The Next Financial Crisis

ALASDAIR THOMPSON delves into the state of the markets – and why we should all be concerned.

Shares and property prices have been rising for a long time. The S&P 500 Index reached a record 3,453 days (approaching 10 years) of rising share prices on 22 August, 2018, the longest bull market in history.

Company share buy-backs and good profits generally drive shares up. Both have been factors contributing to this long bull market run.

However, the main reason markets have risen to record highs has been the easy availability of many trillions of dollars of super low interest rate (below 1% pa) new money from the world’s central banks.

Since the 2008 Global Financial Crisis (GFC), central banks like the US Federal Reserve, Bank of Japan (BoJ), European Central Bank, Bank of England and the People’s Bank of China have been ‘printing’ money and using it to buy financial assets (government and corporate bonds and shares) from commercial banks. This gave commercial banks heaps of ‘cash’ in exchange for the financial assets they sold to the central banks.

So central banks now own a huge proportion of the debt owed by governments. For example, the government-owned BoJ bought, with newly printed money, 42% of all Japanese government debt.

Central banks also own lots of corporate shares. They bought it all with new ‘printed’ money from commercial banks, thereby allowing those commercial banks to lend trillions of dollars to house buyers and to corporates so they could buy-back their shares.

This financed the huge inflation in asset prices worldwide. So much so, that the price of a house is beyond the incomes of new home buyers, and share markets have never been higher.

This central bank money printing, known as Quantitative Easing or QE, continues even now, except the US Federal Reserve stopped it at US$4.55 trillion in 2014.

From 2000 to 2013, the global debt-to-GDP ratio, excluding financial firms, increased from 163% to 212%. In the developed world, the debt to GDP ratio rose from 310% to 385%.

In 2014 the Geneva-based International Centre for Monetary and Banking Studies said: ‘…six years on from the beginning of the financial crisis in advanced economies, the global economy is not yet on a deleveraging path… the ratio of global debt… over GDP… has kept increasing at an unabated pace and breaking new highs…’

Global debt rose by US$70 trillion between 2008 and 2017, to $237 trillion. So says the Institute of International Finance. And much of this debt is bad debt, as was the American sub-prime mortgage debt in 2008.

In the six years to 2015 US$5.4 trillion of oil fracking-related debt was incurred. In the seven years to 2016, China invested over US$9 trillion in white elephant infrastructure and ghost cities.

Emerging markets with USD denominated corporate bonds exceed US$9 trillion consisting of loans made to manufacturers and commodity producers in countries like Turkey, Russia, Brazil, Mexico and Indonesia.

This debt has to be paid off, with interest, in USD. But the US Federal Reserve stopped its QE in 2014 and USDs are now scarcer in the world. They will get even scarcer as President Trump uses trade war tariffs to rein in the US trade deficit.  

Despite all this additional debt, much of it bad debt, nominal growth has been low.

It is only a matter of time before the next big crash hits, driving down these asset prices and when that happens, many banks, people and businesses will be forced into bankruptcy.

There are far fewer but much bigger banks now than there were in 2008. In the 2008 crash they were bailed out by central banks. They had to be, otherwise people’s deposits would have been lost.

But next time they are unlikely to be bailed out with even more printed QE central bank money.  No, the world’s central bankers and financial elites have since then convinced governments to put in place laws that enable governments to ‘bail-in’ banks rather than bail them out.

These laws allow governments to order a write-down or even write-off a large proportion of peoples bank deposits. They may allow us to keep some of our money and they may even allow the money they legally ‘steal’ from us to be converted into bank share capital, which won’t be worth much, at least for some considerable time. So we may become owners of a bank that can’t give back most of our deposits!

To get this all sorted out, governments are now allowed to close banks and ATM’s to halt all transaction processing until the state of a bank’s financial health can be determined and to complete any ‘necessary’ write down of deposits to reduce bank liabilities so they can remain solvent.

Not good. But that’s just the start.

The laws in the USA, Europe, China and Japan have set the scene to seize Systemically Important Financial Institutions, or SIFI banks, freeze money market funds, close exchanges, limit the supply of cash, and order money managers to suspend redemptions to clients.

Just imagine the commercial paralysis. It is not just for natural disasters that we should keep emergency food supplies. We should also keep cash notes on hand for at least a month’s sustenance, but over 50% of Americans have less than $5000 in savings.

The state of emergency declared by President Bush September 14, 2001, following 9/11 has been renewed annually ever since and allows the president to implement martial law, which could be used if money rioting broke out.

The coming crash will be big. Nothing was learned from the 2008 GFC. There is US$70 trillion more debt today than there was in 2008. Overleveraging, more derivatives and a failure to update modelling to recognise the complexity of financial markets will not help predict the timing of it any more than the same obsolete models did in 1998 and again in 2008. But it is coming.

The world keeps getting more complex. Disastrous cyber-attacks and sleeper viruses are examples of new triggers. Systems are dynamic, changing rapidly, and banks are bigger and even more adroit at expanding leveraging and in the use of derivatives. It’s a house of cards waiting to fall.

Concentration of wealth into fewer and fewer hands, the changing face of work due to automation causing unskilled workers to lose income and stagnant incomes among the middle classes have all lead to the many becoming poorer.

This increasing income inequality lowers consumption which in turn reduces investment. Governments have responded by increasing welfare like Working for Families, increasing deficit spending and borrowing to cover it. Redistribution of income and the exhortation to export more and more, with which re-emerging trade wars and protectionism* are associated, are the only growth engines governments are running.

In short, there was no fix after the 1998 or 2008 crashes, things are even more complicated now than then and more people are in a worse position to withstand the next crash when it happens. Governments and financial elites have failed us again. Each of us needs to be as prepared as we can be.

*New Zealand is one of just a few countries supporting full free trade. Others manipulate their currencies, apply tariffs and quotas out of a misplaced desire to export more than they import, all of which hampers world trade as world debt mounts.

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