History of Panics – The force of Creative Destruction

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The History of Financial Panics

By Martin A. Armstrong


Throughout time, the economy of mankind has swung back and forth between some fantastic periods of prosperity and deep dark depressions. It is our failure to understand this mechanism that often drives the politics of the world also between two extremes of totalitarian regimes and communism to periods of enlightenment and republics or democracy. What is most misunderstood is that the economic swings between two extremes is the source of how society progresses forward – its typically two steps forward and one backward.

When beginning my research I cam across a listing of financial panics at the library on campus at Princeton University published before the Great Depression. The list at first did not appear to have regularity to it, yet it covered a period of 224 years. Dividing the number of events (26) into the total duration provided a simple calculation to determine the average. It produced the number to be precisely 8.6153846615.

LlSTING OF YEARS IN WHICH PANIC STRUCK

 

 

 

1683
1711

1720

1731

1745

1763 1772

1783

1792

1814

1818

1825

1857

1866 1869

1871

1872

1873

1884

1890

1893 1895

1896

1899

1901

1903

1907

This listing of panic was international and not limited to just the United States. However, it was just the beginning of a journey that would reveal how everything actually functions and panics are the force of creative destruction. Just like every child must learn that fire burns on their  own sticking their finger into the flame, each generation must likewise learn and from the ashes rises always some solution that ultimately becomes the cause of the next economic crisis. It is a perpetual cycle that move society forward.

CW-FORCE

Going into 1929, the civil work force was composed of about 40% agrarian workers. Two things took place to force a wave of Creative Destruction. First, the invention of the combustion engine created tractors displacing workers. One man could now plow a field instead of 20 or 30. Secondly, the Dust Bowl came during the Great Depression. This is what sent the unemployment rate to 25%. They were unskilled labor and the collapse forced these people to learn skills completing the Industrial Revolution. The Panic of 1907 was the final era of the Railroad. For the boom into 1929, the markets were lead primarily by the auto industry. Thus, the Great Depression transformed the United States into a new Industrial Nation and this is the force of Creative Destruction. We are witnessing this again today with the development of the Internet and how it has been changing everything from book publishing, newspapers, magazines, and expan ding the age of mail-order.

By 1980, agricultural employment had fallen to merely 3% of the total civil work force as innovation brought higher productivity and machines to the farmland in America. It was the Panic of 1907 that lead to the creation of the Federal Reserve and a central banking system in the wake a massive bank failures due to cash drains that headed west to settle insurance claims. Senate investigations lead to a better understanding of regional disparities within any economy and thus a 12 branch Federal Reserves system was established to smooth the regional cash flows problems that resulted in temporary shortages of cash causing bank failures.

OilRig

The forces of Creative Destruction came into play also during the 1970s instigated by OPEC, which forced crude oil prices sharply higher. This dramatic shock in rising oil prices filtered through the economy creating STAGFLATION where prices were rising, however, NOT because of a demand lead boom, but because of a supply side rise in prices squeezing economic growth. Thus, we saw STAGFLATION, which was rising prices with declining economic growth. This was illustrated by the collapse in gold prices by 50% between 1974 and 1976 commingled with a steep recession and a 40% decline in the stock market. Former Federal Reserve Chairman Paul Volcker delivered his lecture calling it the Rediscovery of the Business Cycle – meaning man cannot control the business cycle and all the theories fell to dust.

 

Each and every Panic in history has created some innovation within the economy as well as the political world. It is never all bad. It is a process of two steps forward and one back. Sometimes it is the complete collapse into a Dark Age as with the fall of Rome. Those types of events may occur more at the 1850 year level of measurement.

Smith-MarxThose who believe that we must eliminate all economic downturns such as the socialists who follow the teachings of Karl Marx, fail to understand that such downturns are the very engine of progress – the force of Creative Destruction. This battle between the free markets (economic freedom) discovered by Adam Smith and articulated with the concept of the Invisible Hand, has led to more strife and death than any other contest in human history. Even the Ten Commandments state that the Socialists violate the laws of God by coveting the goods of anyone who has more than they do.

Flat-LineResisting-ChangeTrying to create utopia runs the risk of reducing innovation and progress within society as a whole. There is a cycle to everything and this is simply how the world and everything in it functions from our brain waves, weather, to a woman’s menstrual cycle. You cannot eliminate  the business cycle and panics are a part of nature. Indeed, human nature is simply content to keep things as they are as long as life is good. Only when the economy declines do we find society demanding change, which in turn sparks innovation and progress. Change is the most fear aspect of life for the majority. This is why panic even take place. The majority of people find comfort only with the crowd.

traders-cartoon

Stanley Milgram’s book, Obedience to Authority, demonstrated our hard-wired human nature. Milgram even experimented placing one person on the street staring into the sky at nothing. People thought he was crazy and passed him by. Take 5 people out there staring at nothing in the sky and a crowd will form to look at whatever it is they are observing. The majority of people take comfort in doing as the rest of society does. Then when they are wrong, they all panic.

It is vital that we understand this natural mechanism that drives the economy of society irrespective of the culture for the common denominator is humanity. We must avoid at all costs attempts to create perpetual ideas of utopia for it is as unattainable as the quest to end the aging process. Panics are part of nature and are an important component of the economy driving what is more commonly referred to as the business cycle through these waves of Creative Destruction.

We must realize that recessions and depressions are NOT some disease that can be eradicated by another new law. Like viruses that mutate to defeat man’s latest antibiotics, the economy is always evolving in its own strange way. Labour unions try to prevent evolution most often by opposing innovation that would result in what they see as a loss of jobs. However, what labour fails to understand is that it cannot stand in the way of progress and innovation. The shipping unions of New York City tried to ban container shipping because it took fewer workers to unload the cargo. The end result: ports emerged in New Jersey and elsewhere and NY ports are no more. Labour must understand that it cannot oppose innovation. Labor must embrace the economic evolution and keep pace with technology to maintain its value. Failure to adapt will only result in those unable to change becoming unemployable.

The ultimate survival of the individual within the economy depends upon his willingness to increase his personal knowledge and skills. Like an old car, labour’s value depreciates within the economy whenever it remains stagnant. Jobs that are mainly physical labour are the most vulnerable to progress and the first to suffer.

There have been numerous panics since the dawn of organized economic activity. Even though we pride ourselves as being the most intelligent species on this planet, the scope of our knowledge as a society leaves a lot to be desired. Merely reviewing the financial panics in history lends credence to the old adage that history repeats. But this same adage can also be restated as “man never learns from his past mistakes.”

In the heat of panic, society seeks the cause. We try to reduce everything to a single one-line explanation so we can quickly pass a new law to eradicate this experience from posterity. But as time moves onward, the next boom always comes to an end followed by yet another financial panic. Although the degree of such panics differs from time to time, as is the case with all boom periods, the root causes are merely a minor variation of a standard set of circumstances. The particular focus might also shift from real estate on one panic to stocks or commodities on the next. It will even shift on a global basis depending upon where capital has concentrated, such as the case in Japan in 1989, the US in 1987 or gold in 1980.

To understand the nature of panics requires a global and broad perspective. It is a common threat which runs through each panic and its cause is simply due to an over-concentration of capital into one sector or one nation that leads to an over-valuation. The study offered here takes that view and in the conclusion we hope that you see the common threat which ties all such panics together as a natural occurrence which mankind must come to respect as a law of economics.