Even if we go by the history of financial crises happening once every 10 years, the probable impact of the next one will be small, local and limited.
As it was the tenth anniversary of the collapse of Lehman Brothers, the talk in town has been of a recurrence of that nightmare. As many recall the episode and revalue their actions, it is clear that not enough bankers (if any) were sent to jail or punished in any other way. While there has been a flurry of legislation—Dodd-Frank in the US, the implementation of the recommendations of the Vickers Report in UK and efforts in Basel by the Bank of International Settlements—it seems the fear of failure has not gone away. Banks are holding more capital. The Volcker Rule will prevent the most serious gambling with depositors’ money. Banks have been asked to make “living wills” setting out how they will cope with bankruptcy as this time governments will not bail them out.
Earlier last week, Gordon Brown, the former UK chancellor of exchequer and PM when the crash occurred, said that the world was walking blindfolded into the next crash. Lord Robert Skidelsky has just published a new book, Money and Government, making a fresh case for the use of fiscal policy more than of monetary policy. He wrote in the Guardian last week, warning about the return of the financial firestorm.
Brown said that interest rates being already low in the G7 countries, and that there is no scope for monetary policy to come to the rescue. In 2008, he was able to launch a coordinated reflation of leading economies. Now, thanks to Trump, that system of international cooperation is in disarray. Skidelsky is worried that economists have, as yet, not revised or improved the paradigm of equilibrium and rational expectations which caused the crash last time around.
How do we evaluate these warnings?
There is no doubt that there are many things increasing volatility at present. President Trump is busy dismantling the globalised trading network and carrying out bilateral tariff wars with those countries with which America has the largest deficit—China, EU and NAFTA partners. As of now, it is difficult to know which way the world will go if he is successful and how much the loss of output would be if there are deadlocks in the tariff battles.
Oil price has been rising and even the short lived impact of hurricanes threatening the US east coast is putting pressure on the already high oil price. This in turn has affected the currencies of emerging market economies ( EME). Turkey and Argentina are in severe trouble with interest rates rocketing and their currencies depreciating. India has been caught in these headwinds despite low inflation and good growth. The rupee’s fall is troubling people.
Elsewhere, there is no danger sign. The American economy is growing at a high rate with employment booming and, despite that, wages being stable. Inflation seems to have gone out of the system for a variety of reasons such as increased efficiency in retailing—the Amazon effect—falling prices of cyber products due to constant technical progress, the introduction of robots in workplaces, and cheap manufacturing products being exported by Asia. Only primary commodity prices remain as a likely source of inflation. European Union has political problems of immigration. Italy has a soft fiscal position and its bond yields are uncomfortably high. There is strong rhetoric against the Euro from Italian leaders but there should be no threat to the stability of the Euro.
It is in the EME that danger signs lurk. China is decelerating but reluctantly. It has lot of bad debts and shadow banks. Chinese authorities have not shown good control of their financial markets. Being in a tariff war with US, the temptation to use the renminbi as a weapon of devaluation is great. This would add to the volatility of EME exchange rates. At worst, we could have a recurrence of the Asian currency crisis of the late 1990s, but which will not consume the whole world or not even all EMEs. In fact, as a group, EMEs are a fast growing set of countries. Africa is beginning to be a cause for celebration rather than worry.
My own assessment is that while there is volatility, there is no need to worry about a general crisis. By and large most G7 and G20 economies are growing robustly. There are problems of inequality, fears of AI and of course the tariff wars. The debt levels of households are high but as employment is high, debt repayment should be affordable
If we look at past trends, a big crash such as one of 2008 had not happened since 1929. There have been smaller downturns of course. The Asian crisis of 1998 and the collapse of the dot com boom around 2000 were smaller, local crises. If you are a chartist you may say that every ten years a crisis brews. Even if that were true (which I do not think it is), the impact will be small, local and limited.
-The author is a prominent economist and labour peer