in a “catastrophic widening of the budget deficit,” prompting the Federal Reserve to raise interest rates and increase inflation.

“At some point the bond market will freak out about this… this is an unsustainable path and it will cause a bond market riot,” L&G Investment Management chief economist Tim Drayson told the London Telegraph in December of 2016. “[Trump] will not be able to maintain these fiscal plans indefinitely and someone will have to come into the White House to clean up the mess that it looks like he is about to create.”

L&G’s prediction is so far coming true. The firm predicted that there would be a boom in 2017 and 2018, followed by a significant bust in 2019. While the tax cuts L&G warned about have already been passed and signed into law, Trump has yet to pass his infrastructure plan. While L&G predicted economic growth could increase to as much as 3 percent per quarter in 2018, the growth won’t come without a cost.

“[I]f we get the full Trump plan, there is a bigger boom in 2017 and 2018, then a bigger bust in 2019,” Drayson told the Telegraph.

While it’s still too early to tell, Dagher’s paper and L&G’s forecasting suggests the U.S. is in for a rude economic awakening fairly soon, unless Republicans shake their aversion to laissez-faire economics.

 

Carl Gibson is co-publisher of Grit Post. His work has previously been published in The Guardian, The Washington Post, Al-Jazeera America, and NPR, among others. Follow him on Twitter @crgibs.

Leave a Reply

Your email address will not be published. Required fields are marked *