The Next Financial Meltdown: A Hypothetical Timeline Rooted in Historical Precedents

Introduction

The global financial system is a complex web of interconnected markets, institutions, and regulations. While it has been designed to be robust, history has shown that it is susceptible to meltdowns. The Great Depression of the 1930s, the 2008 Global Financial Crisis, and even the fall of the Roman Empire offer valuable lessons on the vulnerabilities inherent in many financial systems. This article aims to explore how the next financial meltdown could potentially occur, drawing parallels from historical events and detailing a hypothetical timeline.

Please note that not every economic situation is the same and many previous instances, while similar in effect, may have nuances that differentiate it from any other. This is just one reason why predicting any market performance, outcome or future valuation is fraught with errors and very few experts can prognosticate the future correctly. 

Historical References

The Great Depression (1929)

The Great Depression began in August 1929, when the economic expansion of the Roaring Twenties came to an end. A series of financial crises punctuated the contraction. These crises included a stock market crash in October of 1929, a series of regional banking panics in 1930 and 1931, and a series of national and international financial crises from 1931 through 1933. The downturn hit bottom in March 1933, when the commercial banking system collapsed and President Roosevelt declared a national banking holiday.

Sweeping reforms of the financial system accompanied the economic recovery, which was interrupted by a double-dip recession in 1937. Unfortunately, it took many years to return to full output and employment which was precipitated with the United States entering the Second World War. In hindsight, we know the Great Depression was triggered by numerous events leading up to the Crash of 1929, where stock prices plummeted on Wall Street over a period of several days. Many banks had invested heavily in the stock market and now faced insolvency, leading to a cascade of bank failures. The Federal Reserve’s decision to raise interest rates in an attempt to curb the speculation only led to decreased liquidity, crippling the fragile U.S. economy even further (Bernanke, 2000).

The 2007-2008 Global Financial Crisis

The 2007-2008 crisis was a result of excessive risk-taking by global banks and the bursting of the United States housing bubble. Deregulation led to risky investments in mortgage-backed securities, and, when the bubble burst, financial institutions worldwide suffered severe losses, reaching a climax with the bankruptcy of Lehman Brothers and many other venerable institutions. (Reinhart & Rogoff, 2009).

The Global Financial Crisis (GFC) was the most severe worldwide economic crisis since the Great Depression of 1929, according to Wikipedia. Predatory lending targeting low-income homebuyers, excessive risk-taking by global financial institutions, and the bursting of the United States housing bubble culminated in a “perfect storm”.

The preconditioning for the financial crisis was complex and multi-causal. Almost two decades prior, the U.S. Congress had passed legislation encouraging financing for affordable housing. However, in 1999, parts of the Glass-Steagall legislation, which had been adopted in 1933, were repealed, permitting financial institutions to commingle their commercial (risk-averse) and proprietary trading (risk-taking) operations. Arguably the largest contributor to the conditions necessary for financial collapse was the rapid development in predatory financial products such as “no doc loans” and removing the standard 20% down payment which targeted low-income, low-information homebuyers who largely belonged to racial minorities. This market development went unattended by regulators and thus caught the U.S. government by surprise.

After the onset of the crisis, governments deployed massive bailouts of financial institutions and other palliative monetary and fiscal policies to prevent a collapse of the global financial system. In the U.S., the October 3, $800 billion Emergency Economic Stabilization Act of 2008 failed to slow the economic free-fall, but the similarly sized American Recovery and Reinvestment Act of 2009, which included a substantial payroll tax credit, saw economic indicators reverse and stabilize less than a month after its February 17 enactment. The crisis sparked the Great Recession which resulted in increases in unemployment and suicide, and decreases in institutional trust and even fertility, among other metrics. The recession was a significant precondition for the European debt crisis.

In 2010, the Dodd–Frank Wall Street Reform and Consumer Protection Act was enacted in the U.S. as a response to the crisis to “promote the financial stability of the United States”. The Basel III capital and liquidity standards were also adopted by countries around the world.

The Fall of the Roman Empire

The Roman Empire’s fall was a complex event that occurred over a 300-year period. Following hundreds of years of growth, military conquests, and global domination, the decline was influenced by increasing military failures, economic difficulties, and social unrest. Devaluation of the Roman currency (similar to what we have seen in the US over the last few decades), excessive taxation, and continued inflation led to economic instability, which contributed to its downfall according to Joseph Tainter in his “Collapse of Complex Societies” (Tainter, 1988).

Similarities Over the Past 10 Years

Rising Debt Levels

Both public and private debt have been rising globally, like the conditions before the 2008 crisis. According to the International Monetary Fund (IMF), global debt reached an all-time high of $188 trillion in 2019, which is about 230% of world GDP. This represents an unsustainable amount of debt in almost any society, whether historical or modern.

Asset Bubbles

The stock market and real estate sectors are also showing signs of overvaluation, reminiscent of the dot-com bubble in 1999 and the housing bubble in 2007. The S&P 500’s Price-to-earnings P/E ratio has been consistently above its historical average, indicating potential overvaluation.

Political Instability

The rise of populism and protectionism threatens global trade, like the isolationist policies during the Great Depression. Brexit and the U.S. – China trade war are prime examples of how political instability can have economic repercussions. The difficulties we see currently in our own government and political system and the inability for Congress to reach bipartisan approval on almost any topic, lead many to believe we are headed in the wrong direction.

Deregulation

There has been a push for deregulation again in the financial sector, which increases the risk of irresponsible lending and investment practices. Unfortunately, in this author’s opinion, the greed exhibited by many in the financial marketplace again outweighs the common sense we all should have when it comes to financial stability and growth. The repeal of the Glass-Steagall Act in the U.S. is often cited as a precursor to the 2008 crisis.

Hypothetical Timeline of the Next Financial Meltdown

Phase 1: The Trigger (Year 1)

Stock Market Crash

A sudden crash in the stock market, triggered by some esoteric geopolitical tensions or even a natural disaster, can lead to panic selling. The Dow Jones Industrial Average could drop by 30-40% within a week, wiping out trillions in market value and faith in our financial system. Soup kitchens and bread lines return, reminiscent of the 1930’s depression. Major cosmopolitan areas and overpopulated cities are hit the hardest with many individuals unable to afford mortgage payments and employment opportunities are limited.

Phase 2: The Domino Effect (Year 1-2)

Bank Failures

Due to the lack of liquidity, loan defaults and “bank runs” by individuals, many smaller banks and financial institutions are forced to declare bankruptcy, leading to a crisis of confidence in the banking sector. Depositors rush to withdraw their savings, causing a major liquidity crisis.

Credit Crunch

Interbank lending comes to a halt as trust between financial institutions erodes. Central banks intervene by injecting liquidity, but it’s not enough to prevent a burgeoning credit crunch.

Phase 3: Global Contagion (Year 2-3)

International Impact

European and Asian markets, already weakened by their own internal issues such as Brexit and the U.S. – China trade war, are severely affected. Major European banks report significant losses, and the Eurozone enters a recession. While war is still considered good business by many, the lack of liquidity has dried up the “free money” and many countries willingness to foot the bill for arms and ammunition in the name of freedom and democracy.

Currency Devaluation

Countries begin to devalue their currencies to boost exports, leading to a currency war. This exacerbates inflation and further destabilizes the global economy. The barter system returns with a vengeance, further weakening fungible currencies. This in turn makes living in urban environments and not having goods or services to trade even more challenging for the masses.

Phase 4: Government Intervention (Year 3-4)

Interest Rate Hikes

Central banks around the world, including the American FED, hike interest rates to combat inflation. This further strains liquidity and leads to a decline in consumer spending and business investment.

Bailouts and Stimulus Packages

Governments introduce stimulus packages to revive the economy, but with limited success. The U.S. Congress passes a $5 trillion stimulus package, but it fails to prevent a deep recession. 

Phase 5: Social and Political Fallout (Year 4-5)

Unemployment

Joblessness reaches an all-time high, leading to social unrest. Protests and strikes become commonplace, further destabilizing the political landscape.

Political Upheaval

Governments are overthrown or voted out, and extremist parties gain power, advocating for isolationist policies. This leads to a breakdown in international relations and further economic decline.

Lessons from the Roman Empire

The Roman Empire’s fall teaches us that financial meltdowns are often the result of a combination of economic, social, and political factors. Excessive debt, currency devaluation, and political instability were as relevant then as they are today. The Roman Empire also faced a loss of traditional values and social cohesion, which contributed to its decline (Heather, 2005).

Conclusion

While this treatise represents a worst-case example of what could potentially happen, it is impossible to predict the exact circumstances that will lead to the next financial meltdown. Looking back, studying, and understanding the historical precedents offers valuable insights if one is willing to learn from history and other’s missteps. The hypothetical timeline serves as a cautionary tale, emphasizing the need for prudent planning, conservative fiscal management, both at the individual, community association, and governmental levels. I like to remind people to “cover your assets.” 

References

Bernanke, B. S. (2000). Essays on the Great Depression. Princeton University Press.

Reinhart, C. M., & Rogoff, K. S. (2009). This Time is Different: Eight Centuries of Financial Folly. Princeton University Press.

Tainter, J. A. (1988). The Collapse of Complex Societies. Cambridge University Press.

https://en.wikipedia.org/wiki/Fall_of_the_Western_Roman_Empire

“The Fall of the Roman Empire: A New History of Rome and the Barbarians.” Peter Heather, Oxford University Press, 2005.

“Federal Reserve History: The Great Depression.” Federal Reserve History