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A safe bet on next global crisis

Published in The National Business Review (Auckland), 21 August 2015

Economic crisisYou can tell how the mood of the global economy is turning by looking at the books getting published. Over the past few days, review copies of two new books landed on my desk.

The first was A Banquet of Consequences: Have we consumed our own future? by Satyajit Das. Its back cover already informs us that the “strategies and policies deployed to promote economic growth after the Great Recession have failed.”

I have always liked Das personally even though he is one of the gloomiest financial commentators I know. However, if the back blurb is anything to go by, Das has succeeded at taking his economic pessimism to a new level.

The second book is a variation on the same theme. Michael D Tanner, a senior fellow at the Washington-based Cato Institute, calls his Going for Broke: Deficits, debt and the entitlement crisis. Again, knowing Tanner personally, I have nothing but the highest respect for him. Yet looking at the summary, which promises “a growing crisis of super storm proportions,” I suspect this book will not make good bedtime reading either.

It is not as if any new books were required to remind us of the fragile state of the world economy. Recent economic news on a number of fronts have been disturbing. In New Zealand, our immediate concern may have been related to the correction in dairy prices.

However, the downturn in dairy really is just one price fall among other commodities that have plunged recently. Look at what happened to iron ore, oil or coal and the picture that emerges is one of an across-the-board slump. It hardly paints the picture of a buoyant global economy – but it does reflect the marked slowdown in Chinese economic activity.

What has been buoyant above everything else are global stock markets. Since the depths of the global financial crisis (GFC) in early 2009, equity performance has been stunning. The NZX 50 has gained 110%, London’s FTSE 48%, Germany’s DAX 121%, Japan’s Nikkei 134% and the Dow Jones 92%.

The obvious factor driving global stock markets are loose monetary policies in major developed economies. For more than six years now, interest rates have been close to zero in many major economies. Where that was not enough, central banks embarked on unorthodox policies to push even more money into markets, drive down yields and push up asset prices.

Since December 2008, the US Federal funds rate has been between zero and 0.25%. The ECB’s fixed rate is 0.05%, while for almost a year it has been charging a negative rate of -0.2% for deposits. The Bank of England’s base rate is also at an all-time low of 0.5%.

What has changed since the GFC is the level of government debt. The increases in public debt as a percentage of GDP are stunning. Since 2009, the US went up from 59.3% to 90.9%, UK from 64.1% to 101.9% and Japan from 186.6% to 255.8%.

Move vulnerable

Taking all of these developments into account, what emerges is the picture of a world economy that looks far more vulnerable than the one that entered the GFC. When the US subprime market imploded, Lehman Brothers collapsed and the euro crisis first reared its ugly head, at least there were some factors that helped to cushion the blows.

At the time, fiscal and monetary policy were ready to deploy large doses of stimulus. Of the two, it was probably the latter that made the biggest difference. However, an even larger stimulus for the global economy resulted from China, which continued its economic expansion throughout the crisis years.

Compare this 2008/09 situation with where we are today and it is easy to see that our vulnerabilities have increased. Instead of being the factor that propels global economic growth, China has become a concern. Its recent stock market crash and the shock devaluation of the renminbi both underlined the weakening state of the Chinese economy.

As China is slowing, the ability of developed economies to fight the next crisis is limited. At their current ultra-low interest rates, central banks do not have the option to provide monetary stimulus, at least not in a conventional way.

Of course, you could always do more quantitative easing or throw money from helicopters. Conventional monetary policy, however, is powerless when interest rates are as low as they are.

Meanwhile, governments are far more indebted than at any time during the past half a century, so their room for manoeuvre is diminished, too. And where, previously, falling commodity prices might have acted as an automatic stabiliser in an economic downturn, commodities are already cheap, which makes further price falls appear less likely.

Worrying developments

For the world economy, these are worrying developments. It appears that we have navigated through the GFC and post-GFC years with the help of loose monetary policy without actually getting the economy back on to a more sustainable footing. This makes it not only likely that we will see a return of the financial crisis but we will also be struggling to find a proper response to it when it happens.

At a time when China is slowing down, Japan seems to be re-entering recession and an effective solution of the Greek crisis is again postponed by another bailout package, there is no shortage of bad news.

Little wonder, then, that new doom and gloom books are being released. It is the perfect time to predict the next GFC because it increasingly looks like a safe bet.

Unfortunately, there is little in New Zealand we can do about it. The big forces of the global economy are simply beyond our control and we will be at the receiving end of these developments. However, we can try to prepare for the next GFC – or at least we can read books about it.

As for which of the two books I am going to read next, I have not quite decided yet. However, I am about to add my contribution to the growing crisis literature: On August 31, my new essay, Why Europe Failed, will be released. It is just as optimistic as the title suggests.

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