An economic collapse is a breakdown of a national, regional, or territorial economy that typically follows a time of crisis. An economic collapse occurs at the onset of a severe version of an economic contraction, depression, or recession and can last any number of years depending on the severity of the circumstances. An economic collapse can happen rapidly due to an unexpected event, or it may be preceded by several events or signs pointing to fragility in the economy.
Key Takeaways
- Economic collapse is not part of the regular economic cycle of expansion and contraction.
- An economic collapse is most clearly identified by a widespread breakdown in normal market mechanisms and commerce.
- The Great Depression of the 1930s is considered one of the worst economic collapses in history due to its global impact, while the extent of the fallout from the 2020 COVID-19 pandemic remains to be seen.
Identifying and Understanding Economic Collapse
An economic collapse is an extraordinary event that is not necessarily a part of the standard economic cycle. It can occur at any point in the cycle, leading to contraction and recessionary phases. Economic theory outlines several phases that an economy can go through. A full economic cycle includes movement from trough to expansion, followed by a peak, and then a contraction leading back towards the trough. Although an economic collapse should be more likely in an economy that is already contracting, black swan events or trends in the global economy can override any point in the cycle to set off an economic collapse.
Unlike contractions and recessions, there is no agreed-upon guideline for an economic collapse. Instead, the term economic collapse is a label that may be applied by economists and government officials—often months or years after the actual event. Governments tend to speak in terms of economic collapse when crafting large-scale stimulus during market panics. The threat of economic collapse is raised in order to make the case for intervention in the economy.
Navigating an Economic Collapse
Although economies can and still do experience economic collapse, there is a strong incentive for national governments to attempt to stave off or lessen its severity through fiscal and monetary policy. An economic collapse is often combated with several waves of interventions and fiscal measures. For example, banks may close to curb withdrawals, new capital controls may be enforced, billions could be pumped into the economy through the banking system, and entire currencies may be revalued or even replaced. Despite government efforts, some economic collapses result in a complete overthrow of the government both responsible for and responding to the collapse.
Following an economic collapse, there are almost always a number of legislative changes aimed at avoiding a similar situation in the future. These changes are usually informed by a post-collapse analysis aimed at identifying the key factors leading to the collapse and integrating controls in new legislation to mitigate those risks in the future. Over time, the appetite for these financial controls can weaken, leading to the regulation of risky market behavior being relaxed as the memory of the economic collapse fades.
Historical Examples of Economic Collapses
Throughout history, there have been numerous instances of national-level economic collapses. Each collapse typically has its own unique circumstances and factors, although some may share triggers such as the Great Depression. Often, these factors are mixed with common macroeconomic events like hyperinflation, stagflation, stock market crashes, extended bear markets, and imbalanced interest and inflation rates. Additionally, economic collapses can arise from extraordinary events like disastrous government policies, a depressed global market, or more traditional triggers like war, famine, plague, and death.
In the United States, the 1930s Great Depression remains a prime example of an economic collapse, known for both its extensive damage and its prolonged recovery period. The 1929 stock market crash was a key catalyst for the collapse, but the problems were compounded by policy responses and systematic weaknesses. The multi-year economic collapse of the U.S. economy was followed by sweeping regulatory reforms affecting the investment and banking industries, including the Securities Exchange Act of 1934. Many economists have blamed the 1920s collapse on a lack of government involvement in the economy and financial markets.
It took 25 years to fully recover from the Great Depression. Additionally, unemployment during the Depression surpassed 24%.
The 2008 financial crisis is not considered an economic collapse for America’s economy, but a collapse was believed to be imminent at the time. The freezing of the credit market may well have resulted in a more severe situation if not for the liquidity provided by the Federal Reserve.
The bankruptcy of Lehman Brothers was the tipping point for the 2008 financial crisis, but it wasn’t the only cause. The crisis resulted from extremely loose lending and trading policies for institutions, leading to large losses from defaults that were amplified by the derivatives market. Similar to the 1929 collapse, the 2008 financial crisis also led to legislative reform, primarily in the Dodd-Frank Wall Street Reform and Consumer Protection Act.
The 2007-2009 Great Recession lasted less than two years, with the U.S. experiencing six quarters of negative GDP growth and a 5.3% reduction in GDP growth from 2006 to 2009. Unemployment peaked at 9.6% in 2010.
There are also numerous examples of international economic collapses, such as those in the Soviet Union, Latin America, Greece, and Argentina. In the cases of Greece and Argentina, severe issues with sovereign debt led to economic collapses, consumer riots, currency drops, international bailout support, and an overhaul of government structures.
The 2020 COVID-19 pandemic, which spread across the globe—starting in China, then Europe, and the Americas—is another recent example of an external shock leading to a global economic downturn.
Related Terms: economic contraction, depression, recession, stock market crash, monetary policy, fiscal policy.
References
- MarketWatch. “The Dow’s Tumultuous History, in One Chart”.
- United States Census Bureau. “Labor Force (Series D 1-682)”, Page 126.
- World Bank. “GDP Growth (Annual %) – United States”.
- U.S. Bureau of Labor Statistics. “Labor Force Statistics from the Current Population Survey”.
