Navigating the Treacherous Tides of August: Lessons from Economic Crises Past

August, a month often associated with tranquility and respite, has a dark history of economic upheaval that has reverberated across the globe. From the invasion of Kuwait to the collapse of the Soviet Union, this seemingly innocuous month has witnessed some of the most profound financial crises in modern history. As policymakers take their summer breaks, leaving their deputies in charge, the markets tread cautiously, bracing for the potential storms that may brew in the late-summer period.

Uncovering the Perils of the "Eighth Month"

The Curse of August: A Volatile History

The late-summer period has long been a challenging time for markets, with the average spike in the VIX index (a measure of financial market volatility) being higher in the July to September period than any other quarter. This pattern has been observed time and time again, with August serving as a harbinger of economic upheaval.In August 1990, the world was caught off guard when Saddam Hussein's Iraq invaded Kuwait, triggering a threefold increase in oil prices. This added to already strong cost of living pressures in the West, including Britain, where the annual inflation rate climbed above 10%. While Kuwait was eventually liberated, the higher oil price led to a recession in the developed world.The collapse of the Soviet Union in the early 1990s was followed by a deep slump and heavy foreign borrowing to finance economic recovery. By the summer of 1998, the Russian government was struggling to pay its debts, and in August, President Boris Yeltsin capitulated, devaluing the rouble and defaulting on its overseas debt. This event had significant consequences, with the collapse of the US hedge fund Long Term Capital Management, which had to be bailed out by a consortium of 14 banks.

The Calm Before the Storm: August 2007 and 2008

The late-summer period has also been a time when the cracks in the global financial system have become increasingly apparent. In August 2007, the decision by the French bank BNP Paribas to close three of its hedge funds due to losses on sub-prime US mortgages had momentous consequences. Banks had taken enormous punts on the American housing market, and the widespread use of complex financial instruments, known as derivatives, meant it was unclear how heavily individual banks were exposed.The uncertainty led to a credit crunch, with banks stopping lending to each other. The following month, the UK suffered the first run on a high street bank in almost 150 years, as customers queued outside branches of Northern Rock.August 2008 was a lull before the storm, as the cracks in the global financial system continued to widen. On 15 September, Lehman Brothers went bankrupt after no buyer could be found for the US investment bank. Panic set in, and fears of a wholesale collapse of the banking system prompted emergency action from governments around the world, including bailouts, nationalizations, and the creation of new electronic money through quantitative easing.

The UK's Vulnerability: Pound Devaluations and the ERM Crisis

The UK has a special reason for being anxious in August, as four devaluations of the pound have taken place in the past 100 years, and three of them have occurred in September. In every case, the writing was on the wall in August.In 1992, for example, John Major's government spent the month struggling to maintain the pound in the exchange rate mechanism (ERM), a system under which European countries had to peg their currencies to the German mark. George Soros and other currency speculators spent the month building up positions in anticipation that the UK would eventually leave the ERM, which it did on 16 September 1992, known as Black Wednesday.

The Persistent Pattern: Crises and the Late-Summer Period

The frequency with which crises have occurred during the late-summer period has led to a persistent pattern, with the recent mini-crash setting off alarm bells. As Holger Schmieding, chief economist at Berenberg bank, noted, "It is almost a pattern. Not for the first time, equity markets have fallen sharply just before the end of my summer holidays."The lessons of the past are clear: August is a month that demands vigilance and caution from policymakers, investors, and the public alike. The economic and financial landscape can shift rapidly, and the consequences of complacency can be severe. As we navigate the treacherous tides of August, it is crucial to heed the warnings of history and be prepared for the unexpected.