NOTE: 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 may just be a correction. I still argue that bonds are currently overpriced, and this asset class will correct lower parallel with US Federal Reserve Bank (the Fed) rate hikes.
The quantitative easing was a monetary intervention that sent the short-term interest rates down to an extreme level, which is correcting itself back. Though further hikes are needed to adjust for the hot American labor market, and the inflation level, in my view, a Fed fund rate at 4 percent is adequate, which speaks for a 10-year yield above 4.5 percent—such a move might seem like a crisis when it happens.
I argue that it’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 US stock markets and cause a drop of 15 to 20 percent, but again, a correction from high levels.
It could feel like a storm and could temporarily affect consumer spending slightly. However, the markets are far from the global overbought situation ahead of the dot.com crisis in 2000-2001. Right now, the global markets offer cheap stocks in China, and the United Kingdom will soon be a good story. In six months’ time, there will be opportunities in several emerging market countries. Thus, I do not expect the financial markets to spark the next real crisis.
The next global crisis, however, will look very different, and I am significantly worried that it will one day arrive. One could say that there is nothing to worry about, as I have argued that the global economy feels robust. As an example, Graphic 1 states that the US households are significantly less debt-ridden than before the global crisis from 10 years ago.
Overall, this is a healthy development, and a lot of researches show that US households are still scared by the crisis 10 years ago and therefore borrow less. It could also reflect that in the US, a majority of the jobs created is in the low-salary segment, and the number of employees hired on temporary contract 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 low income is the main reason why a 20-percent drop in the stock markets only affects private consumption marginally. A bigger number of households simply don’t have any savings that could be hurt by a sell-off in the equity markets. The middle class with some savings in stocks to withstand bad times is simply disappearing in several countries. The 1.5 billion people in Asia that will move up from a poor economic household situation to the lower middle income in the next 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. The 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 universal since the crisis 10 years ago. But it also confirms a shift in who holds the risk compared to before the financial crisis. At that time, households and corporations were heavily loaded with debt, or leveraged. Since then, corporations, in particular, have improved their balance sheets and are now, in general, doing very well.
Many governments are instead debt-loaded, where the graphic shows some large economies in the world, though others, like India, have done better. I argue that the next global crisis will happen when the trust disappears in government’s capability to repay 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 in case of sudden growing unemployment. All in all, the economic liability explodes for the public finances if the next global crisis hit governments, which is my worry. Investors getting scared about government risks can trigger this situation. It has been seen before and will happen again.
In case of a crisis, investors will take flight, and traditionally, a currency therefore gets cheaper, which again helps the country’s exports, and this way, a recovery is initiated via an increased export of goods.
But in the next global crisis, investors might take flight into newer options like cryptocurrencies. This will weaken the currency that investors leave, but it doesn’t increase the value of another national currency, which means the devaluation effect becomes less against the prior crises. Some consumers might choose to move their savings to places they are comfortable with, which could be an account at 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, particularly monetary policy. It means that it can be harder for a country to move out of an economic crisis. Further, the hope for an export-driven recovery becomes more difficult because economic growth is getting more domestic in most countries. Many countries are becoming more protective, but what’s important is that more economic growth is service-sector driven.
It means that a country in economic trouble must recover on its internal strength, which is very difficult, as the Greece experience shows. A government debt crisis doesn’t necessarily have to happen globally, but such a crisis can spread and generate an extraordinary run toward 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.
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.
- Peter Lundgreen is the founding CEO of Lundgreen’s Capital, the leading independent advisor to Danish municipalities and public institutions in Europe. He has a solid 30-year experience in the finance industry and has been sharing his financial and economic know-how the past decades. Although based in Denmark, Peter’s expertise transcends the European financial zone and market, as he has created a high level of proficiency and competency on major global economies and finance markets, particularly in China.