4 Shocks That Shook Economies

Shocks That Shook Economies

By: Devansh Gupta (SGGSCC)

Financial panics or crisis have been in existence since the dawn of humanity. Not only they have contributed towards causing tremendous terror for the systems of the economy, but also have caused people to question the viability of current financial systems. People who bet on the markets have been seen losing their entire money in a short span of time.

To give a brief idea, a financial crisis is the failure of financial systems, leading to economy slowdown, recession or even worse, depression. The constant pumping of a bubble leads to an eventual burst. Any segment of the economy can face this bubble burst, be it Currency or Debt or Real Estate. What comes next? No one knows.

These shocks range from being minor and hence recoverable, to being massive and more destructive. The latter entails a wider population of affected victims and is difficult to cope up from; difficult, but not impossible.

Causes

The causes and reasons for a financial crisis mainly include Debt (or Leverage), Future Uncertainty, Failure of regulatory measures and lastly, the market’s behavior.

Out of all the above mentioned the most potent is Future Uncertainty, which is a quite logical and indelible reason. It is a well-defined fact that the future is unpredictable and the risk involved is massive. The current situation that global economies are facing due to the spread of a contagion, perfectly describes the need to accept this fact.

Another major reason that is worth discussion is failure of regulatory measures. These are mainly institutional measures, which lie in the jurisdiction of the Government and other regulatory bodies. It has often happened that these institutions have themselves faced the plight of the crisis. Banks and lending institutions regularly face the risk of payment defaults, and when this repayment bubble pumps and explodes, it affects the parties seriously.

The History

If you look at the history of financial panics, you would be astounded to find that the first ever panic is believed to have taken place as back as during the 1630s. The Dutch population saw a speculative opportunity in the market when prices of exotic tulips surged. People spent a year’s income on rare tulip bulbs, in a hope to sell them on profit. And as it happens, the price bubble burst and it wreaked havoc on the Dutch economy. The consequences were such that merchants were washed off on the footpaths as beggars, and people were pushed back to their original, mundane life.

Even though many authors believe in the above anecdote, there are a few who say that the story has been falsified. What truly happened was a small spur of high-end people speculating in a niche of tulip market. But, till date no substantial proof exists.

The next recorded bubble was that of South Sea Bubble, in the 1720s. This is one of the earliest recorded modern crises, named after the company involved, South Sea Company, a British joint-stock company. The company had collaborated with the British government to reduce the cost of national debt. With rapid expansion, the company’s stock also surged and soon the bubble burst, leaving investors in the deep sea. Soon after, it was found that many government officials and the founders of the company were involved in malpractices like bribery and insider trading.

The Panic of 1819

The Panic of 1819 was the first widespread financial panic of the States. The crisis resulted in a collapse of the US economy, which persisted for a period of three years. The consequences led to it being named the First Great Depression. The main reason behind the crisis was global interdependencies. In the year 1815, France and Great Britain decided to end their warfare and signed a peace treaty. While the nations were indulged in war, the US had prospered. Both these nations needed industrial and agricultural goods to sustain the country during times of conflicts. The ending of the war meant that American goods were no longer in demand from Europe.

A part of the American population was left destitute, so much so that they could not even repay their loans. The Bank of the United States, as well as state and private banks, began recalling loans, demanding immediate payment and this resulted in the Banking Crisis of 1819, further fuelling the panic. People blamed open trade for the depression and opined that tariffs should be implemented on imports.

The then president, Monroe, resorted to monetary expansion. State banks suspended specie payments (redemption of paper money in bullion form) and issued large amounts of inconvertible notes.

The Great Depression of 1929

And now, let’s talk about the elephant in the room – the Great Depression; an event which left the global population stunned. These 43 months of crisis were obliterated anything and everything connected with the global economy.

During the “roaring twenties” – a period of high earnings from 1920-29 – every participant of the US economy was investing in the bourses. Be it janitors, sweepers, millionaires, housewives – everyone had poured their savings in the market. Simple economics played and the prices started to shoot, due to rapid inflation in demand – and almost all stocks became overvalued.

Fearful investors started selling off their holdings and the crash swept in. People lost more than they ever earned in their lives. The bloodshed in the markets caused devastation which spread throughout all countries. People lost jobs, companies lost capital wealth, and borrowers ended up in mega-debt.

Conclusion

A description of these events act as a reminder that catastrophes can swell up to cause global devastation. Our history is full of examples of financial panics – some problematic at a local level, others dangerously severe. The only way to tackle is planning in advance for such contingencies. The risk can obviously not be 100% predictable. But, risk-mitigating practices can, to some extent, help develop a shield to reduce the impact of the hit.

Holding people liable, and playing the blame-game would not lead us anywhere. What is required is to think collaboratively, for the prosperity of humanity.

1. wikipedia.org 2. thebalance.com 3. history.com 4. britannica.com

REFERENCES

Cryptocurrency: “Technological tour-de-force” or “Fraud, worse than tulip bombs”

By: Mansi Suhaney and Aman Arora (IMT Ghaziabad)

Evolution of Money : Barter, Beads, Bullion, Banknotes, Bitcoins

Blockchain : Basic Building Block of Crypto

Blockchain is a specific type of database which stores data in blocks that are chained together. It is a record of transactions, like a traditional ledger, which can be any movement of money, goods or secure data. This data is assigned an address—a string of data, publicly viewable on the blockchain. The owner of the data is given a private key, a hash of the address data. It stores information in a way that makes it virtually impossible to add, remove or change data without being detected by other users.

Key features Working of blockchain

Cryptocurrency

Cryptocurrency is a form of digital asset based on a network that is distributed across a large number of computers. This decentralized structure allows them to exist outside the control of authorities. Cryptocurrencies allow for secure online payments denominated in terms of virtual "tokens", represented by ledger entries internal to the system. It is secured by cryptography, making it nearly impossible to counterfeit/double-spend. Bitcoin is by far the most popular cryptocurrency, followed by Etherum, Litecoin, and Cardano. As on March 2021, the aggregate value of all the cryptocurrencies in existence was around $1.86 trillion—with bitcoin representing more than 60% of it*.

Key attributes

* Source : Coinmarketcap

No financial intermediaries required

Traditional vs Cryptomarkets

Particulars Traditional Markets

Market Hours Strict timings, banking holidays, pre and post market trading for professionals

Settlement Settlement takes place in central depository with varying settlement period creating an unnecessary counterparty risk Intermediaries Financial advisors, brokers / dealers, market makers, exchange, clearing houses

Crypto Markets

24 X 7, 365 days a year participation; Information can be priced in real time making the markets more efficient and liquid Settled by an exchange on its books or confirmed by the numbers of blocks on block-chain following the transaction

No reliance on intermediaries, settlement is done through the same venue on which the order was placed – centralized exchange, decentralized exchange, OTC desk

Order flow: traditional market Order flow: crypto market

* Source : Kraken Research

Advantages of Cryptocurrency

 Easy to use  No intermediaries required  Security  Minimal processing fees  Inflation resistant and protection against unlawful government seizures  Portable  Transparent

Drawbacks

 The semi-anonymous nature of transactions makes them well-suited for illegal activities  Rapid surges and collapses in value impacts its exchange rate with other currencies  While blockchains are highly secure, but other aspects of ecosystem, including exchanges and wallets, aren’t immune to hacking  Environmental concerns

Crypto Market : The Rise

Cryptomarket has been continuously outperforming other assets’ and indices’ returns. It has shown 1989% (c.21 times) increase in value from 2013 to 2017; whereas the growth has been 5890% (c.60 times) from 2017 to 2021.

Data as on April of respective year

Growth of crypto market Crypto Market - breakup

Particulars YTD May 2021 returns

Bitcoin 36% Ether 272% Dogecoin 7544% S&P 17% NASDAQ 6% Gold 0.2%

* Source : Coinmarketcap, HDFC Research

Crypto Market: The Fall

A speculative bubble: The fact there is a strong correlation between bitcoin prices and google searches indicates that it is perhaps more of a fad

* Source : HDFC Research

2017 boom and 2018 crash

After an unprecedented boom in 2017, bitcoin’s price fell by c.65% in January 2018. Subsequently, all other cryptocurrencies followed Bitcoin's crash. By September 2018, cryptocurrencies had collapsed 80% from their peak in January 2018, making the 2018 cryptocurrency crash worse than the Dot-com bubble's 78% collapse. By 26 November, Bitcoin also fell by over 80% from its peak, having lost almost one-third of its value in the previous week.

2021 boom and crash

In early 2021, Bitcoin's price witnessed another boom, soaring more than 700% since March 2020 and surged, above $40,000 in January 2021 and $50,000 in mid-Feb. On May 19th, Bitcoin tanked 30% to $31,000, Ethereum lost 40%, and Dogecoin was down 45%.

Coinmarketcap, HDFC Research

Elon Musk’s rol(ling) in Cryptocurrency: The Tweet and The Thwack

Bitcoin’s volatility fueled by Musk’s tweet

1. Musk announced in start of February 2021 that Tesla would invest $1.5 billion in bitcoin; the price of one bitcoin hit a first time high crossing $50,000 2. May 2021, Musk tweeted about bitcoin mining’s environmental cost due to computing power, and announced that Tesla would no longer accept payment in the currency; Bitcoin’s price crashed soon after to nearly $30,000, c.50% from its high of $64,800 in April, 2021 3. Musk took to Twitter to indicate his support to help miners make their processes greener. Following the tweets, Bitcoin jumped 19% to trade at $39,944, which had earlier slumped to nearly $30,000

Impact on Dogecoin’s price movement

1. On 8th May, Musk referred to Dogecoin as a "hustle“ resulting in slump in the price of Dogecoin from c.$0.75 to c,$0.45 (40% down) 2. Musk tweeted “Working with Doge to improve system transaction efficiency. Potentially promising,” on 14th May which caused the price of dogecoin to soar from about $0.43 to $0.52

~USD 780 bn has been wiped off the market capitalization of the entire crypto market from 17th May till 24th May 2021

* Source : Coindesk, HDFC Research, Coingecko

Cryptocurrency in India: Timelines and Guidelines

Currently in India, cryptocurrencies aren’t legal tender whereas cryptocurrency exchanges, while effectively legal, regulations for the same are being considered

 2008 : A paper titled ‘Bitcoin: A Peer to Peer Electronic Cash System’ was published by a pseudonymous developer by the name of Satoshi Nakamoto  2012 – 2016 : Cryptocurrencies steadily gain traction leading to rise in exchanges, including Zebpay, Coinsecure, Unocoin, Koinex and Pocket Bits  Feb 2017 : RBI Press Release states that virtual currencies aren’t backed by RBI and that their value isn’t underpinned by an asset, hence is speculative  Dec 2017 : The RBI and the Ministry of Finance issue compared cryptocurrencies to Ponzi schemes  April 2018 : The RBI issues a circular preventing commercial and cooperative banks from

“dealing or settling” in virtual currencies  March 2020 : The Supreme Court strikes down RBI’s banking ban on crypto, terming the

April’2018 circular unconstitutional citing lack of legal basis to impose restrictions at the moment  Jan 2021 : Government seeks to pass a bill which shall prohibit all private cryptocurrencies in India

Future scope – Marketmania or a New Asset Class for India

Volatility in prices, and government plans to prohibit private currencies, makes cryptos a bewildering asset

No income, utility or relationship with economic fundamentals of cryptos make it difficult for it to be considered a store of value

Multiple credible investors and institutions are engaging with crypto, which has cemented its position as an official asset class (most widely distributed asset in history except Dollar & Euro)

Easily stored and transported, unlike gold making it a valuable asset class Technically, cryptocurrencies are still trapped in a downtrend which began in mid-December amid increasing fears of a regulatory crackdown by governments. Though unlikely, this downtrend may come to an end if investor sentiments suddenly change in favour of cryptocurrencies again. The government has been giving conflicting signals on this. FM Nirmala Sitharaman, said that there won’t be a total ban on the use of cryptocurrencies in the country but the Centre soon plans to introduce the Cryptocurrency and Regulation of Official Digital Currency Bill, 2021, which is said to contain provisions completely banning the use of all cryptocurrencies.

Potential Usecases

 Smart contracts with IoT  Battling electoral fraud  Investment solutions  Medical records  Property records  AR experiences