Watching and reading today's financial market reports of gyrating markets
and swooning prices can scare even the most determined investor. "Financial
Panics" have been around as long as there have been organized economies.
The terminology used to describe these periods of economic weakness and market
turmoil has changed over the years and helps us to understand the nature of the
economic cycle and policymakers' responses. Our current vocabulary vogue shows
the hopes of our time. "Soft Landing" and "slowdown" are
current in the halls of power. The not too hot and cold "Goldilocks
Economy" has powered the financial markets into their current frenzy. Did
anyone ever consider that a big bear scared poor Goldilocks out of her
post-porridge comfortable bed and made her run away in terror?
Up to the early 20th century, economic setbacks were known as "financial
panics". Booms ended with people stretched. Without central bankers to
rescue them from their inevitable excesses, commercial banks failed. These
shocks spread. More banks failed. Bank shareholders lost all their assets, as
their personal wealth backed their bank. "Financial panic" ensued as
people strived to save themselves, usually beggaring their neighbour in the
process.
Ken Follet's recent novel, A Dangerous
Fortune, is an excellent read and a lesson in the financial state of
this period. Interestingly, it is said to be based on the near collapse of
Barings Bank in this period, when some of their South American financings went
sour. This is the same Barings Bank that recently had to be rescued from
collapse due to a rogue trader Nick Leeson's huge derivative bets.
In the newly industrialized Western world of the late 1800s, the regular
occurring "financial panics" reflected the "credit cycle".
The "credit cycle" occurred when strong money growth, credit creation
and economic activity were inevitably followed by the bankruptcy of financial
institutions as lowered credit standards and asset-based lending took their
toll.
When national governments banned commercial banks from issuing their own
banknotes and assumed the responsibility for money creation, the more gentle
term "depression" was applied to the inevitable economic setbacks.
This in part reflected the regulators' urge for more stable financial markets.
The speculative credit bubble of the 1920s was followed by the great stock
market collapse of 1929. The resulting severity of the Great Depression of the
1930s removed whatever enthusiasm that remained for the term "depression".
The financial bureaucrats of recently created national monetary authorities,
armed with their "Keynesian" mandates to establish economic stability,
came up with "recession" as their attempt to take the sting out of
slowing economies and tighter credit. "Recession" is still our
euphemism of choice, although "soft-landing" seems to be gaining a
large fan club in the late 1990s.
A regulatory sign of our times?
Much of our current financial market regulation and monetary structure dates
back to the aftermath of the great Depression of the 1930s. Its severity led to
major rethinking of economic policy and the creation of national central banks.
Many of our current financial market regulations, insider trading legislation
for example, dates back to this period. It is interesting to note that some of
the financial regulation that was put into place after the great 1929 Crash is
being replaced today. The legislated separation of banks and investment banks
in the United States was put into place to prevent some of the problems that
caused the huge stock market debacle in 1929. Much of the devastation wreaked
on the markets in this period was a result of "margin lending" by
banks to investors which this legislated separation was meant to prevent. The "efficient
market" camp believes we're finally too financially sophisticated to need
this government meddling in the free market. The cynics believe we've let
enough time pass to forget our grandparents' lesson, which we will have to learn
ourselves. |
What of our current "feel-good" financial market vocabulary? Think
about "Goldilocks economy" or "soft landing". Why are all
sorts of salesmen from Bill Clinton and Alan Greenspan to your local mutual fund
guru chatting up "productivity" and "technological innovation"?
Demographics anyone?
There's nothing wrong with words, but when sugar-coating becomes the rule,
there's bound to be some sour medicine coming soon. Market timing is not ever
an easy thing to do but if words are an indication, make sure your portfolio has
the hatches battened down for some stormy weather ahead. If you have expensive
assets, employ substantial leverage or engage in speculative flings, you might
consider how you'll do in a not so rosy investment world. As always, consult
your professional advisers and know what you're investing in.
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