The Next Meltdown

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The financial crisis happened even faster. Within days of the Austrian ultimatum, the delicate web of international credit was torn to shreds. German trading companies ceased to remit the money they owed to brokers in London. European investors rushed to withdraw their money from New York. As nervous banks called in loans, panic selling swept the world's financial markets. But the further asset prices fell, the worse the crisis became. Securities that had been the collateral for immense pyramids of debt were suddenly unsellable. The central banks had to admit they lacked the means to stem the outflow. The only way to avoid a complete financial implosion was literally to close the world's stock exchanges. London's exchange remained shut down until January 1915.

Could such a "great drain" happen again, sucking liquidity out of the international financial system? Many experts would dismiss the idea as mere doom mongering. A full-scale war, they say, is one of those "10-sigma" (10 standard deviation) events that are so rare they lie outside the domain of risk management. Like an asteroid hitting the earth or a global influenza pandemic, a really big war belongs in the realm of uncertainty. You just can't price it in.

But try rereading the events of 1914 with the place names changed. Imagine the assassination of the U.S. Vice President in Baghdad this coming June. The U.S. suspects Iranian involvement and sends an ultimatum to Tehran. Israel takes the American side; Russia lines up with the Iranians ... It's not a wholly implausible sequence. And some central bankers admit privately that they would have to struggle to counter the liquidity crunch that such a geopolitical shock would trigger. A stock-market shutdown in 2007? History warns us not to rule it out.

Ferguson is the Laurence A. Tisch Professor of History at Harvard University