Lessons from ten great crashes

A crisis century is what the 21st century has been described by millennials and Gen Z who have experienced crash after crash. This millennium has been characterised by the dotcom bubble and bust in 2000-2001. That was soon followed by the 2008-9 global financial crisis. In the slipstream of the U.S. subprime crisis that was the root of the global financial crisis, the euro crisis erupted in 2010 which lasted for several more years. Then, in 2019, China reported a case of Covid-19 . The first pandemic in 100 years caused the biggest one day stock market crashes in history as economies closed down. Just as lockdowns were beginning to be lifted, Russia invaded Ukraine in February 2022 and we were faced with a cost-of-living crisis that is still being felt today. China’s property bust is adding further stress to a world that has already seen five financial crises in just over 2 decades. It’s no wonder that this feels like the crisis century.

Importantly, these crises were great crashes in that each caused a recession that led to misery for millions of people. Sadly, there were also several great crashes in the preceding two decades to 2000 as well.

After the golden age of economic growth in the 1950s and 1960s that did not have financial crises of this scale, the 1970s started to see high inflation and stagnant growth, dubbed stagflation. That turmoil contributed to the great crashes of the 1980s, namely, the Latin American crises of 1980-1981 and the U.S. savings and loan crisis later that decade. These were soon followed by the European Exchange Rate Mechanism (ERM) crash of 1992 and the Mexican peso crisis of 1994. Rounding off the decade was the Asian financial crisis of 1998-1999, which became an emerging market crisis that impacted Russia in 1998, Turkey in 1999, and then spread to Brazil and Argentina, resulting in Argentina becoming the biggest rescue by the International Monetary Fund to date.

Thus, it seemed timely to write a book on ten of these great crashes of the past century. And, importantly, what we can learn from them. The aim is to determine how best to mitigate the damage of the next inevitable crash to try and limit its damage and not for it to become a global meltdown.

Each of the ten crashes that I write about in this book has a unique set of causes and consequences but, despite their differences, they all feature three distinct phases: euphoria, credibility and an aftermath that is determined by the first two phases.

Euphoria or exuberance (or irrational exuberance), often used interchangeably, leads people to invest in markets they believe will only rise and rise. To resolve a financial crisis when the inevitable bust happens, credible policies are essential. These two aspects can shape the aftermath, which makes the difference between a quick recovery or a long, protracted recession. For each crisis, the responses of governments or institutions will be analysed to determine which led to the best outcomes, and which to the worst, in the hope that these lessons will be learned.

Ten great crashes

There have been many more financial crashes than are included in my book, but not all of them ended up inflicting widespread economic pain. The ten crises that I highlight led to recession, which also marks them out as ‘great crashes’ since not all financial crises lead to an economic slump even though all recessions come with a stock market decline. For instance, Black Monday on 19 October 1987 was the worst one-day stock market fall in history until the 2020 pandemic crash. U.S. and global markets fell dramatically into bear markets in a matter of days and yet no recession ensued. By contrast, the dot com bubble bursting in 2000–2001 led to a U.S. recession, though not a deep one, and so it is covered while others are not. There have also been numerous housing market crashes, but most did not trigger financial meltdowns like the U.S. subprime crisis that became known as the 2008 global financial crisis. That was certainly the case with the Japanese crash. The early 1990s real-estate crash wasn’t limited to Japan; a number of countries experienced the bursting of a housing bubble after an exuberant 1980s, which led to a global recession. However, those economies did not end up in a long stagnation, unlike Japan, which, three decades on, is still struggling to recover its pre-crash growth rates. Thus, Japan warrants a chapter because focusing on that economy offers lessons to try to minimise the impact of a housing bust, and avoid it resulting in lost decades of growth.

The ten crises that I cover starts with three generations of currency crises that have occurred since the globalisation of financial markets. As mentioned earlier, the late twentieth century and twenty-first century have seen a bonanza of financial crises. A series of financial crises of all kinds, including banking, housing and stock market crashes, currency and sovereign debt crises, have accompanied the opening up and globalisation of financial markets since the 1970s. That decade saw the expansion in offshore banking and currency trading has led to close linkages among markets, with the result that a crash can spread rapidly from country to country. Although there have been crises of all shapes and sizes over the centuries, the past several decades has seen a series of financial disasters regularly encompassing economies around the world.

The first was the early 1980s Latin American currency crisis. It was followed by the 1992 collapse of the European Exchange Rate Mechanism (ERM) whereby European currencies had been pegged to the German Mark. The third-generation model was the 1997–98 Asian financial crisis, which ultimately spread across the world to Turkey, Russia, Brazil and Argentina. Simultaneously, a savings and loans crisis was raging in the United States and a spectacular real-estate crash was toppling the once-thriving economy in Japan.

At the start of the twenty-first century, there was no respite as the dot com bubble burst, triggering a recession in the U.S. that impacted the international market. Then the world witnessed the worst systemic banking crisis since the 1929 Great Crash. That was the 2008 global financial crisis, with its origins in reckless subprime mortgage lending in the U.S., which led to a near meltdown of the American financial industry that almost brought down the British banking system and deeply affected others.

Towards the tail end of the U.S. subprime crisis came the 2010 euro crisis, which saw the bailouts of Ireland, Portugal and Greece (the largest in history, taking the top spot from Argentina) as well as the rescue of the entire banking systems of Spain and Cyprus. Shortly thereafter the world was hit by the Covid-19 pandemic. The ensuing market crashes were the sharpest in history. Financial markets fell from record highs and unemployment claims jumped more sharply than at any time since the Great Depression of the 1930s. The financial markets rebounded, but the real economy struggled. The massive government actions to rescue economies revealed the extent to which the lessons from history have been heeded or ignored.

What will spark the next great crash? China’s recent property market woes could point to it being the next global meltdown. There will undoubtedly be financial crises in other countries and other sectors that could arrive first, but China stands out as its sheer economic size makes any crisis a potentially significant one – not only for itself but also for the global economy. And China is overdue for one. Its economy has the rare distinction of having escaped a serious financial crisis during four decades of pretty much uninterrupted growth except for one quarter during the Covid-19 lockdown. It has, of course, had booms and busts, but not yet a great crash. Although the property sector has crashed, it has not yet resulted in a wider crisis or a recession. One reason is because of the state dominance of the financial system, which benefits from government support. But, with mounting debts and looming fragility, it would be entirely consistent with economic history throughout the ages for China to experience one. If so, then it would likely be a ‘great crash’. Even though the nature and impact of a crisis in China will be distinct, the traits of debt driven by euphoria and the credibility of its institutions already point to similarities with other financial crises.

Lessons from history

It’s not only policymakers who can learn from what has come before; we can all apply our understanding of the three phases of crises outlined in my book, namely, euphoria, credibility and aftermath, to better position ourselves for the next inevitable crash.

Firstly, be wary of euphoria and avoid piling into rising markets by borrowing too much. It’s tough to stand on the sidelines of an exuberant market, but it would be worse to feel so euphoric that we borrow too much and can’t afford to repay our debts when the inevitable bust happens. It is difficult to differentiate between an increase in fundamental value and a bubble, but since all markets, bubbly or not, will deflate, the lesson remains the same. Invest instead for the long term since markets will rise again. And here’s the hard part, try not to sell at the bottom of the market or retire then. Drawing down a lump sum from your pension or buying an annuity would lock in any loss in asset value that reduces your income in retirement, so seek professional advice and consider any decisions carefully to not make unrealised losses concrete by taking certain actions.

Secondly, it is certainly challenging to identify when the next crash might occur, but we can look for evidence of credible policies to determine how it could play out. When too much debt in a market is causing its growth to slow, that is a sign of a potential crash. Whether it becomes a crisis depends on whether policymakers can orchestrate a managed deflation of the market and cushion any impact on the economy. For instance, are regulatory measures in place to reduce the amount of borrowing in a rising market? Does government policy support keeping people in work and viable businesses afloat, so that a deep or prolonged recession is less likely to follow a crisis?

Thirdly, it’s important to bear in mind that financial markets have crashed regularly for centuries and the aftermaths have varied considerably, so it’s best to prepare our finances in anticipation that the next crisis is never that far away. The well-known advice to ‘save for a rainy day’ captures this well. For the business community, there are also lessons to be learned. Firms such as Amazon that ran tight ships despite the dizzying heights of the dotcom market not only survived but thrived after the crisis. A crash inevitably separates the strong from the weak, and a well-placed company that continues to invest prudently could even end up in a better position at the end of one.

Linda Yueh is Adjunct Professor of Economics and London Business School and the author of The Great Crashes: Lessons from Global Meltdowns and How to Prevent Them