Sunday, August 05, 2018

The Fire Next Time

We may not be far away from our next financial crisis. There are, Larry Elliott writes, a number of things that could trigger it:

It is not the likeliest of outcomes but not all that far-fetched either. China’s debt; Brexit; a global trade conflict: any of them could blow up into something serious. These sort of events form the basis of the war games that policy makers play from time to time.

But if there is a next time  --  and there always is a next time -- we have far less flexibility to deal with the crisis:

There are at least four ways in which policy is more constrained than it was a decade ago. First, and most obviously, there is monetary policy; the options available to central banks. At its August meeting in 2008, the Bank of England left interest rates unchanged at 5%, which meant it had plenty of scope to cut when it finally woke up to the seriousness of the situation. Even after last Thursday’s rate rise, official borrowing costs are only 0.75%, providing much less room for manoeuvre.

Then there is fiscal policy:

In Britain, the budget deficit – the gap between what the government spends and what it receives in taxes – expanded rapidly during the crisis from 2% of gross domestic product to a peacetime record of 10% of GDP. It has taken 10 years to bring the deficit back to where it started and meanwhile national debt as a share of the economy has more than doubled to over 80% of GDP. Despite a prolonged austerity drive, set to continue well into the next decade, the public finances are in worse shape than they were when Lehmans went bust.

Third, the international cooperation which saw us through the last crisis has all but disappeared:

One of the small comforts from the crisis of 2008-09 was that it generated a sense of international solidarity because the world’s biggest economies quickly realised they need to help each other. There was a collective commitment to shore up banks; the creation of a new body, the G20, to bring together developed and emerging market economies; as well as an agreement to refrain from protectionism. As Adam Tooze notes in his new book about the crisis, Crashed, the US Federal Reserve quietly acted as the lender of last resort to Europe’s troubled banks.

Now the world has changed:

Europe and the US went their separate ways over austerity; the G20 failed to live up to its early promise and even before the arrival of Donald Trump in the White House, countries had quietly been finding ways to defend the interests of domestic producers. Trump has, of course, taken isolationism to a whole new level by picking trade fights not only with China but with the EU, Canada and Mexico as well. In the current beggar-my-neighbour environment, the chances of the world coming together in the event of a new crisis appear slim.

And, fourth and finally, the political climate has changed:

The last crisis came at the end of a prolonged upswing, in which wages and living standards rose steadily. Britain went 16 years without a single quarter of falling output and in the latter part of this period, when Labour was in power, there was bountiful investment in the public sector.
Feast has been replaced by famine. Wage rises have turned into pay freezes; living standards have stagnated and the public sector bears the scars of a decade of cuts. Austerity fatigue has set in, making it nigh on impossible for governments to insist that voters endure a new round of sacrifices. The public mood is already sour.

So, when the crisis hits, it really will be -- to echo James Baldwin -- "The Fire Next Time."

Image: Matt Lynn Digital


bill said...

Owen here are a few more for your list.

1. the 2000 dot com bubble was caused by thousands of companies created out of thin air that eventually proved worthless drawing the rest of the market down with it. Amazon etc.?

2 the 2007 correction was caused primarily by the widespread sale of collateralized debt that eventually proved worthless. Today there is almost double the amount then.

3. The only part of most of the worlds economy that can buy things for cash are a few old people that are so rich they don't need anything. Most of the world lives in poverty or the lucky ones in the hand to mouth working class that has to borrow to consume. ie. there is no middle class real market left.

4. water and food are rapidly vanishing which means only the rich old dudes will still be able to eat what they want. the rest of us will be too concerned with surviving.

5. housing, both rental and self owned by historical standards is now unaffordable to most people under 40 without taking on insane amounts of debt to obtain it.

6.The only reality that have is that our economy today almost entirely consists of built in obsolescence which means replacing your stove every 5 years in a world where building one that lasts 25 years or more makes more sense as there is ten times the market there was 50 years ago globally. This is the one that will kill us as we use probably twice as many resources as we need to to make all this junk which is a direct cause of global warming that we now experience daily.

So, How do we deal with this mess?

Owen Gray said...

What you say about the housing market is particularly true where we live, bill. Prices have skyrocketed. When we downsized, we benefited from those prices. But our children -- all have university degrees -- couldn't afford to live here.

At some point, it's all going to fall apart. But whether there is a bright spot after the crash is anybody's guess.

The Mound of Sound said...

Kevin Phillips, in his 2005 book, "American Theocracy," explores how economically dominant superpowers enter a terminal stage from which they eventually fall. It occurs when, having become dominant through a robust manufacturing economy, they transition into a financial economy, FIRE (finance, insurance, real estate), and outsource their manufacturing to a low wage satellite to pursue higher-rate returns from speculation. They essentially use their own capital to grow their successor's economy.

The transition, however, is fueled by economic reversals, recessions. Post-recession manufacturing economies recover quickly and fully. FIRE economies don't. They become more brittle, more vulnerable to future recessions. As the dominant economy weakens the successor economy grows and dominance transfers from old to new.

History shows that more than half of these transitions result in war. Who knows what's in store this time? I say that because the dynamic has changed. It has become much more a net sum game due to the complicating, magnifying factors such as the exhaustion of natural resources, climate change, etc. If, at the end of the day, all you're left with is a shit sandwich, the loser is the one who has to take the biggest bite.

Owen Gray said...

The last bout of global free trade ended with the beginning of World War I, Mound. History suggests that our future isn't bright.