What is the potential risk of a Global Financial Crisis 2? Is it realistically on the cards or just pessimistic hype and gratuitous drama? Should we sell down our portfolios, hide in Gold or run for the hills? Regardless of who you speak to, whether you resonate with Keynesian or Neo-classical macroeconomics, the question still remains; are we at risk of another Global Financial Crisis, and if so, when?
An increasing number of respected financial experts are now warning that we are right on the verge of another great economic crisis. Of course that doesn’t mean that it will happen. Experts have been wrong before, but there is no doubt that uncertainty rumbles through our current economic environment. Alarm bells have been sounding in various parts of the world from the China Stock Market bubble, US Bond Market bubble to Japan’s high debt levels (highest in world at 235% GDP) just to name a few. If something dramatic were to happen somewhere in the world, subsequently causing a total blowout or even an ongoing ripple effect, could Australia weather another global financial crisis?
The UK based National Institute of Economic and Social Research (NIESR) recently published a report reducing their 2015 forecast for global economic growth from 3.2% to 3.0%. The NIESR think tank identifies the Greek economy as a key risk to global growth and cuts growth forecasts for US and many emerging market economies. A small downward adjustment in growth by one research institution doesn’t appear to be too worrying, but when we start to look at various aspects of our global environment, should we be concerned? Many economists agree that positive global economic growth just isn’t there, but does that constitute talk of a financial crisis? Are our growth expectations just too high?
In 2008, the Global Financial Crisis was the result of a bursting credit bubble in the US with many experts pinning the collapse on high risk, complex financial products and the failure of regulators & credit rating agencies. As with any large event, it is never just one thing. Have we learned our lessons from that pivotal event?
In March this year, the Business Council of Australia (BCA) released its 2015-16 Budget submission report. It carried some very strong warnings to the Federal Government and amongst other matters, noted that if their recommendations or measures weren’t taken, this could happen:
“The GFC triggered a $70 billion deterioration in the budget over just two years. If another GFC hit today our starting point would be a $40 billion deficit and net debt of 15 per cent of GDP, in stark contrast to the $20 billion surplus (and zero debt) in 2008.
A similar shock and response today would leave a deficit of around $110 billion or 7 per cent of GDP, and increase Commonwealth net debt to around 20 per cent of GDP. A deficit of this order of magnitude is nearly twice the Commonwealth’s current health spending and more than half total individual income tax receipts.”
So, are these warnings we need to heed or just ignore, so we don’t talk ourselves into a potential catastrophe. Are we vulnerable to global economic shocks?
The reality is the global debt levels aren’t sustainable and this is just one issue of many facing our global economic situation at present. Since mid 2014, total global debt — government, corporate and household — reached $199 trillion, an increase of $57 trillion from the end of 2007, according to McKinsey Global Institute.
In Asia and Latin America, bank credit has risen at double-digit rates over the past few years and in China, debt levels have quadrupled.
According to a recent report from the International Monetary Fund (IMF), Australia has world’s worst debt trajectory with debt expected to grow 32 % (estimated from 17 % at the end of 2014 to 22.4 % of GDP in 2020). Apparently, Australian household debt has reached 130% of GDP, which is the highest level on record and the highest in the world. Over the past few years, low interest rates have fuelled people to purchase the great Australian dream. If we have an upswing in the interest rates, even a small movement could send already overcommitted homeowners into a panic, leading to a potential widespread mortgage default.
According to Treasurer Joe Hockey, Australia is paying an interest bill on gross debt of $1billion per month. How or when this likely to ever reduce is concerning, given we haven’t learnt from the GFC, that fuelling economic growth with debt doesn’t always work. Are our governments thinking short term, trying to cushion the blow to save political favour?
After all the hype to stimulate a sluggish economy with borrowing to invest, Australia is now experiencing a property bubble, primarily in Sydney and Melbourne. In December last year, concerns about a possible housing bubble led the Australian Prudential and Regulation Authority (APRA) to request the banks limit lending growth to 10% and increase their provisions for bad debt. In March 2015 however, lending soared by 21% compared with the same time a year earlier, as the ‘crazy’ property frenzy continued.
Add to the property issue are concerning survey statistics released by the Australian Bureau of Statistics (ABS) who predict falls in business investment across the board in the 2015–2016 financial year: mining down as much as 35%; manufacturing down 24% and services, the largest area of employment, down at least 5%.
The slump in commodity prices, combined with rate interest cuts by the Reserve Bank of Australia (RBA), has caused a slide in the currency. From a high of 110 cents to the US dollar at the peak of the mining boom in 2011, the Australian dollar is now hovering at six-year lows of between 73 cents and 75 cents. Some analysts believe the currency could go even further.
A recent assessment by Deutsche Bank’s chief economist Adam Boynton forecast a fall in the Australian dollar to 65 cents in 2016 and 60 cents in 2017. If the US Federal Reserve begins raising interest rates from their historic lows (widely expected to be as soon as September), it would be a positive for global economy in many respects, but not great for our AUD, and that fall could take place sooner and more rapidly. The effects of rising interest rates will ripple through stock markets around the world.
Speaking of US Bond Markets, in July this year, former Federal Reserve Chairman Alan Greenspan admits he is ‘quite’ worried about a bond market bubble; “What people are not focusing on is we have a bond market bubble and when that decides to work its way off we’re in trouble,” he said.
So with a falling dollar, tightening credit, weak commodities and looming trade deficit on the table is Australia prepared and capable to withstanding a hiccup in the global economy?
Some doomsday economic analysts believe there is a frequency of financial crisis and recessions that on average arises every 58 months (using data from the US National Bureau of Economic Research) so statistically speaking we should have expected the beginning of the next crisis in April 2015. If that is truly the case, are we in a pre or post crisis period now?
There are some forecasters, analysts and economists who have correctly predicted past crisis and whilst it can be a little daunting, are issuing warnings and predictions that are well worth reading and taking seriously.
Economist Ross Garnaut saw it before and after he wrote the prophetic book Dog Days at the end of 2011 and US Robert Kiyosaki believes we are headed to a global crisis in 2016 on the basis that 401k babyboomers needing access to their funds at that time and the US printing vast amounts of money.
Harry S Dent of Dent Research and Author of ‘The Great Crash Ahead’, has been predicting a global financial crisis for the past few years and said on the 28th July 2015 in a market update, that he believes there are six signs of an impending crash. “Just today we have a number of those signs starting to hit. Despite a $486 billion fund to prop up its market, China’s stocks sunk another 8.5% today – the biggest one-day drop since 2007. This is following a 35% crash into early July. Now, after bouncing back up to 4,200, the Shanghai Composite is down to 3,750. If it falls another 10% to below its recent low of 3,374, that will be the decisive blow – for us and them. I say this because China is my No. 1 indicator for a global market crash.”
China’s stimulus has cost over $1trillion so far. Beijing has rolled out a huge stimulus pack with mixed results. Economists and analysts are concerned that the China stock market stimulus has put the whole country at risk by artificially stimulating their economy. So how much money has been spent supporting their market? Economist and Peking University Professor Christopher Balding has tallied it up and arrived at an astonishing $1.3trillion! That’s more than 5 times the $247 billion the US government spent supporting financial institutions after the 2008 financial crisis.
In addition, Michael Lombardi of Lombardi Publishing Corporation has recently stated “our prediction is that today’s stock market is setting up for a huge tumble…a collapse that will make the stock market crashes of 2008 and 1929 look like a cake-walk. I know. It’s a dire prediction. But we believe the makings for this collapse have already been put into place”.
Australian expatriate Professor Steve Keen, Head of the School, of Economics, History and Politics, Kingston University was nominated as Business Day’s most successful economic forecaster last year. Professor Keen used the ideas of another economist Hyman Minsky to set for the possibility of a global debt crisis that some would say now appears discerning. Professor Keen tried to warn Australia against allowing capital to keep flooding into housing rather than into the business. Too much private debt
Editor and publisher Marc Faber of Gloom, Doom & Boom Report said recently “I don’t think the U.S. economy is doing particularly well. One of the problems is affordability, and cost-of-living increases. For most households, the cost of living has gone up very substantially and so their spending power is limited. In addition to that if you look at tax revenues in the U.S., corporate tax as a percent of GDP is essentially flat. However, what has gone up a lot as a percent of GDP is individual taxes, so it has some negative impact on the economy.”
In fact, Faber goes so far as to forecast: “We could very well be in a recession in the U.S. within six months.”
As the dust appears to be settling on the Greek debt crisis, world markets are pretending its business as usual. Or is it? Some Economists believe Greece is just the tip of the iceberg with many countries using nothing but debt to fuel their growth. A significant study by the International Monetary Fund (IMF June 2012) found that an over-indebted population is directly correlated with a volatile economy. The IMF study said the relationship between financial depth and economic growth depends on whether lending is used to finance investment in productive assets of to feed speculative bubbles. Using data that for 45 countries for the period 1994-2005, Beck et al. (2009) show that enterprise credit is positively associated with economic growth but that there is no correlation between growth and household credit. The study also outlined if the level of private credit hits 80% to 100% of gross domestic product (GDP), there’s trouble ahead.
So if the global economic environment is shrouded in debt, how do countries go about reducing these liabilities? Is it even possible in a world with no or low growth and low inflation? Policy makers will generally try and rely on existing fiscal and monetary policies to avoid economic demise however the traditional tools for dealing with high debt – growth, inflation, austerity measures, but will that be enough?
Things don’t appear very rosy but just as some as depicting an impending global calamity, others are pointing to the likelihood of a period of recession that is a period of sustained economic downturn. A leading economic forecaster Chris Richardson from Deloitte Access Economics is predicting that China’s slowdown has further to go and there are implications for Australia. He told ABC News ‘”The chance of a recession is higher now than it’s been for quite some time and China, and the potential for stumble there, is what people need to focus on much more than Greece or indeed China’s share market,” he told ABC News. “It is China’s economy which is key.”
The economic battle between the two largest economies potentially holds the key for the world’s financial direction. As modern wealthy countries tend to a more consumer based economy, developing countries increase their share of ‘producerism’ due to the reduced cost of doing business. This is creating a widening trade deficit including the world’s largest economy the US. As we saw in the recent resource boom in Australia, this scenario helped shield us from the full impact of the 2008 GFC and our large mineral exports kept the AUD high.
The difference with China’s exports to the US, is that the Chinese are keeping the trade income in US dollars, such as treasury bonds, and not converting the income into Yuan therefore reducing upward pressure on the value of the Yuan. China does not have a floating exchange rate that is determined by market forces, as in the case with most advanced economies. Instead it pegs its currency, the yuan to the US dollar. Since 2014, China has approximately $4trillon of US Reserves. So China is devaluing their currency and the US is printing money (quantitative easing). Combine this with the People’s Bank of China (PBOC) printing of money, helps reduce upward pressure on the value of the Yuan. China’s continuous purchase of US debt is an interesting scenario. China purchasing US bonds not only benefits the Chinese but also symbiotically helps the US as the price of Treasury bonds increases due to demand, the cost of US debt cheapens. It does however continue to raise concerns about the US becoming a net debtor nation, susceptible to the demands of a creditor nation.
Some economists believe western countries have been able to load up on debt, hiding hefty losses in their GDP growth figures as this data reveals very little about the underlying dynamics of an economy, if it doesn’t simultaneously attempt to analyse what part of the growth is credited to artificially fuelling the economy with new loans. By borrowing new debt they keep up the appearance of growth, albeit sluggish. If those economies were funding investments, it would be ok but the new debt is apparently going towards financing the losses and wasted on consumption. How long can these extravagant debt levels continue to multiply? With the deteriorating debt situation and diminishing share of the global pie, western countries may well have lost their economic power.
Amongst other concerns there is the worry that political forces are essentially keen to win the next election, keeping up a semblance of prosperity and traditional economics of borrowing in an attempt to stimulate growth, and this might not prove to the most prudent way forward in today’s fast paced, instant gratification society.
So, are we at risk of a Global Financial Crisis 2, yes we are always ‘at risk’. There is always going to be an element of risk, but to what extent are we exposed? Will the risk be high or low? An economic catastrophe, or just a move into a more depressed economic climate? The naysayers have got it wrong before. Will we look back in years to come and this period of uncertainty just show as a small speedbump on our economic roadmap? Only time will tell.