Financial Implosion

Readers Question: What do people mean by countries/society/financial implosion?

Financial implosion implies a serious financial crisis where a country experiences a severe economic and financial crisis. The concept of implosion suggests that a crisis in one part of the economy would have a knock on effects to other parts as well – leading to a significant decline in living standards and creating a serious of economic problems such as inflation, unemployment and rapid decline in living standards. A financial implosion could come in various forms. For example:

1. Sovereign debt crisis. If a countries government debt becomes unmanageable and the government are unable to pay back the debt, it would have to default on repayments or print money to pay back debt. If it defaulted on debt, investors would lose money and would be much more unwilling to hold onto future government bonds. If the government dealt with insolvency by printing money (e.g. Weimar Germany 1922), then it would create inflation and likely hyper-inflation. This would cause an effective default for those holding bonds.

Negative Impact of a Sovereign Debt Crisis

If a country experiences a sovereign debt crisis, it could have a serious knock-on effects for the rest of the economy.

  • Individuals and financial bodies who held bonds would see a fall in the value of their savings.
  • Hyperinflation – if the country responds by printing money. Hyperinflation would cause instability and wipe away people’s savings
  • Capital Flight. If a country is insolvent, there is likely to be capital flight away from the country. For example, foreign investors wouldn’t want to hold on to the countries bonds any more. Even domestic investors would fear losing the value of their money and make seek to save money abroad. Therefore, there could be a sharp fall in the exchange rate and a fall in living standards as imports become more expensive.
  • Austerity policies. As a consequence of a sovereign debt crisis, the government would be forced to cut government spending rapidly and or increase taxes. This would lead to unemployment and a fall in aggregate demand. Therefore, it could push the economy into recession – making the government’s budget position worse (due to falling tax revenues). To a large extent, Eurozone economies are facing this kind of deflationary debt spiral – efforts to slash budget deficits are causing a rapid fall in economic growth. In a country like Greece, there is a strong element of economic implosion – policies to deal with the crisis are only making it worse – it is hard to see a way out. (the tragedy of Greece)
  • If a sovereign debt crisis causes a recession, then you increase the risk of bank losses. IN a recession firms are likely to go bankrupt, this could lead to firms making a large loss, which could be felt by banks. If banks lose money, they may need a government bailout, but if the government is already insolvent then there is no-one to bailout the banks.
  • If banks go bankrupt (e.g US in the early 1930s) then people lose confidence in the banking system and may start to withdraw money from banks. This could cause a run on the banks and a dramatic decline in confidence in the financial system. If there isn’t a lender of last resort (e.g. US was slow to act in 1930s) – then you could see banks fail, people lose savings and lose confidence in the economy.

Causes of financial implosion

A Financial implosion could also come from other sources:

For example, in a very highly indebted country (both private and public sector) the economy may be vulnerable to a change in economic fortunes. For example, in 1929, the Wall Street boom in share values was partly financed by buying shares on the margin (buying shares on credit). When the stock market fell, many were left with huge losses. These huge losses caused panic throughout the financial system as banks and individuals were left with large losses. (See: Causes of wall street crash 1929)

Financial Implosion in the US?

A quick Google search for the term ‘financial implosion’ brings up quite a popular form of American website

Something along the lines of:

‘Prepare for the imminent US financial implosion’ – ‘Buy your solar generator now!  Invest in silver! ‘Hyperinflation and  great depression just around the corner!’

There were people saying this 20 years ago, and I’m sure there will be people warning of imminent financial implosion for the next 50 years.

When I look at the US economy, I don’t see an imminent financial implosion. Even if you look at one of the biggest financial implosions – The Wall Street crash of 1929 and consequent Great depression – the economy still recovered in time – Americans didn’t quite go back to living as cavemen. The great depression definitely contained an element of financial implosion, but the economic pain could have been significantly alleviated with better policies. I don’t see anything inevitable about financial implosion – unless there is persistence with the wrong and destructive economic policies.

I don’t accept the view that if debt is too high, this means the inevitable financial implosion of a country. The UK experienced no financial implosion with national debt of over 200% of GDP in the 1950s. I don’t see why there should be a financial implosion now, given government debt is heading towards 70% of GDP.

There may be a serious re-adjustment process, but there are many examples of countries who have come through the balance of payments crisis, sovereign debt default and hyperinflation and still managed to offer reasonable economic growth and living standards.

Economic Implosion in the Eurozone?

The situation for Eurozone economies like Greece is one of the worst combinations of policies, we’ve seen for a long time. The Greek economy is really a tragic situation with repeated declines in GDP and living standards as they grapple to deal with the seemingly impossible contradictions of being in the Eurozone, trying to solve insolvency and uncompetitiveness through intense austerity. Whilst Greece remains in the Eurozone and pursues the current policies, it is hard to see an end to the negative spiral of economic decline, rising unemployment and debt crisis. The Greek situation is made more difficult by the politics of remaining in the Euro. However, whether ‘implosion’ is the right word I don’t know. Eventually, there will be an end of sorts to the economic crisis. Economies are much more flexible and resilient than some pessimists might admit.


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