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by Valentino Piana (2015)



1. Summary features of this phase in the business cycle
2. Typical pathways in key economic areas
3. Key events
4. Winners and losers
5. Influence on election outcomes
  6. Potential countervailing developments  
  7. Transition to the next phase  

8. Empirical examples


Summary features of this phase in the business cycle

Deep crisis on multiple fronts: falling GDP, financial and fiscal crisis, credit crunch, value chains' disruption, loss of confidence and trust by domestic and international players.

Typical pathways in key economic areas

Domestic business dynamics

Payments delay and cancelation for delivered goods and services lead to a generalised lack of liquidity and of cashflow (including an effective devaluation of inventory values) and to chains of bankruptcy, with a growing burden of outstanding credits to banks, unpaid bills for utilities (leading to interrruption of electricity, gas, and other key inputs), and tax arrears. Mortality of firms widely overshadow the birth of new firms.

Entire sectors collapse, leaving open ways to foreign competitors and to unvoluntary nationalisation, where the state is called to pay for the debts.

Trust along the supply chains is at a minimum, with new customers asked for tight payment deadlines and quantity ceilings to avoid further problems. The credibility of accountancy is greatly reduced, because many variables are moving very quickly and liquidity flows are widely divergent from values in competence.

Financial markets

The stock exchange shrinks in values and quantity exchanged. It becomes a net destroyer of wealth, with one or more waves of "panic".

The banking sector, stressed by real and financial crisis, faces the dilemma of letting big banks go bankrupt, with current accounts cancelled (or insured up to a certain threshold by the government, which in turn boost the public debt) or allow unsolvable partners to continue business, with a rising systemic risk (their domestic counterparts will be seen with growing suspicion by foreign counterparts). A run to the bank, with people hecticly cashing out, adds further stresses.

Foreign trade

General distrust in the currency and the domestic banking sector lead wealthy people to move capital out of the country, with strong devaluation, if allowed by a floating exchange rate, or steep fall in reserves of foreign currencies at the central bank.

Foreign debt explodes, if it is denominated in foreign currencies.

Predatory foreign investors look for particulary depreciated assets and companies to buy for a fraction of their value in normal conditions.

Labour market

People employed in firms gone bankrupt lose job, wage and possibly cumulated savings and retirement benefits. Unemployment raise substantially and a fraction of the labour force is tempted to emigrate or change location to save on living costs. Large arrears in due wages drive household savings down. The increased risk of losing the job and the expected (much) lower wage in a new jobplace (if any) boost reasons for precautionary savings. In all this consumption shrinks, depressing domestic demand.

Public finance

Tax revenue is in free fall, both for the shrinking GDP and the reduction of tax base (due to the shift towards informality of companies, workers and transactions) as well as for tax arrears.

Successive waves of fiscal contraction and GDP falls make austerity attempts (to brake the growth of public deficit) self-defeating. The sustainability of public debt is considered demaged by domestic and international investors. In certain cases, a default of the sovereign debt occurs.

Key events

Negative suprises, below previous (already negative) expectations, are very common. Revision of GDP and public deficit estimates worsen what previously held. Famous brands close plants, well-respected institutions are abrupt discovered in their weaknesses.

Suicides of well-known investors and industrialists, possibly in connection with particular scandals add drama to a general picture that the media amplify and accelerate in speed and psychological impacts.

Winners and losers

Workers are the main losers, with falling expected and actual wages, work conditions and social protection. But also entrepreneurs believing in their product may well feel the pain of failure, due to the adverse conditions.

Speculators on fears and quick capital movement in and out the country and the informal economy can cumulate important wealth.

Influence on election outcomes

It's difficult that in depresson the economy is not at the centre of voters' information and decisionmaking. The confidence in government and even in the overall political system is shaken, with growing consensus for radical alternatives.

In turn, the establishment and many previous backers of the government strongly fear the arrival of such alternative forces to the power and their policies, which rebounds in further (but opposite) extremism.

In such heated political climate, specific events and developments near the election day can have a disproportionate impact.

Potential countervailing developments

Calm yet resolute leadership can provide rational and emotional stabilisation, representing a reference point for an exit strategy from the crisis.

The price deflation and depreciation of assets and products can attract buyers, while the social movements put in motion by the crisis can find suprising shining lights in the darkness.

Transition to the next phase

Feverishing negative development of depression can find a turning point as a trough due to strong policy measures, external reveral and political major novelties. Recovery will heal the wounded social texture.

In absence of such decisive steps, stagnation can keep the economy at the bottom, with eroding consensus to the institution and a potential revolution or other dramatic changes possibly involved. Statehood, country unity, and peace are in danger.

Empirical examples

* USA 1929: after several years of strong growth in the stock exchange, at least in part alimented by loans, the collapse of stock values, steep and protracted, destroyed wealth, led to unpaid loans and a chain of financial and industrial bankrupties. The weakest firms, the hypertrophic industrial empires, with "chinese boxes" as control shareholders, and a pile of debt, were the first to go under, but they pushed their business partners down as well. Firms in bankruptcy danger quickly liquidated inventories at the lowest possible price, undercutting normal prices for the other firms of the sector, which decreased production. Overall, manufacturing firms drastically cut employment. Sticking to its lassez-faire political credo, the govermnet did not take special steps and tried to balance the budget, adding a fiscal contraction to a monetary restriction, chosen by the central bank. The disastrous consequences of internal instability and compound erroneous policies were the deepest and longest depression, political polarisation, and protectionism.

* Germany 1931: The banking crisis exploded in a context where unemployment passed from less than 2 mln in 1929 to 4.5 mln in 1930 and 6 mln in 1932. The bankruptcy in 1931 of Credit Anstalt, the largest bank of Austria controlling directly or indirectly about 2/3 of the total industry of the country, gave the start to withdrawals of cash from the banks, including the most important Berlin "Grossenbanken". Trust in the country evaporated, with France imposing political requests in exchange for any financial help. The failure of Danat Bank in July, the second largest bank in Germany, provoked a further run to the banks: all institute of the countries closed for two weeks in a euphemistically called "bank holiday". The state founded a new "guarantee" bank to re-open credit among the banks and with the central bank, offered a guarantee to current account owners and began payments to those who had suffered losses from their bank's collapse. At the end of 1932, the state controlled more than half of the capital of the countries' bank, which in turn controlled a large part of the national economy. Controls on capital flows and on the freedom of press were established.


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