A U.S. economic crisis is a severe and sudden upset in any part of the economy. It could be a stock market crash, a spike in inflation or unemployment, or a series of bank failures. They have severe effects even though they don’t always lead to a recession.
The United States seems to have an economic crisis every 10 years or so. They are difficult to eradicate because their causes are different. But the results are always the same. They include high unemployment, near-bank collapse, and an economic contraction. These are all symptoms of a recession. But a financial crisis doesn’t have to lead to a recession if it’s addressed in time.
Economic Crisis History
These six crises help you recognize the warning signs of the next one. You’ll see when government action prevents complete economic collapse and when it makes things worse.
The Great Depression of 1929. The first warning was a stock market bubble during the Roaring 20’s. Wise investors could have started taking profits in the summer of 1929. In October, the 1929 stock market crash kicked off the Depression. It wiped out the life savings for millions of people. It wasn’t the last time a stock market crash caused a recession.
One of the Depression’s causes was the Dust Bowl. This decade-long droughtcontributed to famine and homelessness. Another cause was the Federal Reserve’suse of contractionary monetary policy. It wanted to protect the value of the dollar, then based on the gold standard. The Fed’s policies created deflation. The Consumer Price Index fell 27 percent between November 1929 and March 1933, according to the Bureau of Labor Statistics.
The effects of the Great Depression devastated America for 10 years. Housing prices fell 31 percent. At its bottom in 1933, gross domestic product had fallen 29 percent, according to the Bureau of Economic Analysis. Falling prices sent many firms into bankruptcy. The BLS also reported that the unemployment rate peaked at 24.9 percent in 1933.
Massive government spending on the New Deal and World War II ended the depression. But it drove the debt-to-GDP ratio to a record 126 percent. If climate change creates another massive drought, a Great Depression could happen again.
1970s Stagflation. The 1973 OPEC oil embargo signaled the start of this crisis. The government’s reaction turned it into a full-fledged crisis of double-digit inflation AND recession. The economy contracted 4.8 percent by the first quarter of 1974, according to the BEA. In 1975, unemployment peaked at 9 percent. Prices sky-rocketed after President Nixon untied the dollar from the gold standard. To curb inflation, he froze wages and prices. That made businesses lay off workers who couldn’t lower wages or increase prices.
Fed Chairman Paul Volcker used contractionary monetary policy to end the crisis. He raised interest rates to stifle inflation. The warning signals for the crisis were the announcements from OPEC and Nixon over their proposed disruptive actions.
1981 Recession. High-interest rates to curb inflation created the worst recession since the Great Depression. The economy shrank for six of the crisis’ 12 quarters. The worst was Q2 1980 at 8 percent. Unemployment was above 10 percent for 10 months. It rose to 10.8 percent in November and December 1982, the highest level in any modern recession.
President Ronald Reagan cut taxes and increased spending to end it. That doubled the national debt during his eight years in office.
1989 Savings and Loan Crisis. Charles Keating and other unethical bankers created this crisis. They raised capital by using federally insured deposits for risky real estate investments. Five Senators accepted campaign contributions in return for decimating the bank regulator so it couldn’t investigate the criminal activities. There was no warning to the general public since the banks lied about their business dealings. The S&L Crisis resulted in 1,000 bank closures.
The crisis created a recession in July 1990. By the fourth quarter, the economy shrank 3.6 percent. Unemployment peaked at 7.8 percent in June 1992. The subsequent bailout added $126 billion to the national debt. It’s one of the 10 worst booms and busts since 1980.
9/11 Attacks. Four terrorist attacks occurred on September 11, 2001. They stopped air traffic. The two attacks that destroyed the World Trade Towers closed the New York Stock Exchange until September 17. When it reopened, the Dow dropped 617.70 points. There was no warning for the general public.
The crisis threw the United States back into the 2001 recession, extending it until 2003. The economy shrank 1.1 percent in the first quarter and 1.7 percent in the third quarter. Unemployment peaked at 6.3 percent in June 2003. Some of this was not because of the attacks themselves. It was due to uncertainty about whether the United States would go to war. The resultant War on Terror added $2 trillion to the national debt.
2008 Financial Crisis. The financial crisis was worse than any other crisis except the Depression. The first warning came in 2006 when housing prices started falling and mortgage defaults began rising. The Fed and most analysts ignored it. They welcomed a slowdown in the over-heated housing market.
In 2007, the subprime mortgage crisis hit. Lenders had allowed too many people to take out subprime mortgages. When they defaulted, the banks called in their credit default swaps. That drove insurance companies like the American International Group to bankruptcy. By mid-summer, banks had stopped lending.
In 2008, the Fed stepped in to keep Bear Stearns and AIG afloat. The U.S. Treasury nationalized mortgage guarantors Fannie Mae and Freddie Mac to keep the housing market afloat. But they could not help investment bank Lehman Brothers. Its bankruptcy caused a global banking panic. The Dow fell 770 points, its worst one-day drop ever. Frightened companies withdrew a record $140 billion from their money market accounts. If the money markets had crashed, companies would have lost access to the cash they need to operate.
The economy shrank 2.3 percent in the first quarter, 2.1 percent in the third quarter, and 8.4 percent in the fourth quarter. It went on to contract 4.4 percent in Q1 2009, and 0.6 percent in Q2.
Congress approved a $700 billion bank bailout package to restore confidence and prevent a collapse. Obama’s economic stimulus package pumped $836 billion into the economy, reversing the decline in July 2009.
Is the United States on the Brink of Another Crisis?
Modern U.S. economic history predicts the next crisis will occur between 2019 and 2021. That doesn’t tell you where it will come from, what the result will be, and how to defend yourself. What would have protected you in previous crises might be the worst thing to do in the next one.
You must watch for the warning signals. The first sign is an asset bubble. In 2008, it was housing prices. In 2001, it was high-tech stock market prices. In 1929, it was the stock market. It’s usually accompanied by a feeling that “everyone” is getting rich beyond their wildest dreams by investing in this asset class.
The next warning is the “get rich quick” ads everywhere. You feel like you’re being left out. And, this is true for some time leading up to the crash. That’s the nature of an asset bubble.
The third symptom occurs when self-proclaimed experts write books predicting prosperity beyond imagination. They say “this time it’s different.” It’s called irrational exuberance. It could last for months or even a year or two. But it never lasts forever.
In March 2019, the Federal Reserve warned of another economic crisis due to climate change. Extreme weather caused by climate change is forcing farms, utilities, and other companies to declare bankruptcy. As those loans go under, it will damage banks’ balance sheets just like subprime mortgages did during the financial crisis.
The Fed blamed the growth in fossil fuels on the lack of a carbon tax. Businesses and households are not accurately charged for using these fuels. The Fed calls this “a fundamental market failure.” It said that failure could lead to a financial crisis.
Think this sounds far-fetched? Wildfires have already forced utility giant Pacific Gas & Electric into bankruptcy. It faced $30 billion in fire-related liability costs. Munich Re, the world’s largest reinsurance firm, blamed global warming for $24 billion of losses in the California wildfires. It warned that insurance firms will have to raise premiums to cover rising costs from extreme weather. That could make insurance too expensive for most people.
How to Protect Yourself From the Next Crisis
Prepare now by immediately taking the following five steps:
- Pay off all credit card debt.
- Save three to six months’ worth of living expenses. That will cushion you if you lose your job.
- Find a financial adviser you would trust with the key to your house.
- Work with your adviser to create a customized financial plan that meets your specific needs. That will determine your asset allocation. Make sure you have a diversified portfolio.
- Rebalance the allocation once or twice a year. Regularly skim off profits from the investments that have grown the most. Plunge these into an asset class that’s weak. That automatically ensure you “buy low and sell high.” It also protects you from losing too much when the crisis hits.
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Are We Headed for Another Great Depression?
Six Reasons Why 50 Percent of Americans Think Another Depression Is Likely
If the United States had an economic downturn on the scale of the Great Depression of 1929, your life would change dramatically. One out of every four people you know would lose their job. The unemployment rate would quintuple from around an average rate of 5 percent to 25 percent.
Economic output would plummet 25 percent. The gross domestic product would fall from near a $20 trillion level to near $14 trillion. Instead of inflation at about 2 percent, deflation would cause prices to drop. The Consumer Price Index fell 27 percent between November 1929 to March 1933, according to the Bureau of Labor Statistics. Trade wars caused international trade to shrink 65 percent.
Could it happen again? In a 2011 CNN poll, almost 50 percent of Americans believed it could. They thought it would happen within a year. Fortunately, they were wrong. However, many people are still worried about a depression reoccurring. Others are convinced we are already in a depression. They can’t see where the drive for growth will come from. What makes these Americans so worried?
First, almost 25 percent of the unemployed have been looking for work for six months or more. Hundreds of thousands of discouraged workers have given up looking for work, and are no longer counted in the unemployed numbers, which drives the labor force participation rate down. Not everyone has returned to the job market. Approximately five million people are working part-time because they can’t find a full-time job. This is all despite the fact that the unemployment rate is near the 4 percent natural rate of unemployment.
Stock Market Volatility
Second, volatility spooks investors when the Dow swings 400 points up or down a day. Stock market losses suffered during the 2008 stock market crash were devastating. The Dow dropped 53 percent from its high of 14,043 in October 2007 to 6,594.44 on March 5, 2009. It dropped 777 points during intra-day trading on September 29, 2008, its largest one-day drop ever. Investors who lost money are understandably still spooked by that experience. The Dow closing history shows the behavior of the stock market since the Great Depression.
Its fluctuations follow the phases of the business cycle.
In early 2016, stock prices plummeted. Investors lost trillions, and some countries went into recession. That followed losses in 2015 when almost 70 percent of all U.S. investors lost money. According to some, it was the worst year for stocks since 2008. Almost 1,000 hedge funds shut down, and junk bonds were crashing.
Five of the ten largest one-day point drops in the Dow have occurred in 2018. The largest ever one-day point drop in the history of the Dow occurred on February 5, when it dropped 1,175 points. This was followed closely by the second-largest ever drop on February 8, when it dropped 1,032 points. The three other massive one-day drops were 831 points on October 10, 724 points on March 22, and 665 points on February 2.
Oil prices have also been volatile. They rose to $50 a barrel after plummeting to a 13-year low of $26.55/barrel in January 2016. That was just 18 months after a high of $100.26/barrel in June 2014. Oil prices were pushed down by an increase in supply from U.S. shale oil producers and the strength of the U.S. dollar. Volatility makes people want to save, in case prices skyrocket again. The oil price forecast for the next 30 years reveals that oil prices could increase to over $200/barrel to meet demands from China and emerging markets.
The Financial Crisis of 2008
Third, the 2008 financial crisis weakened the economy’s structure. It faces future global stresses without its normal resilience.
The housing collapse was worse in the recession than the Great Depression. Prices fell 31.8 percent from their peak of $229,000 in June 2007 to $156,100 in February 2011. They fell 24 percent during the Depression. In the early stages of the recovery, foreclosures made up 30 percent of all home sales.
Many homeowners were upside down in their mortgages. They couldn’t sell their homes or refinance to take advantage of record-low interest rates. The housing collapse was caused by mortgage financing reliant upon mortgage-backed securities. After 2008, banks stopped purchasing them on the secondary market. As a result, 90 percent of all mortgages were guaranteed, Fannie Mae or Freddie Mac. The government took ownership, but banks still aren’t lending without Fannie or Freddie guarantees. In effect, the Federal government is still supporting the U.S. housing market.
A primer on the subprime mortgage crisis clarifies how rising interest rates triggered the crisis.
Business credit froze up. Demand for any asset-backed commercial paper disappeared. The panic over the value of these commercialized debt obligations led to the financial sector’s crisis, causing the intervention of the Federal Reserve and the Treasury. The governments of the world stepped in to provide all the liquidity for frozen credit markets. The U.S. debt was downgraded. Europe wasn’t much better. Even worse, all that addition to the money supply didn’t find its way into the regular economy.
Banks sat on cash, unwilling to lend. They paid back the $700 billion bailout.
Expansionary Monetary Policy and the Federal Reserve
Fourth, the Federal Reserve used up its usual expansionary monetary policy tools to fight the financial crisis. It ended quantitative easing, but that only means it isn’t adding to its bloated balance sheet. It keeps rolling over the $4 trillion in U.S. debt that it purchased for that program.
Fifth, the federal government is unlikely to come to the rescue with stimulus spending as it did in 2009. The nearly $22 trillion debt means that Congress would prefer to cut spending instead.
Six Reasons Why the Depression Could Reoccur
- Stock market crashes can cause depressions by wiping out investors’ life savings. If people have borrowed money to invest, then they will be forced to sell all they have to pay back the loans. Derivatives make any crash even worse through this leveraging. Crashes also make it difficult for companies to raise the needed funds to grow. Finally, a stock market crash can destroy the confidence required to get the economy going again.
- Lower housing prices and resultant foreclosures totaled at least $1 trillion in losses to banks, hedge funds, and other owners of subprime mortgages on the secondary market. Banks continue to hoard cash even though housing prices have increased. They are still digesting the losses from one million foreclosures.
- Business credit is needed for businesses so they can continue to run on a daily basis. Without credit, small businesses can’t grow, stifling the 65 percent of all new jobs that they provide.
- Bank near-failures frightened depositors into taking out their cash. Although the Federal Deposit Insurance Corporation insures these deposits, some became concerned that this agency would also run out of money. Commercial banks depend on consumer deposits to fund their day-to-day business, as well as make loans.
- High oil prices could return once U.S. shale producers are forced out of business. Millions of jobs were lost when oil prices plummeted. At the same time, many consumers bought new cars and SUVs when gas prices were low. They will be pinched when prices rise again.
- Deflation is an even bigger threat. Low oil and gas prices have had a deflationary impact, and so has a 25 percent increase in the U.S. dollar that depresses import prices. These deflationary pressures seem like a boon to consumers, but they make it difficult for businesses to raise wages. The result could be a downward spiral. That is similar to what happened during the Great Depression.
Six Reasons Why the Depression Won’t Reoccur
- Stock price declines haven’t exceeded 11 percent in one day or 30 percent in a year. The kick-off to the Depression was the Stock Market Crash of 1929. By the stock market’s close on Black Tuesday, the Dow had fallen 25 percent in just four days.
- Housing prices and foreclosures have recovered. Rental rates are relatively high, which has brought investors back to the housing market. Now that confidence has been restored, housing prices will continue to rise. The foreclosure pipeline, which once seemed endless, has disappeared.
- Business credit has been affected the most. The world’s central banks have pumped in much of the liquidity needed. In effect, they have replaced the financial system itself.
- Monetary policy is expansionary, unlike the contractionary monetary policies that caused the Great Depression. During the recession in the summer of 1929, the Fed decreased the money supply by 30 percent. It raised the fed funds rate to defend the value of the dollar. Without liquidity, banks collapsed, forcing people to remove all funds and stuff them under the mattress, causing economic collapse. The FDIC helps prevent bank runs by insuring deposits.
- Economic output fell 4 percent from its high of $14.4 trillion in the 2nd quarter of 2008 to its low of $13.9 trillion a year later. It fell a whopping 25 percent during the Depression. It has recovered to $18 trillion.
- There is a big difference between a recession and a depression. Even if another Great Recession does occur, it is unlikely to turn in a global depression.
There is a long-term threat that could cause another Great Depression. That is the worsening peril from climate change. In May 2018, Stanford University scientists calculated how much global warming would cost the world’s economy. If the world’s nations adhered to the Paris Climate Agreement, and temperatures only rose 2.5 percent, then the global gross domestic product would fall 15 percent. However, if nothing is done, temperatures will rise by 4 degrees Celsius by 2100. Global GDP would decline by more than 30 percent from 2010 levels, which would be worse than the Great Depression, where global trade fell 25 percent.
The only difference is that it would be permanent.
When the economy is uncertain, it’s time to get defensive. The only way to do that is to increase your income and reduce your spending. That way, you’ll have money to reduce your debt. Make sure you have a cushion, and then build up your savings. The best investment is still a diversified portfolio.
If possible, make sure you have a college degree. Education is the great divide in this society. The unemployment rate for college grads is half the average. Although housing is historically cheap, as are interest rates, only buy a house you can easily afford. The smaller the house, the less furniture you’ll have to buy to fill it. The economy is going to experience a lot of uncertainty due to climate change. The best way to prepare is to have enough resources to be flexible.
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