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