The scars are still raw five years after one of the worst financial crises in modern memory came to an end. Ever since the Dow Jones Industrial Average (^DJI 0.15%) bottomed out in 2009, investors have been bombarded by warnings and predictions of imminent collapse from every corner of the punditsphere, and millions have listened, choosing to stay on the sidelines to nurse their portfolio's wounds.
But the prophets of doom haven't been right so far. The global economy, while not as robust as it could be, is hardly in freefall. Our most recent financial crisis, while undoubtedly hugely important in our own lives, simply isn't as transformative as some of history's worst economic collapses. It changed our lives, but the world continues to operate much as it did before.
To understand how transformative a financial crisis can truly be, let's look back at five historical collapses that actually changed the course of history. These events toppled empires, altered economies, and shifted the global balance of power in ways few of us have experienced in our lifetimes. Let's start with the most recent event, the one against which our latest crash is often measured.
1929: The Great Depression
The Roaring '20s had it all: exciting new technologies, innovative new financial products, and enough boundless enthusiasm to push it all over the brink. It was the bull market that set the standard against which all others may be compared for centuries to come -- the Dow's value quintupled from its 1921 trough to its 1929 peak, and even after adjusting for inflation the index still grew 400% in those eight years. By comparison, the great bull market of the 1990s produced only 260% in real gains.
There were important and very legitimate economic reasons for much of the boom. Productivity grew at a record-high rate throughout the Roaring '20s. Automobiles and electricity were also in the early stages of transforming the Western world from an agrarian culture into an urban one.
However, irrational exuberance, combined with the excessive leverage created by the era's financial innovations, eventually drove market prices far above their typical levels. The cyclically adjusted P/E ratio (CAPE), a 10-year average of marketwide valuations, increased by almost 200% during the 1990s but grew by over 500% during the Roaring '20s. An absence of real government control over the financial system and the broader economy mean that there would be no strong hand to stop everything from tumbling over the abyss once optimism ended.
It took a World War to really restore America to its former economic strength, and the Dow wouldn't recapture its 1929 high for 25 years. Along the way, the United States, and much of the rest of the Western world, found its government institutions irrevocably transformed by the creation of new social-insurance programs and the massive expansion of government power that accompanied them. From the time of the Dow's 1929 peak to its final recapture of that peak in 1954, the world experienced its worst modern depression, the rise of fascism, the most destructive war in history, the harnessing of atomic power, the invention of electronic computers, the birth of modern pharmaceuticals, the beginning of the Cold War, and many other momentous events.
1789: French Revolution
There have been plenty of economic crises over the past 250 years, but until the Great Depression, none had affected the sweep of global history so profoundly as the one behind the French monarchy's collapse in 1789. Pre-revolution France was a nation where wealthy elites grew fat as the masses went hungry -- nobles, clergymen, and the upper-middle-class bourgeoisie accounted for about 10% of the French population but took in roughly half of all national income in 1788.
Revolution came to France, ironically enough, after King Louis XVI poured far too much of the crown's money into the American Revolution. All told, French spending on the war cost 1.3 billion livres, which was equivalent to roughly 3.5% of the entire world's economic output by the war's end in 1783. Total French debts soared to almost 3 billion livres, and half of all French government revenue wound up going toward debt repayment, even though annual interest rates were below 6%.
Deficits continued to mount after the war as French military leaders built up the navy in anticipation of further battles with Britain, and finance ministers began to fear insolvency. Attempts to change the French tax code by assembly vote were rejected by the elite on whom those changes would fall, but representatives of the common folk seized political power and quickly pushed for more radical changes.
The bloody revolution that followed wracked France for a decade, leading directly to the Napoleonic era and the eventual transformation of Europe from a patchwork of loosely aligned territories into several stridently nationalistic imperial powers. Britain, which France had spent so heavily to defeat in America and turn back at home, became the greatest beneficiary of France's economic collapse, and the century following Napoleon's final defeat became known as the Pax Britannica.
1720: South Sea and Mississippi Bubbles
The tulip bubble might be more famous, but the South Sea Company and the Mississippi Company, twin bubbles that inflated in Britain and France in the early 18th century, had a greater impact on global financial developments. The similarities run deep: Both bubbles capitalized on the enormous public interest in the two nations' growing American colonies and their apparently limitless economic potential, and both bubbles were blown by brilliant hucksters backed by explicit government support.
Both bubbles ended at roughly the same time, but not before inflating to truly staggering levels. Since they weren't required to provide the slightest shred of evidence to back up outlandish claims, both touted themselves as holding the keys to untold New World riches. Since both companies also had broad government support and held large amounts of their respective royal courts' money, both claimed an uncontestable (though unverifiable) legitimacy that lent whatever they said a veneer of truth. All manner of ridiculous lies were gladly broadcast about these companies' holdings in the New World as share prices shot higher day after day. Eventually, profit-taking at the top of each bubble turned into a torrent, and many investors were ruined.
Public anger over these stock implosions held back the development of robust trading markets in both Britain and France for nearly a century. The Paris Bourse wasn't built until after Napoleon's downfall, and the Bubble Act (ironically passed to help the South Sea Company by restricting competing stocks from entering the market) tamped down British stock trading until its repeal in 1825, a quarter-century after the construction of the first London Stock Exchange.
The financial impact of the twin bubbles was also enormous for the time: When adjusted for inflation, the South Sea Company's peak market capitalization ranks it as the third-largest company in the history of capitalism, and the Mississippi Company's market cap is the second-largest. The combined peak capitalization of these two companies -- 500 million British pounds -- was equal to about half of the entire world's economic output at the time.
1627: Bankruptcy of the Spanish Empire
The Spanish Empire rose to global prominence as its conquistadores spread across the New World, plundering native riches and extracting shipload after shipload of gold and silver from its far-flung territories to fund its growth. It's estimated that Spain held the modern equivalent of nearly $3 trillion in gold and silver by the end of the 16th century, which would have been worth almost 20 times the entire world's global economic output. The Empire used this mind-boggling hoard to fund numerous military campaigns throughout Europe that won it territories stretching across much of Italy, Germany, and the Netherlands.
Constant warmongering and military occupation depleted the Spanish treasury, which suffered ongoing inflationary pressures from the constant influx of New World silver and gold. Instead of reforming royal finances, the ineffectual King Philip III set Spain on a long-term slide toward irrelevance when his default on Spanish debts prevented the Empire from putting down a Dutch rebellion in 1607. This failure, five years after the Dutch had established the first publicly traded company in history (it soon became the largest as well), shifted European economic power to Amsterdam.
A revived effort to dominate the Netherlands in the 1620s by newly crowned King Philip IV was cut short by a disastrous economic collapse in the vital Spanish province of Castile in 1627. The Spanish crown had devalued its currency (even $3 trillion in gold and silver can only go so far) to the point where it became effectively worthless, and Spanish forces were left to plunder the countryside for their "wages" for a time. While Spanish forces continued to battle across Europe for decades, Spain never again won meaningful territories nor enjoyed status as the dominant European empire.
The ascent of the developmentally disabled and malformed Charles II (a byproduct of such convoluted inbreeding that his grandmother was also his aunt and one woman was counted as 14 of his ancestors) to the Spanish throne in 1665 was the final nail in the coffin for the Spanish Empire. Like Charles, its final Habsburg ruler, Spain drooled and stumbled its way toward the end of the 17th century as a result of decades of ignorance and bad planning. Spain's 1627 default on its debts was its fifth in 70 years, but this final collapse put Spanish power on the wane for good, clearing the way for the growth of mercantilist empires in the Netherlands and in England.
235: Crisis of the Third Century and the decline of Rome
Why are there are so few momentous financial crises before the modern era? It's pretty simple -- a strong central authority has to start up the economic engines in the first place before they can break down later.
The earliest known crisis of such magnitude took place during the latter Roman Empire, which had long ago expanded across the Mediterranean and into the Middle East, Africa, and Asia Minor by the time its economy began to break down in the third century. By this point, Rome had been projecting power out from its capital for nearly 800 years, and that power had become increasingly fragile following the assassination of Emperor Commodus (the one played by Joaquin Phoenix in Gladiator) in the year 193. The dynasty that assumed control after his death ruled for four decades, but it was ended in 235 with the assassination of Emperor Alexander Severus by his own troops after a botched attempt to pacify Germanic raiders.
The power struggle that erupted after 235 shattered the Empire's internal cohesion and thus wrecked its trade network. Currency debasement spiraled out of control as the shrunken Empire lost its grip on outer provinces and was forced to mint coins with ever-lesser amounts of precious metal. Cities and towns of all sizes fell into ruin as Rome could no longer afford the legions that had long kept peace inside its borders and ensured the safety of traders and travelers on thousands of miles of roads. Rome's advanced trade-based interdependent internal economy deteriorated (particularly in the eastern half of the empire) into a more feudal sort of life in which large landowners built self-sustaining holdings and granted protection to the poor in exchange for their freedom.
The splintered Empire was finally stitched back together by the military campaigns of Emperor Aurelian in 275, but it never regained its old glory. Aurelian attempted to restore faith in the Roman currency, but his reign was brief and his efforts unsuccessful.
Another effort at currency reform came during the reign of Emperor Diocletian beginning in 284, but this failed in a far more spectacular fashion. Since the component metals of his coins were worth more than the coins' face value, the Empire steadily depleted its stores of gold and silver, and many citizens opted to simply melt the coins down instead of using them to pay debts. By the fourth century, Diocletian recognized how ridiculous this was and attempted to redenominate the coinage by edict, cutting its value in half. This, of course, caused a lot of inflation, which Diocletian answered with a second edict called the Edict on Maximum Prices. Now a price ceiling was placed on goods of all types, which only made the Roman Empire's economy move further into the black market.
Diocletian became the first Roman emperor to voluntarily abdicate his throne four years later, but the economy still hadn't recovered. By the end of the fourth century, the Roman Empire was broken forever. The legacy of its economic collapse -- of weakened trade and governing authority, of fortified outpost-towns with feudal lords and indentured peasants -- endured in Europe for more than a thousand years.