What can we learn from the economic crisis?

We launch a new column called “Improving financial literacy”, which will immerse you in the nuances of the global economic environment. Knowing the market helps you feel more confident in making effective investment decisions and estimated predictions. Today we will start with market crises, which can be tough, but very important lessons.

First oil shock (1970-1973)

It all started with the increase in US military spending from 1965 to 1970. Inflation grew by 3.5 times, while the national debt and the economic slowdown intensified the general distrust of the dollar. Leading countries began to actively exchange it for gold. As a result, in 1971 US President Richard Nixon was forced to announce the abolition of the gold standard.

And in 1973, the Organization of the Petroleum Exporting Countries (OPEC) for the first time imposed an oil embargo on the United States and its allies. This pulled the growth of average annual oil prices - from $2.7 to $11 per barrel.

As a result, after the end of the Bretton Woods system, the dollar began a rapid correction - the market considered it expensive. After the embargo, OPEC raised oil prices to compensate for their lost income, which they received in dollars. These events marked the end of a golden age of global economic growth and the beginning of the struggle for fully self-sufficient energy production.

Second oil shock (1980-1983)

The trigger for the new crisis was once again oil, but this time the one from Iran. After the Islamic revolution, repressions rolled across the country: Iran simply had no time for oil, and its production and export fell sharply.

OPEC oil prices skyrocketed again, from $12.8 per barrel in 1978 to $35.5 in 1980. Then the United States announced a reduction in trade relations with Iran and at the same time stopped government regulation of import oil prices. This decision caused a panic on the stock exchange and a serious increase in gasoline prices in the United States. As a result, inflation has grown all over the world from 12% to 18%.

The decline in global production was smaller than the previous time. In OECD countries, for example, it was only 4% in 1982 compared to 1979. However, the fall phase itself took as much as 20 months. Production capacities were underutilized, which caused a sharp surge in unemployment in the capitalist world.

Third oil shock (1990-1992)

The next macroeconomic collapse in 1990 was again based on wars and oil. As a result of Iraq's invasion of Kuwait, the loss of oil supplies from both countries and the reduction in production in Saudi Arabia, the world price of "black gold" increased from $14 per barrel in 1988 to $46 in October 1990.

Rapid US intervention and subsequent military success helped reduce the potential risk to future supplies (at this time the US was still dependent on Middle Eastern oil). Nine months after the start of the conflict, the jump in prices was largely leveled.

As a result, however, world inflation increased from 6% in 1988 to 8% in 1991. Unemployment also rose to 4.8%. At the same time, again, both the United States and their partners saw no point in raising key rates to control inflation and oil prices. They were confident  in the future success of Desert Storm to protect large oil production facilities and also wanted to maintain trust for the economic policies created in the 1980s.

Dot-com boom and fourth oil shock (2000-2003)

This time the cause of the crisis was the so-called dot-coms (from .com). The events began to unfold as early as 1995 during the rapid economic growth in the United States under the presidency of Bill Clinton, which was driven by successful management. Relative control over oil prices was achieved, the social security system and taxation were reformed, investment in IT increased, etc.

All these factors together created favorable conditions for innovative activity both within the country and abroad. Technology companies have been attracting more and more funds, steadily increasing their market capitalization. The demand for the shares of such companies was enormous.

At the same time, however, few managers had any idea how to effectively lead the new business model. The money received from investors was often put not in expansion and sustainability, but in servicing loans and aggressive marketing.

As a result of reckless investment, the NASDAQ Composite rose an incredible 1100% between 1995 and 2001. Due to intense competition, many Internet companies stopped paying their obligations, declaring themselves bankrupt and appropriating investor funds.

This crisis forced investors to forget about their activities for a long time. In total, they lost about $ 5 trillion of investments - both in the United States and in Europe, and even in Asia. Many remained in debt.

US mortgage crisis and fifth oil shock (2007-2011)

The most severe and large-scale crisis of the 21st century was initiated by fraud with securities in the real estate market. Due to the low key rate and the current cycle of economic growth, it was very profitable to take out a mortgage in the US. Banks issued themi literally to everyone, even to those who, with 100% probability, would not pay them on time. Lenders understood that they would not receive the money back, but they hedged with the help of debt bonds - CDO (Collateralized Debt Obligations).

Due to the specifics of the tool, it was possible to create a “CDO waterfall”, which was actively used by investment banks. According to various estimates, the volume of trade in such securities in 2008 reached $85 trillion. Moreover, the rating agencies deliberately assigned the maximum ratings to CDOs in order to accelerate their prices, despite the fact that the quality of the securities was actually extremely low.

For example, a CDO bought by a German entity could contain a CDO that had previously been purchased by a Chinese broker, which in turn was a pure CDO on France's debt to a US construction company. The cost and number of such "webs" grew exponentially. It culminated in the leaked data on colossal arrears of debtors to banks, as well as the reverse assignment of a real rating to such products.

After that, an incredible turmoil began in the markets. Most companies tried to sell previously purchased CDOs, but didn’t manage to because there was no demand. This led to a collapse in stock and real estate prices, as well as the bankruptcy of the largest US financial conglomerates.

The crisis pulled other industries, in particular, the oil industry. Oil prices fell from a record $147 in July to $36 in December 2008 (-75%). World GDP from 2008 to 2009 declined by more than 5%.

Political crisis and sixth oil shock (2014-2016)

Oil entered the recovery phase. About a year later it was already worth $75-80, and by the beginning of 2011 it had once again overcome the mark of $100 per barrel. In the five years since 2009, the global economy grew by almost a third. Inflation decreased, stock indexes were growing from year to year, oil production increased.

In 2013, completely dependent on oil from OPEC and Russia, the US discovered a new shale oil and natural gas field in North Dakota. Moreover, it allowed launching production in a very short time. The situation was aggravated by the fact that another oil shelf was discovered in Texas, three times larger, with a potential production of 9 million barrels per day (almost a third of the actual OPEC production). Fearing to lose the market, OPEC leader Saudi Arabia  gradually began to reduce the price of its oil against the background of increasing production in the United States.

At the same time, a drastic change of government took place in Ukraine. It resulted in Russia's maneuvers with Crimea, which leaders of developed countries did not appreciate. Russia, as a major oil exporter, was invited to OPEC, which compromised the trust of the capitalist countries  to the organization.

The price of "black gold" fell because of the fear of a new oil war - this time from $115 in June 2014 to $32 in December 2016. However, the US oil production capacity could not meet the current global demand for oil, which simply forced the world community to temporarily improve international relations.

What is it that all these crises share?

As you can see, one of the main factors in the emergence of global crises is the high price of oil, which is called “black gold” for a reason. Still, we live in the world of internal combustion engines, which are in dire need of petroleum products.

On a global scale, the United States (294 million tons / 2021), China (557 million), India (204 million) and Europe (476 million) are the main consumers of oil, in total taking more than 70% of world oil imports. However, now the United States is gradually becoming an oil exporter, coming after Saudi Arabia, Russia and Iraq.

After World War II, the United States became the world's energy-hungry economic leader, which meant both price regulation and a direct increase in its share of the oil market. But at the same time, more than 70% of oil is controlled by the countries of the OPEC cartel, whose interests do not quite coincide with the birthplace of capitalism, which causes a lot of negative consequences for the world economy. 

The result of such a political confrontation is the formation of economic cycles in which the oil market plays one of the key roles. The Soviet economist Nikolai Kondratyev had found out and proved that in the long term, economic indicators show a certain cyclicality: growth phases are replaced by recessions, with a certain period and amplitude of long-term fluctuations. 

In our case, the characteristic length of the identified oil “supercycle” is approximately 25 years. Many modern analysts predict the formation of a new “super cycle” already in this decade, which is quite well connected with our conclusions.

What is the use of all this for an ordinary investor? 

First, understanding the cyclical nature of the economy makes it possible to determine the stages (fall/crisis, stagnation/depression, recovery or growth) of economic development  in advance.

Secondly, knowing the causes and consequences of crisis conditions will allow you to predict the actions of professional participants and market regulators, which, in turn, can reduce the risk of losing your funds. 

Thirdly, although historical retrospective does not guarantee 100% repetition in the future, all this will give you a general idea of ​​the cause-and-effect relationships between key events on the world stage.

Robocash d.o.o (“Robocash”) is a company registered in the Republic of Croatia under registration No. 081224371, with legal address at Petračiceva 4, Zagreb, Croatia, 10110.

Robocash is not regulated under any financial services license. When you invest on Robocash, you buy claim rights for loan receivables and investments in loan receivables are subject to risks. We advise diversifying investments and carefully evaluating the risks.