The response to the 2008 economic crisis has relied far too much on monetary stimulus, in the form of quantitative easing and near-zero (or even negative) interest rates, and included far too little structural reform. This means that the next crisis could come soon – and pave the way for a large-scale military conflict.
BEIJING – The next economic crisis is closer than you think. But what you should really worry about is what comes after: in the current social, political, and technological landscape, a prolonged economic crisis, combined with rising income inequality, could well escalate into a major global military conflict.
The 2008-09 global financial crisis almost bankrupted governments and caused systemic collapse. Policymakers managed to pull the global economy back from the brink, using massive monetary stimulus, including quantitative easing and near-zero (or even negative) interest rates.
But monetary stimulus is like an adrenaline shot to jump-start an arrested heart; it can revive the patient, but it does nothing to cure the disease. Treating a sick economy requires structural reforms, which can cover everything from financial and labor markets to tax systems, fertility patterns, and education policies.1
Policymakers have utterly failed to pursue such reforms, despite promising to do so. Instead, they have remained preoccupied with politics. From Italy to Germany, forming and sustaining governments now seems to take more time than actual governing. And Greece, for example, has relied on money from international creditors to keep its head (barely) above water, rather than genuinely reforming its pension system or improving its business environment.
The lack of structural reform has meant that the unprecedented excess liquidity that central banks injected into their economies was not allocated to its most efficient uses. Instead, it raised global asset prices to levels even higher than those prevailing before 2008.
In the United States, housing prices are now 8% higher than they were at the peak of the property bubble in 2006, according to the property website Zillow. The price-to-earnings (CAPE) ratio, which measures whether stock-market prices are within a reasonable range, is now higher than it was both in 2008 and at the start of the Great Depression in 1929.
As monetary tightening reveals the vulnerabilities in the real economy, the collapse of asset-price bubbles will trigger another economic crisis – one that could be even more severe than the last, because we have built up a tolerance to our strongest macroeconomic medications. A decade of regular adrenaline shots, in the form of ultra-low interest rates and unconventional monetary policies, has severely depleted their power to stabilize and stimulate the economy.
If history is any guide, the consequences of this mistake could extend far beyond the economy. According to Harvard’s Benjamin Friedman, prolonged periods of economic distress have been characterized also by public antipathy toward minority groups or foreign countries – attitudes that can help to fuel unrest, terrorism, or even war.
For example, during the Great Depression, US President Herbert Hoover signed the 1930 Smoot-Hawley Tariff Act, intended to protect American workers and farmers from foreign competition. In the subsequent five years, global trade shrank by two-thirds. Within a decade, World War II had begun.
To be sure, WWII, like World War I, was caused by a multitude of factors; there is no standard path to war. But there is reason to believe that high levels of inequality can play a significant role in stoking conflict.
According to research by the economist Thomas Piketty, a spike in income inequality is often followed by a great crisis. Income inequality then declines for a while, before rising again, until a new peak – and a new disaster.
This is all the more worrying in view of the numerous other factors stoking social unrest and diplomatic tension, including
- technological disruption, a
- record-breaking migration crisis,
- anxiety over globalization,
- political polarization, and
- rising nationalism.
All are symptoms of failed policies that could turn out to be trigger points for a future crisis.
.. Voters have good reason to be frustrated, but the emotionally appealing populists to whom they are increasingly giving their support are offering ill-advised solutions that will only make matters worse. For example, despite the world’s unprecedented interconnectedness, multilateralism is increasingly being eschewed, as countries – most notably, Donald Trump’s US – pursue unilateral, isolationist policies. Meanwhile, proxy wars are raging in Syria and Yemen.
Against this background, we must take seriously the possibility that the next economic crisis could lead to a large-scale military confrontation. By the logicof the political scientist Samuel Huntington , considering such a scenario could help us avoid it, because it would force us to take action. In this case, the key will be for policymakers to pursue the structural reforms that they have long promised, while replacing finger-pointing and antagonism with a sensible and respectful global dialogue. The alternative may well be global conflagration.
Another epic economic collapse is coming
.. the contraction probably will begin with the annual budget deficit exceeding $1 trillion.
.. The president’s Office of Management and Budget — not that there really is a meaningful budget getting actual management — projects that the deficit for fiscal 2019, which begins in six weeks, will be $1.085 trillion. This is while the economy is, according to the economic historian in the Oval Office, “as good as it’s ever been, ever.”
.. The fastest — 13.4 percent — was 1950’s fourth quarter, perhaps produced largely by bad news: The Cold War was on, the Korean War had begun in June, and fear of the atomic bomb was rising (New York City installed its first air-raid siren in October), as was (consequently) a home-building boom outside cities and “scare buying” of products that might become scarce during World War III.
.. Today, Shiller says, “it seems likely that people in many countries may be accelerating their purchases — of soybeans, steel and many other commodities — fearing future government intervention in the form of a trade war.” And fearing the probable: higher interest rates.
.. among those economies, ours is performing especially well. What, however, if this is significantly an effect of exploding debt? Publicly held U.S. government debt has tripled in a decade.
.. the political class is more united by class interest than it is divided by ideology. From left to right, this class has a permanent incentive to run enormous deficits — to charge, through taxation, current voters significantly less than the cost of the government goods and services they consume, and saddle future voters with the cost of servicing the resulting debt after the current crop of politicians has left the scene.
.. This crop derives its political philosophy from the musical “Annie”: Tomorrow is always a day away. For normal people, however, the day after tomorrow always arrives.
Turkey’s Financial Crisis Surprised Many. Except This Analyst.
.. The stock prices of European banks, which have been big lenders to their Turkish counterparts, dropped sharply on Friday, with investors worried that a wave of corporate bankruptcies in Turkey would lead to a banking bust in the country. The currencies of China, Brazil and Mexico also weakened. And in the United States, major stock-market indexes fell more than 1 percent before recovering slightly.
Suddenly, Mr. Lee’s largely ignored prophecy — that a decade of Turkish companies and real estate developers gorging on cheap foreign debt would end badly, not just for Turkey but for the world — does not seem so outlandish.
“Turkey is the canary in the coal mine,” said Tim Lee, an analyst who warned of Turkey’s trouble in 2011. “We are going have another crash that will be worse than 2008 in certain ways.”
.. Mr. Lee, 58, made his initial call — that Turkey was in deep financial trouble — in 2011.
.. Mr. Lee noticed that Turkish banks were borrowing in dollars to make other loans to fast-growing Turkish companies. He also saw that, over all, Turkey’s economy was growing more reliant on financing from foreign investors. It struck him as similar to what had happened to Thailand in the years before the Asian financial crisis in 1997.
.. The threat is that as the lira loses value, it becomes more expensive for Turkish companies to repay their dollar-denominated loans.
.. Turkey could be a signal for what lies ahead for assets and economies that were inflated by cheap debt.
.. “It has been some hard sledding,” Mr. Lee admitted. “I have lost a lot of clients because I have been too bearish.”
.. Yet he is doubling down on his doomsday message: The river of global cash will dry up, the dollar will spike and there will be a series of financial seizures. Investors, he thinks, will flee developing economies, then Europe and eventually the American stock and bond markets.
A Decade After Bear’s Collapse, the Seeds of Instability Are Germinating Again
A big financial-firm collapse in near future is exceedingly unlikely, but another crisis isn’t
.. Bear and Lehman were the manifestation of deeper economic forces that since the 1970s have produced crises roughly every decade. They are still at work today: ample flows of capital across borders, mounting debts owed by governments, corporations and households, and ultralow interest rates that nurture risk-taking in hidden corners of the economy.
By the early 1980s, though, deregulation had allowed capital to flow freely within and across borders and crises became a regular occurrence: the Latin American debt crisis that began in 1982,
- the U.S. commercial real estate and savings and loan crisis of the 1980s,
- the Asian and Russian financial crisis of 1997-98,
- the dot-com bubble of 1998-2000,
- the U.S. mortgage crisis of 2007-2009 and
- the European sovereign debt crisis of 2009-2013
.. Bear was both facilitator and victim of a housing bubble inflated by low interest rates and huge inflows of foreign capital—a “global saving glut” as then-Federal Reserve Chairman Ben Bernanke put it.
.. It arranged mortgages that financed the housing bubble while borrowing heavily with short-term IOUs.
.. When those mortgages went bad, Bear’s creditors yanked their funds—a de facto run on the bank.
Most of the regulatory effort since has been to ensure the largest financial institutions such asJPMorgan Chase & Co., which bought Bear Stearns in a fire sale brokered by the Fed, don’t succumb to anything similar:
- thicker buffers of capital to absorb losses,
- more reserves of cash and liquid assets to pay off skittish creditors,
- restrictions on trading and compensation that incentivize risk-taking, and
- new procedures for winding down failing institutions without taxpayer bailout or a chaotic bankruptcy.
Hyun Song Shin, research chief at the Bank for International Settlements, warned in a 2014 speech against the tendency to “focus on known past weaknesses rather than asking where the new dangers are.”
.. bond markets are growing at the expense of banks in supplying credit, enabling business and government debt loads in many countries to surpass their precrisis peaks.
.. Emerging markets have borrowed heavily in dollars, which leaves them vulnerable should the dollar’s value rise sharply
.. Total U.S. debt, at around 250% of GDP, still stands at crisis-era peaks while debt levels in China have caught up and passed the U.S.
.. Crises surprise because they usually start with an assumption so sensible that everyone acts on it, planting the seeds of its own undoing:
- in 1982 that countries like Mexico don’t default;
- in 1997 that Asia’s fixed exchange rates wouldn’t break;
- in 2007 that housing prices never declined nationwide; and
- in 2011 that euro members wouldn’t default.
.. the equivalent today might be, “We will never see higher inflation or higher growth.” If either in fact occurs, the low interest rates that have raised household stock and property wealth to an all-time high relative to disposable income won’t be sustainable.
.. A 1.5 to 2 percentage point increase in real interest rates, which he isn’t forecasting, would be small by historical standards but could potentially make the debts of Italy or Portugal unsustainable.
.. Central banks know this, of course, which is one reason they are wary of raising interest rates too quickly—while nervous that if they raise them too slowly, the problem will get worse.