What Is an Economic Tsunami?

An economic tsunami is a widespread set of economic troubles caused by a single significant event. The downstream effects of economic tsunamis generally spread to broad geographic areas, multiple industry sectors, or both.

Key Takeaways

  • An economic tsunami is a widespread set of economic troubles caused by a single significant event.
  • The downstream effects of economic tsunamis generally spread to broad geographic areas, multiple industry sectors, or both.
  • Globalization is one of the main reasons why the shockwaves of an economic downturn in one part of the world can be felt on the other side of the globe.

Understanding Economic Tsunami

Economic tsunamis take their name from natural tsunamis, which are abnormally large waves triggered by a disturbance to the ocean floor, such as an earthquake. The resulting wave causes widespread destruction as it reaches shore and floods low-lying coastal areas. 

Likewise, economic tsunamis generate destructive effects beyond the geographic area or industry sector in which the triggering event takes place. These consequences can illustrate previously undetected connections between parts of the global economy that create a ripple effect only under extreme stress.

Depending on the severity of the consequences and the mechanism by which they spread, economic tsunamis can lead to new regulations as markets attempt to adapt to mitigate or prevent a future recurrence under similar conditions.

Example of an Economic Tsunami

The 2008 global financial crisis sits among the most prevalent recent examples of an economic tsunami. The subprime mortgage market in the U.S. acted as a trigger in this case, with large investment banks (IBs) miscalculating the amount of risk in certain collateralized debt instruments.

Unexpectedly high default rates led to large financial losses in portfolios with high credit ratings, which triggered massive losses for highly leveraged investments made by financial institutions (FIs) and hedge funds. The resulting liquidity crunch spread rapidly beyond the subprime mortgage market. In response, the U.S. government took over secondary mortgage market giants Fannie Mae and Freddie Mac, while Lehman Brothers filed for bankruptcy. Losses at Bear Stearns and Merrill Lynch led to acquisitions of those companies by JPMorgan Chase & Co. and Bank of America, respectively.

Foreign banks also suffered losses through investments affected by the economic crisis. Iceland's banking sector suffered a nearly complete collapse following the subprime crisis, tanking the nation's economy. Meanwhile, in the United Kingdom, the British government stepped in to bail out its banking sector.

The U.S., U.K., and Iceland all undertook varying degrees of regulatory reform following the crisis. Iceland's economy essentially reinvented itself to rely more heavily upon tourism than on international banking. The U.S. introduced a range of regulatory controls via the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as well as the Housing and Economic Recovery Act of 2008. Many of these regulations strengthened oversight of mortgage lending. The U.K. response included the introduction of the Financial Services Act in 2012.

Special Considerations

Globalization is one of the main reasons why an economic downturn in one part of the world can be felt on the other side of the globe. Free trade agreements (FTAs) between different countries have brought many benefits to the global economy. Among them, it has made companies more competitive and helped to lower the prices that consumers pay for various goods and services.

But there are some caveats. The increased interconnectedness of national economies means that an economic downturn in one country can create a domino effect through its trading partners. Nations now depend on each other to stay afloat. If the economy of a key buyer or seller of goods and services experiences turbulence, this could be expected to have a knock-on effect, impacting exports and imports in other countries.

Trade Wars

Growing calls from some quarters to unwind globalization is also stirring up threats of economic tsunamis. An example of this is the trade war between China and the United States. A bitter standoff between the world's two biggest economies is hurting companies from both countries, weighing on equity markets, investment, the labor market, and consumer spending. U.S. exports to China fell from $64 billion in the first six months of 2018 to $51 billion in the first half of 2019. According to the Federal Reserve, President Donald Trump's protectionist tariffs are indirectly costing the average American household over $1,000 a year.

Other countries have been caught in the crossfire, too. The International Monetary Fund (IMF) warned that America's trade spat with China could cost the global economy roughly $700 billion by 2020.

In the first six months of 2019, the United States' biggest trade partners were, in the following order: Mexico, Canada, China, Japan, and Germany.