Lessons from the Past: What We Can Learn from These 5 Economic Crises

Currency

Philosopher George Santayana once claimed that, “Those who forget the past are condemned to repeat it.” With talks abounding of a global economic recovery, but equal voices proclaiming that caution should be the word of the day, there are many lessons to be learned about the current economic climate and some potential dangers to it from looking at past crises.

1970s Oil Crises

In the 1970s, the United States was hit with two oil crises. The first occurred after OPEC scaled back oil production and sharply increased their prices, and the second occurred after the Iranian Revolution. These supply shocks to the oil market, which, being so closely tied to energy, increased costs across the board for companies and individuals alike, causing economic upheaval throughout the industrialized world.

While it doesn’t take a degree in economics to realize that a constriction of supply sends prices higher, the concerns are more potent for some countries than for others. The United States greatly expanded domestic oil production in the wake of the crises. However, for a country such as China that is poor in domestic sources of energy, the problem is far more pressing. This helps to explain the motivation for China’s approval of Russia’s disdain for a potential invasion of Syria as even the tension in the middle east forces oil prices upwards.

Gold coins

Savings and Loan Crisis

In the 1980s and early ’90s, many so-called savings and loans businesses went bankrupt in the United States. These companies gave out loans, such as mortgages, to individuals who were members. The problem came when interest rates increased. The companies had locked in fixed-rate, long-term loans and had no way to raise capital to cover their debts when the prevailing market interest rates were so much higher than the returns they could offer.

Many economists are skeptical about whether interest rates can remain long at their historic lows. Even if central banks do try to maintain rock bottom interest rates, market interest rates are almost certain to rise, making it not only more difficult to maintain lower rates but also subjecting the rest of the economy to the higher rates. This could put into question the forward guidance policies issued by the banks such as the European Central Bank in addition to creating even more banking woes across the world.

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Black Wednesday

In 1979, European countries established the European Exchange Rate Mechanism (ERM), by which currencies of member countries would be tied to each other to reduce volatility. The pound joined in 1990, tying the pound to other European currencies, provided, of course, that the pound’s true value could be maintained within a certain percentage of the nominal value posted by the mechanism.

In 1992, fears abounded over the pound losing value as it hovered near the lower threshold of being kicked out of the ERM. In part driven by speculators such as George Soros, the pound continued to lose value and, despite massive buying of the pound by the British government and drastic interest rate hikes to 10, 12, and then 15 percent — the pound fell out of the ECM. This meant that the British government lost over 3 billion dollars when the pounds that they had bought lost value, while Soros and other speculators came out ahead.

Today, concerns persist over the currencies of developing countries such as India and Brazil, where currency values have dropped due to the potential tapering of American quantitative easing. In order to prevent a run in on their currencies, the BRICS countries established a $100 billion dollar fund at the G20 summit last week in St. Petersburg, but many economists have warned that this may not be enough. If a run-in does occur on one of the currencies, the countries stand to give up billions of dollars, just like the United Kingdom did on Black Wednesday.

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Mexican Financial Crisis

Mexico faced a crisis– sometimes known as the Tequila Crisis– in 1994 after Ernesto Zedillo took office. He inherited a terrible situation wherein the Mexican government had raised bonds in Mexican pesos that were payable in U.S. dollars. In addition, the peso was closely pegged to the dollar. However, when investors saw the precarious state of the Mexican government, there was a run-in on the central bank for dollars rather than pesos, and the supply was quickly depleted.

Zedillo was forced to abandon his policy of currency pegging and float the peso, which depreciated by nearly 50 percent in a short period of time. Only loans from the U.S. treasury department and the American government’s buying of the peso helped to stabilize the situation.

Again, the Mexican Crisis showcases the danger of trying to maintain currency values when the market thinks otherwise. Especially when debt levels rise, investors become weary, and interest rates skyrocket as confidence decreases and currency values fall. This trip is especially concerning to countries, such as China, that still keep their currency pegged to the currencies of other countries. China has begun to move away from this policy, claiming that it eventually wishes the yuan to become a reserve currency.

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Asian Financial Crisis

Asian markets in the late 1990s suffered greatly as currency values sank sharply. Beginning with Thailand’s floating of the baht, economies were put under massive strain as currencies lost value and markets tanked. Hit particularly hard were the countries of Indonesia and South Korea, with the IMF stepping in with loans to help the beleaguered nations. In addition, Thailand was unable to pay back its debts, forcing additional international aid.

The Asian crisis is oddly reminiscent of the massive bailouts needed in European countries such as Greece and Cyprus — with the exception, of course, that the euro has not been abandoned — meaning that the other eurozone countries have had to bear the brunt of the currency losing value instead. In addition, many have pointed to the end of quantitative easing and falling currency values in Indonesia stand as a reminder of what happened 15 years ago. The economic turmoil can cause problems not only socially but also politically. Suharto, the longtime Indonesian leader, was forced to step down during the crisis.

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