Snapshots of Russian Financial Crisis

One common argument I've heard recently about the banking difficulties is that if the economy is damaged, there's a point beyond which the damage is so severe that a depression will set in. In another words, a little bit of damage is bad, a lot of damage is worse, but after a certain point, too much damage causes the entire economy to unravel and dogs to sleep with cats.

One data point against this view might be the Russian financial collapse of 1998. I don't fully know the details of what happened, but I do know how the Russian Trading System (the stock market) reacted. You can see that the market lost most of its value from mid-1997 to mid-1998.

(Source)

By my calculations, the RTS lost about 92% of its value. To get a sense of the magnitude of the loss, that would be a DJIA reading of under 1200 down from its high of just over 14000 back in 2007.

What happened next?

The precipitous drop from the first chart is a mere undulation on the left side of the second chart. After the bottom hit, the stock market began to rise immediately, and fast. Less than five years after the bottom, the RTS regained everything it had lost. Four years after that, it had quadrupled its previous all time high (from just under 600 to just over 2400). In other words, in nine years, it multiplied its value about 50 times that at the bottom. That's an annual return of about 55% from the bottom.

To further emphasize, that's an annual return of about 15% from the top of the previous bubble. (As a benchmark for comparision, the DJIA has historically grown 10-11% per year on average during its history.) An hypothetical omniscient being knowing what was coming in late 1997 and early 1998 would have given the advice, "Yes, there will be pain in the short term, but in the slightly longer term, things will be fine."

From what I know about the crisis, which is admittedly, very little, there was little intervention by the Russian government, and what intervention was done had little effect. Certainly, nothing was done that compares to the various bailouts enacted and proposed over the last several months in the US.

I don't know if any of this applies to the current situation in the US. Things may be very different here. But this is one example of a market washout that did not lead to a depression, but rather, was followed by robust growth. There's an oft-heard viewpoint from proponents of the market that when bad investments pile up in the economy, the best thing to do is to let them fail. It puts the economy on sounder footing which is required for growth to resume. The Russian financial collapse of 1998 might be one example confirming this view.


You might have noticed the precipitous drop in the RTS in the last year. Nearly all of the world's financial markets have done the same. I don't know how meaningful the drop is in foreign markets, so I did not include it in my calculations, though even if I had, the numbers would be less robust but still impressive.

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Many Russians, including the key officials of the Ministry of Finance and the Central Bank, evidently became convinced that it was wrong about everything. They saw free-market capitalism as a secure highway to prosperity rather than a turbulent ocean which must always be navigated with great prudence.

Ditto for smart ass investment bankers with math formulas showing guaranteed profits. Dave