Teaser: Lately, there have been many comments about the next global financial crisis to the 10-year “anniversary”, but a new crisis is building, though very slowly.
The “financial crisis” that will hit Wall Street and other markets around the world will “just” be a correction. I still argue that bonds are overpriced, and this asset class will correct lower parallel with the rate hikes from the U.S. Federal Reserve Bank (Fed).
The quantitative easing was a monetary intervention that sent the short-term interest rates down to an extreme level, which is correcting itself back now. Though further hikes are needed to adjust for the hot American labour market, and the inflation level. In my view, a Fed fund rate at four pct. is adequate, which speaks for a 10-year yield above 4.5 pct. – such a move might seem like a crisis when it happens.
This is what’s currently happening, but it’s not a long-term trend, nor a crisis, but a correction back from an overpriced situation. It might very well generate pressure on the U.S. stock markets and cause a drop of 15 to 20 pct., but again, a correction from high levels. To conclude, I do not expect the next real crisis to originate from the financial markets.
The next true global crisis will look very different, but currently, there is nothing to worry about as the global economy is fairly robust. As an example, graphic one states that the U.S. households are significantly less debt-ridden than before the global crisis from 10 years ago.
Overall, this is a healthy development, further does research show that U.S. households are still scared by the crisis 10 years ago and therefore borrow less.
The data could also reflect that in the U.S., a majority of the job creation is in the low salary segment, and the number of employees hired on temporary contracts remains high, like in many countries in the world. This doesn’t give enough comfort to borrow money, or the income might not qualify for a credit score that is high enough to achieve full financing for a car or a home.
The growing number of households with a low income is a main reason why a 20 pct. drop in the stock markets only affects private consumption marginally. A bigger share of the households simply don’t have any savings that could be hurt by a sell-off in the equity markets. The 1.5 Billion people in Asia that will move from a poor economic household situation up to the lower middle income during the coming 10 years won’t have any significant savings for a long period either.
This alone is a big change in how households can withstand a crisis. It further underlines that the next global crisis will be very different compared to prior crises. A problem though is that the political leadership and their economic advisors tend to suggest the same tools for crisis management, which has been used in the past 40 years.
The trust in increased government spending has been outspoken since the crisis 10 years ago, which is shown in graphic two. It also confirms a shift in who holds the risk compared to before the financial crisis. At that time, households and corporations were heavily debt loaded, or leveraged. Since then, corporations in particular, have improved their balance sheets and are now in general, doing very well.
Many governments are now debt-loaded instead, and I argue that the next global crisis happens when the trust disappears in the government’s capability to repay the debt – can it happen? Sure, it can. And to circle back to the growing number of low-income households without savings, then they can only hope for help from the government or society in general, in case of sudden growing unemployment. All in all, the economic liability explodes for the public finances if the next global crisis hits at the government level, which is my long-term concern – though, as mentioned, long-term.
I consider a debt trap as a rising risk for more countries because the income among more households is under pressure than before, which results in less dynamic economies. Demographic developments mean that the public debt has to be refinanced by a smaller number of taxpayers – and who guarantees that future taxpayers will oblige to repay debt that was incurred even before they were born? These kinds of risks can emerge especially if too many households suffer from economic constrains for too long.
In case of a crisis, investors will fly somewhere else with their assets, but in the next global crisis, investors might take flight into newer options like cryptocurrencies. Some consumers might choose to move their savings to places they are comfortable with, which could be an account at the large corporations they know, like an internet-based company where they spend their money anyway.
I could very well imagine this happening as companies are getting bigger than countries, and savers might even very understandably prefer to invest in securities issued by large global corporations instead of, for example, Italian government bonds.
If this will be the development, then it starts getting more challenging to conduct fiscal policy, but in particular, monetary policy. It means that it can be harder for a country to move out of an economic crisis. Further does the hope for an export-driven recovery become more difficult because economic growth is getting increasingly domestic in most countries. Many countries are becoming more protective, but what’s very important is that more economic growth is service-sector driven.
It means that a country in economic trouble relies more on a recovery by internal strength than earlier, which is very difficult – ask Greece. A government debt crisis doesn’t necessarily have to happen globally, but such a crisis can spread and generate an extraordinary run towards the alternative flight destinations.
Should that time come, I only see one realistic escape for the countries that end up caught in a debt trap – that is a debt write-off by the creditors, which will be households in the country and other governments.
Because the risk is government debt, then the time horizon is long and unclear, which is why I only add a bit on the risk barometer, though the barometer is slowly moving in that direction.
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