Twelve steps to market meltdown

At times of financial crisis there is often a feeling that all the old certainties have been blown away. But what is striking about the entire history of stock-market crises is that they fall into a pattern — and this pattern makes it possible to make broad predictions about the panic cycles that have been remarkably consistent for more than a century.

American experts have dominated the sub-genre of identifying panic cycles, notably the market historian Charles Kindleberger and the economist Hyman Minsky. Based on their work, it is possible to identify the stages of the cycle — but not, to pre-empt the obvious question, to know exactly when it will end. So, here’s a 12-point guide.

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Andrew Watts

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Stage 1: all cycles can be said to begin with buoyant equity markets fuelled by a major development which stimulates at least one sector of the economy. In recent memory, one such stimulus was the development of the internet that led to the dotcom boom. In the most recent cycle the stimulus was clearly provided by the provision of cheap and plentiful credit to businesses and individuals, largely as a consequence of US monetary policy.

Stage 2: what all these stimuli have in common is that they lead to the expansion of money supply and of bank credit — spectacularly so in the current period. Stage 3: the cash swilling around the system induces irrational euphoria, producing heavy speculation and excessive borrowing. Stage 4: the entry of large numbers of market novices into the stock market is the most visible characteristic of this next stage. Tales of fortunes made stimulate even greater risk-taking, combined with a reckless belief that this time it will be different. The classic example was the statement by Irving Fisher, the renowned Yale University professor, who said, just ahead of 1929 crash, ‘Stock prices have reached what looks like a permanently high plateau.’