Looking for opinions on the next financial crisis?
Here's a portion of the prelude to the opinions. I was one of those quoted.
It is often stated that there is a major financial crisis every 10 years or so. Having said that, it’s been a little over a decade since the Lehman Brothers collapse sparked the last global financial crisis (GFC) and with global economic growth starting to show signs of petering out, some in the media and elsewhere in the public eye are forecasting another global financial crisis in the very near future.
There has been a variety of reports from prominent analysts lately with predictions as to when the next crisis will hit and what will spark it. Strategists at J.P. Morgan Chase recently made a splash with their announcement of a new predictive model that pencils in the next crisis to hit in 2020. Additionally, J.P. Morgan’s Global Head of Macro Quantitative and Derivatives Research, Marko Kolanovic, has highlighted a potential precipitous decline in stocks that could cause what has been termed “the Great Liquidity Crisis.” He identified the shift away from actively managed investing toward passive investing strategies such as exchange-traded funds, index funds and quantitative-based trading strategies, as well as computerized trading as the potential culprit, which could not only be the catalyst for the next crisis but could also exacerbate the fallout.
According to Joyce Chang and Jan Loeys of J.P. Morgan, “The shift from active to passive asset management, and specifically the decline of active value investors, reduces the ability of the market to prevent and recover from large drawdowns.” Passive investing strategies have removed a pool of buyers who can swoop in if valuations tumble, while many of these computerized trading programs are designed to sell automatically when weakness shows, which would only worsen the situation.
Others have pointed to the China-U.S. trade war, the move toward protectionist trade policies in general around the world, and even the possibility of a cyber attack taking down the global financial system as possible causes of the next crisis. With that said, we decided to ask 26 economic and financial market experts what they believe will be the catalyst for the next financial crisis and when they think it could happen.
Here are a few snips of what several of the respondents thought. Emphasis is mine.
Sovereign Debt. The riskiest asset today is sovereign bonds at abnormally low yields, compressed by central bank policies. With $6.5 trillion in negative-yielding bonds, the nominal and real losses in pension funds will likely be added to the losses in other asset classes.
Incorrect perception of liquidity and VaR. Years of high asset correlation and synchronised bubble led by sovereign debt have led investors to believe that there is always a massive amount of liquidity waiting to buy the dips to catch the rally. This is simply a myth. That “massive liquidity” is just leverage and when margin calls and losses start to appear in different areas -emerging markets, European equities, US tech stocks- the liquidity that most investors count on to continue to fuel the rally simply vanishes. Why? Because VaR (value at risk) is also incorrectly calculated.
The fallacy of synchronised growth triggered the beginning of what could lead to the next recession. A generalized belief that monetary policy had been very effective, growth was robust and generalized, and debt increases where just a collateral damage but not a global concern. And with the fallacy of synchronised growth came the excess complacency and the acceleration of imbalances
What will the next crisis look like?
Nothing like the last one, in my opinion. Contagion is much more difficult because there have been some lessons learnt from the Lehman crisis. There are stronger mechanisms to avoid a widespread domino effect in the banking system.
When the biggest bubble is sovereign debt the crisis we face is not one of massive financial market losses and real economy contagion, but a slow fall in asset prices, as we are seeing, and global stagnation.
I am not sure what is meant by a financial crisis in this context. Will there be some countries or sectors that face serious financial problems? The answer is sure. We can say that several developing countries, most notably Argentina and Turkey, are already in this boat. But if the claim is that there will be some financial crisis that rocks the world economy, this is just silly. Prior to the crisis caused by the collapse of the housing bubble, you would have to back more than 70 years to find a world shaking financial crisis. So the 10-year story clearly does not fit here. The 2008 crisis could shake the world economy because it was being driven by housing bubbles in the U.S. and Europe. That is not true today, although several countries do face a risk from housing bubbles, notable Australia, Canada, and the UK. If higher interest rates or other factors deflate these bubbles, their economies are likely to fall into a recession (with or without financial crises). I don't see this a world-wide story however.
What do I think? I am careful not to exaggerate what we can actually conclude. I don’t think we can forecast more than a year ahead, nor can anyone else. We can safely say that a recession has not already begun (despite some doomsayer claims) and that the odds against a recession starting in the next year are 3-1.
And the cause? No one knows that either, although it usually happens after a pop in the ten-year yield, a later move in short-term rates via the Fed, and a yield curve inversion. That process may play out again, but we are early in the story.
Given that the main driver of the stock market has been interest rates, one should anticipate a rise in rates to drain the punch bowl. The recent weakness in emerging markets is a reaction to the steady tightening of financial conditions resulting from higher US rates.
The domestic US economy has remained largely immune. Tariff barriers and tax cuts have more than offset the monetary drain.
Historically the correlation between the US stock market and other equity markets is high. Recent decoupling is within the normal range.There are sound fundemental reasons for the decoupling to continue, but it is unwise to predict that, 'this time it's different.'
The global economic recovery since 2008 has been exceptionally shallow. US fiscal policy has engineered a growth spurt by pump-priming. When the downturn arrives it will be protracted, but it may not be as catastrophic as it was in 2008. Lightening seldom strikes in the same way twice. A 'melancholy long withdrawing breath,' might be a more likely scenario. A decade of zombie companies propped up by another, much larger round of QE.
When will it happen? Probably not yet. The economic expansion (outside the tech and biotech sectors) has been engineered by central banks and governments. Animal spirits are mired in debt; this has muted the rate of economic growth for the past decade and will prolong the downturn in the same manner as it has constrained the upturn.
The next crisis has already begun, but we do not yet see the signs. The most likely sources of stress are opaque accounting and questionable governance at Chinese firms, Donald Trump's fiscally irresponsible tax cuts for the rich and corporations, and the rise of various other populist leaders (besides Trump) who prefer mercantilist trade policies. Other factors of interest are over-compliant central banks that value economic growth over economic stability and the rising costs of climate disruption. In terms of a global recession, I think that corporate debt markets might be the first to run into trouble either due to fraud or regulatory interventions that reduce liquidity or the perceptions of risk. Although the international trading system is fairly robust relative to the situation in the 1930s, I could see a Trumpian-style war of all-against-all as a likely first casualty of any sizable macro disruption, in the same way that rising tariffs in the US (Smoot-Hawley) and elsewhere were erected in the years after 1929's Black Friday. Although companies with large domestic revenues might appear as beneficiaries in an isolationist world, I think that their share prices will fall after a brief increase as they experience disruptions and other collateral damage from populist policies.
In a nutshell, I see crises as caused by a collapse in credit from a high level of private debt. Since the US & UK had that experience in 2008 and are still carrying high levels of private debt, their credit levels are low compared to past years, and a serious decline in credit-based demand as happened in 2007/9 (from +15% to -6% of GDP in the US's case) is unlikely. However I think they'll continue slipping from positive to negative credit over time, as Japan has done since its crisis in 1990. Many countries that avoided a crisis in 2007/8 did so by continuing to expand private debt: China, Canada, Korea, Australia and France are prominent there. I think they will have localised crises in the next 1-3 years.
The next crisis will not be as severe as the last crisis, because the banks are in good shape. As such, think of the crises that happened in 1987 or 2000-2, which were not systemic. Also, look at places where floating rate liabilities and other short liabilities are used to support long-term assets. All crises occur from short-term liabilities financing overvalued assets. As such, look at real estate in hot coastal markets (where ARM financing is high), corporate floating rate debt, and private student loans. Something will be triggered as a result of the Fed tightening rates. We already have the first taste of that with weak countries like Argentina, Turkey, South Africa, etc. The initial effects of monetary tightening have knocked down those countries because they relied on increasing liquidity. The next phase will come when decreasing liquidity makes something crack where a set of oversupplied assets can no longer service its debts. Again, this isn’t a repeat of 2008-9 (though we still haven’t fixed repo financing). This will be something where demand fails because stimulus cannot continually increase, and we are oversupplied in a number of areas – autos, homebuilders, etc. That what recessions are for – eliminating bad debts, and recycling the assets into better-financed holders at lower prices.
Mike 'Mish' Shedlock
It's been about 10 years since the last financial crisis. FocusEconomics wants to know if another one is due.
The short answer is yes. In the last 10 years not a single fundamental economic flaw has been fixed in the US, Europe, Japan, or China. The Fed was behind the curve for years contributing to the bubble. Massive rounds of QE in the US, EU, and Japan created extreme equity and junk bond bubbles. Trump's tariffs are ill-founded as is Congressional spending wasted on war.
- Junk Bond Bubble Bursting
- Equity Bubble Bursting
Many will blame the Fed. The Fed is surely to blame, but it is prior bubble-blowing policy, not rate hikes now that are the problem.
It does not matter what the catalyst is actually. And there might not be any catalyst other than simple exhaustion: The pool of greater fools in stocks, bonds, and housing simply ran out.
Regardless, I expect all eight of the above discussion points to be in play when the crisis does hit.
Mike Shedlock a.k.a. Mish is a registered investment advisor representative for SitkaPacific Capital Management.
I picked snips from eight writers containing a variety of opinions.
I am closest aligned with Daniel Lacalle, and least aligned with Dean Baker.
Lacalle cites central bank errors, liquidity issues, various bubbles, and zombification. He concludes with I line I have stated many times: "But the governments and central banks will not blame themselves, they will present themselves -again- as the solution."
Steve Keen concerns over debt are unquestionably spot on.
Mike "Mish" Shedlock