It seems every great crash, the underlying fundamentals always point to an ever increasing debt until it becomes unsustainable and bursts.

How true would you say is that statement above?

  • 4
    Maybe I'm just not an expert, but this seems quite subjective to me. – Pops Sep 20 '10 at 23:10

While debt increases the likelihood and magnitude of a crash, speculation, excess supply and other market factors can result in crashes without requiring excessive debt. A popular counter example of crashes due to speculation is 16th century Dutch Tulip Mania.

The dot com bubble is a more recent example of a speculative crash. There were debt related issues for some companies and the run ups in stock prices were increased by leveraged traders, but the actual crash was the result of failures of start up companies to produce profits. While all tech stocks fell together, sound companies with products and profits survive today.

As for recessions, they are simply periods of time with decreased economic activity. Recessions can be caused by financial crashes, decreased demand following a war, or supply shocks like the oil crisis in the 1970's.

In summary, debt is simply a magnifier. It can increase profits just as easily as can increase losses. The real problems with crashes and recessions are often related to unfounded faith in increasing value and unexpected changes in demand.

  • In general, when the value of any important asset (e.g. house prices, stocks, etc.) falls sharply, this can often create a balance-sheet recession. Good answer, anyway. – Noldorin Sep 21 '10 at 0:37

The statement can be true, but isn't a general rule.

Crashes and recessions are two different things.

A crash is when the market rapidly revalues something when prices are out of equilibrium, whether it be stocks, a commodity or even a service.

When the internet was new, nobody knew how to design webpages, so web page designers were in huge demand and commanded insane price premiums. I literally had college classmates billing real companies $200+/hr for marginal web skills. Eventually, the market "clued up" and that industry collapsed overnight.

Another example of a crash from the supply point of view was the discovery of silver in the western US during the 19th century -- these discoveries increased the supply of the commodity to the point that silver coin eroded in value and devastated small family farms, who mostly dealt in silver currency.

Recessions are often linked to crashes, but you don't need a crash to have a recession. Basically, during a recession, trade and industrial activity drop. The economy operates in cycles, and the euphoria and over-optimistic projections of a growing or booming economy lead to periods of reduced growth where the economy essentially reorganizes itself.

Capital is a (if not the) key element of the economic cycle -- it's a catalyst that makes things happen. Debt is one form of capital -- it's not good, not bad. Generally cheap capital (ie. low interest rates) bring economic growth. Why? If I can borrow at 4%, I can then perform some sort of economic activity (bake bread, make computers, assemble cars, etc) that will earn myself 6, 8 or 10% on the dollar. When interest rates go up, economic activity slows, because the higher cost of credit increases the risk of losing money on an investment.

The downside of cheap capital is that risk taking gets too easy and you can run into situations like the $2M ranch houses in California. The downside of expensive/tight capital is that it gets harder for businesses to operate and economic activity slows down. The effects of either extreme cascade and snowball.


The root cause can be said to always be a crisis in confidence. It may be due to a very real event. However, confidence is what pushes the markets up and worries are what bring them down.


A lack of trust in the regulator can also stop everyone trading.

If you don’t believe the bank notes you are getting paid with are real, why do any work?

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