Lessons from history

This has been a good decade neither for investors, nor government ministers. The years up to the financial crisis were full of optimism, as a new era of globalisation and world-linking supply chains promised turbo-charged economic growth for emerging markets, convergence between the rich and poor, and double-digit returns for investors in the Bric countries (Brazil, Russia, India and China).

Where are we now?

The banking collapse of 2007-2008 turned that prediction on its head. Since then, trade volumes have stagnated, and emerging markets are now growing by less than half their earlier rates. Brazil is a political and economic basket case, China is attempting to outrun its debts, but with no certainty that it will succeed, Russia is becoming a poor man’s version of the Soviet Union, and India remains, as ever, full of promise, but short on delivery.

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Meanwhile, the west has become prey to political populism as mainstream politicians baulk at the electoral cost of the supply-side reforms required. Despite the efforts of the European Central Bank (ECB), the eurozone remains embedded in deflation, while the US is growing at less than half of its potential.

It is no surprise then that electorates are angry and turning to Donald Trump, Marine Le Pen and even more extreme views – both on the left and right wings – for nationalist and autarkic solutions.

Part of capitalism

For good or ill, these crises are part of capitalism, and happily for investors, this year the analysts of stock markets from the London Business School have chosen to examine (in the Credit Suisse Global Investment Returns Yearbook 2016) the experience of investors after three such events.

These were the truly international banking disasters – the 1890 Baring and Latin American debt crisis and banking panic; the 1930s and the Great Depression; and 2008 and the Lehman Brothers shock, together with the European sovereign debt crisis and, of course, the ongoing Great Recession.

The economy today

Historical comparisons need to recognise changes in reality and, as the authors say, today’s economy is very different from that of a century ago. Servicing is now bigger than manufacturing, governments are far more intrusive with the gold standard just a mere memory, and fiscal and monetary policies are expected to be able to respond to economic shocks.

So although the world economy is now more stable and robust, the actual comparisons show similar falls in employment, industrial production, corporate profits and bank lending.

The world’s response this time around leaned heavily on avoiding the mistakes of the 1930s. Fiscal policy was eased everywhere, and monetary policy concentrated on avoiding further banking failures and an even worse contraction of credit.

This worked but, as the authors say, the risk is to underestimate the power of the deflationary dynamic that was unleashed by the crisis, which is exactly what happened in the 1930s.

Europe is particularly at risk since eurozone rules have much in common with the gold standard, but with no possibility of resignation.

The more successful economies of the 1930s were those that left the gold standard early, while, this time around, the Mediterranean periphery of the eurozone suffered years of GDP decline before the ECB was willing to ease policy to offset these deflationary effects.