What is Economic Collapse?
An economic collapse is a severe contraction in the economy led by an extraordinary event, financial or structural, which is not part of a normal economic cycle, requiring intervention by the government or the monetary authorities and leading to a contraction in growth, rise in unemployment and sometimes social unrests too.
Top 4 Reasons for Economic Collapse
Economic collapse can happen due to a wide variety of reasons including the ones mentioned below. Every collapse is different and led by entirely different circumstances.
#1 – Widespread Defaults
Economic collapse can start from or lead to a default by over-leveraged entities. Sometimes it can also lead to a default on debt obligations of the government. Widespread defaults trigger a loop wherein businesses go bust and default on the bank and other borrowings, leading to banks losing their money and freezing credit, which further leads to the liquidity crisis in the economy leading to other businesses also defaulting. several governments sometimes close banks during an economic collapse.
#2 – Wars/Civil Unrests
Big wars/civil unrests result in the total collapse of economies as they drain the resources (financial, human and physical) towards infighting. The biggest wars in history have led to many economies going bankrupt and defaulting on their obligations. It becomes hard for the government to increase revenue and sometimes the governments resort to printing money, which causes hyperinflation.
#3 – Hyperinflation
Hyperinflation or accelerated inflation quickly erodes the value of a currency leading to citizens not being able to afford basic goods and services in the normal course. The currency loses value and people run towards safer foreign currencies to preserve the value of money. The economy comes to a standstill and it takes a heavy foreign intervention to put the economy back on track.
#4 – Price Crashes
It happens when a country is heavily dependent on the export of one commodity as a major source of revenue. High dependence on one commodity leads to a decline in revenue for the government if the price of the commodity crashes. The problem aggravates if the government is the largest producer of the commodity. State’s revenue crashes, leading to wage cuts and spending cuts, which leads to further economic contraction and collapse.
Real-World Examples of Economic Collapse
Let’s discuss examples of economic collapse.
The Russian financial crisis of 1998 and the argentine economic crisis are the two real-world examples of economic collapse. The Russian crisis was caused by low oil prices and expenditure cuts by the government after the end of the cold war. The country defaulted on government bonds which led to the collapse of Long Term Capital Management (LTCM) as it spread panic in the debt markets. LTCM was saved by a private bailout arranged by the U.S. Federal Reserve and dissolved in the year 2000.
The Argentine economic crisis happened after the Russian crisis bringing the Argentine economy down 28% in three years. It was characterized by riots, rising unemployment, default by the government, a rise of alternative currencies and end of peso’s fixed rate to the US Dollar. The president of the country eventually fled the country. The economy was later stabilized by a slew of measures taken by the new government.
Difference between Economic Collapse and Recession
Let’s now look at the difference between economic collapse and recession.
A recession is a temporary decline in growth and an increase in unemployment of economies which is corrected by minimal interventions by the federal or the monetary authorities. While it is the total derailing of the economy that happens due to extraordinary factors that are many times beyond the control of the government.
An economic collapse generally takes drastic measures to correct itself. it may include overthrowing the current government, forming of new legislation, write-off of debts, curbing bank withdrawals and in extreme situations civil and social unrest. It is generally characterized by a severe decline in economic activity (sometimes more than 25%).
Effects of Economic Collapse
The following are the effects of economic collapse.
- It severely disrupts the normal course of business and results in huge unemployment and poverty.
- In the event of wars, there is a heavy loss of life and property.
- Economic collapse results in capital destruction as the governments too can default on their debt obligations when that happens.
- The supply of basic goods like food and fuel and services like healthcare and electricity are significantly disrupted leading to a collapse of normal life.
- There are major overhauls in governance and regulatory mechanisms after an economic collapse.
- In desperation, people leave their nations and move to safer destinations.
- The central banks start printing a lot of currency to honor their obligations leading to excessively high inflation
- Economic collapse results in crashes across the financial market of the country. Debt defaults can lead to the value of bonds going down to zero.
Important Points to Note about Change in Economic Collapse
- This happens in a short period of time and the damage is done pretty quickly.
- Most collapses lead to an overhaul of the economies as economies look to new sources of revenue to come out of the economic mayhem.
- Full confidence restoration after an economic collapse takes a significant amount of time and work.
- It is primarily a developing world phenomenon and developed countries seldom have such collapses.
An economic collapse has a little positive and a lot of negatives. Those who suffer the most are the poor and daily wage earners. Their earnings collapse; they lose their livelihood and indulge in unlawful practices. The governments have to do their bit to avert the crisis by using appropriate checks and balances.
Looking at the consequences of such a crisis, many countries across the world have started building additional sources of revenue (in case they are dependent on a single revenue source) and have built reserves to counter the rainy days.
The economic collapses in the modern world are few as the governments and monetary authorities intervene immediately to mend the situation. Though, there have been instances of smaller countries getting into trouble because not all countries have resources similar to what bigger countries have to counter a significant economic collapse. Thus, there will always be instances of smaller countries going through economic collapse once in a while.
This has been a guide to what is an economic collapse and its definition. Here we discuss the effects and reasons for happening economic collapse with examples. You can learn more from the following articles –