The next financial crisis

Clueless central banks? A trade war? Southern debt? Ten years after the last one, leading economists including Jayati GhoshCédric Durand and others think about where the next crisis might come from...

The ‘great unwind’ – Alfie Stirling

For economists, searching for the next crisis out there in the real world is like looking for a needle in a haystack. It may make more sense to look for the causes of a future crisis from within the actions of policymakers rather than bankers.

Among these causes, what has become known as the ‘great unwind’ – the phenomenon whereby almost every major economy is planning to raise interest rates at the same time – stands out as one of the most risky and uncertain human-made events of modern times.

The great unwind has been made necessary by almost a decade of monetary (or interest rate) life support. From the US to Europe and to Japan, central banks have gone to unprecedented lengths to keep major economies afloat since the crisis.

Two medicines have been prescribed. One: record low interest rates (including negative interest rates in places such as Japan and Switzerland) which make it cheaper for banks to borrow money from central banks. Two: the creation of cheap money for banks in the form of quantitative easing. These policies flood financial markets with new cash, which if left unaddressed can lead to inflation as well as the development of dangerous new asset bubbles. Most central banks are nervously monitoring the effects.

China has offered a small taste of what could come. Between 2014 and 2015, cheap credit saw people borrow to invest in the country’s stock market. Herd mentality saw corporate share prices rise 150 per cent in just 12 months, despite little change in the underlying value of companies. This discrepancy culminated in the bubble bursting, with Chinese stock markets losing 30 per cent of their value in just three weeks.

Interest rates need to rise, but this in itself is almost as risky as keeping them low. According to the International Monetary Fund, global debt is now at a record high of $164 trillion, or 225 per cent of world GDP – significantly higher than before the onset of the 2007 crisis.

Raising interest rates too quickly in just one country risks suffocating a significant number of families and firms with higher debt repayments, bringing about defaults and, potentially, recession. But nobody knows quite what will happen if almost every major economy raises interest rates or reverses quantitative easing at the same time.

Unfortunately for us all, policymakers don’t have the luxury of slowly and carefully feeling their way to higher interest rates; raising rates too slowly has its own potential for disaster. Cutting interest rates is the main recession-fighting tool. This means that governments need rates to rise to a high enough level before the next crisis hits so that cutting them will provide a meaningful stimulus.

The issue for most countries is that interest rates are still at the point known as the ‘effective lower bound’ – the level below which further cuts have little or no positive marginal effect on spending.

With global downturns taking place most decades on average, the lower bound is a worrying place to be, 10 years on from the last recession. There is, therefore, an urgent need to raise interest rates quickly before the next recession hits.

Failure to unwind low interest rates risks excessive inflation and and asset bubbles, but policymakers are faced with a Catch 22: raise interest rates too slowly and they risk being dangerously ill-equipped to combat the next downturn; raise rates too quickly, however, and they risk creating the next recession themselves.

Central bankers and politicians have become used to thinking about crises – like those that might arise from automation or climate change – as something that happens to them. The truth is, the next one is likely to be of their own making.

Alfie Stirling is head of economics at the New Economics Foundation in London. @Alfie_Stirling

The fall of Rome – Cédric Durand

Beware of Italy! For years commentators have pointed out that the country is the weakest link in a still-faltering Europe. Ten times bigger than Greece, it has a public debt of over 130 per cent of GDP and has suffered two decades of stagnation. GDP per capita is now barely above its level of the late 1990s. Now the Italian economy is entering uncharted political waters, following the announcement of a coalition government, formed by an alliance of the far-right League party and the Five Star populist movement. These political developments bring back to the fore unresolved faultlines within the Eurozone and could trigger the second phase of a great financial crisis.

The Eurozone sovereign debt crisis of 2010-14 was an unheard warning. At the cost of the martyrdom of the Greek people and self-defeating austerity policies, the dominance of financialization survived a few years. But this respite rests on a fragile form of bureaucratic Caesarism: the hardening of technocratic governance via memoranda has reduced so much the scope for democratic politics that the whole legitimacy of the European integration project is undermined. Nativist movements are leading a perilous nationalist revival while, on the Left, new forms of populist politics attempt to launch a socially progressive project. Both are on a collision course with the European Union.

It would mean the end of the European Union as we know it

On the one hand, mainstream neoliberal parties of northern Europe, blinkered by selfishness, entertain the false idea that core economies like Germany are subsidizing countries like Greece and Italy on the periphery. However, by keeping the zone in the limbo of a currency union without a federal budget – Germany’s surpluses can’t be recycled to help the southern countries as that would mean they were in a federal union – they refuse the only political commitment that could guarantee the EU’s long-term survival. What is clear is that within the straightjacket of the Eurozone, there is no way to accommodate anti-neoliberal policies. Meanwhile, the deepening of the single market forbids any attempt to develop meaningful industrial policies and devours public services inherited from the post-War era.

If the newly elected majority in Rome tries to break out of these iron cages, we know what the sequence of events will be from the example of Greece: capital flight will result in soaring interest rates and bank failure. The European Central Bank would have to step in and confront a rebel government with nothing to negotiate but complete surrender or expulsion from the single currency. Considering the size of the Italian economy, the precedence of Greece’s humiliation and the destabilizing force of Brexit, any such development would mean the end of the European Union as we know it. In the meantime, financial instability will shake banks and markets all over the world and test the extent to which governments and central bankers can resort once more to extraordinary measures of financial containment. The likelihood of Italian politics triggering the next global financial collapse indicates that after a decades-long era of financialization, we are veering back towards a time of politics.

Cédric Durand teaches economics at the University of Paris 13 and is the author of Fictitious Capital (Verso).

Asian fragilities – Jayati Ghosh

This is supposed to be ‘the Asian century’. The spectacular rise of China and overall dynamism of the Asian region created the widespread perception that Western capitalism is stagnant and moribund, unlike Asian capitalism which will show rapid growth and create a new geo-economic balance. Developments in the wake of the global financial crisis appeared to confirm this: while growth rates in Asia (and in the largest economies of China and India) dipped in 2009, just as they did in most of the world, the recovery was rapid and subsequent rates of growth remained higher than elsewhere.

But the optimistic view of the newly emerging growth pole in the East missed the evidence that the greater dynamism of Asia was mostly due to a tiny set of countries: first, Japan and South Korea until the late 1980s; subsequently, China in the current century. And Chinese exceptionalism has been just that – exceptional, based on an astute use of unorthodox economic policies by a heavily centralized and controlling state. More to the point, since the global crisis, the recovery and expansion in almost all the major economies of Asia has been heavily based on debt. Even in China, debt-to-GDP ratios have more than doubled since before the crisis, and in many other Asian economies certain forms of debt – especially in housing and personal finance – have reached alarming proportions. In Asia – perhaps even more than in the Global North – the strategy of inducing recovery through lending private money has increased fragilities that could generate another crisis in the future. This is already evident in India, where bad corporate loans are creating debt so large that companies can’t take on additional debt to finance future projects – a phenomenon called ‘debt overhang’. This has become a drag on bank lending and on private investment, leading to absolute reductions in investment over the past few years.

Meanwhile, Asian economies are even more beholden to the unpredictable movements of global stock markets. In the run-up to the global crisis, the flow of liquidity primed both advanced economies and, mainly Asian, emerging markets. And once the ‘easy money’ response to the financial crisis was put in place, markets across the world turned buoyant once again (see ‘The great unwind’, page 17). Several emerging markets in Asia became the targets of betting on currency values, as speculative investors moved in, backed with cheap capital. As a result, markets in South Korea, India and Thailand have been febrile and volatile, vulnerable to violent swings.

The legacy of these ‘bull runs’ – when everyone expects prices to rise – is large accumulation of foreign investments in both stock and bond markets. In such conditions, the slightest piece of negative news can lead to investors quickly taking their money out of these markets, triggering steep currency depreciation and internal financial problems. In other words, the flutter of a butterfly’s wings in a distant part of the world can create a financial storm in Asia.

Jayati Ghosh, one of the world’s leading economists, is professor of economics at Jawaharlal Nehru University.

Silicon Valley hubris – Wendy Liu

Apple, Microsoft, Amazon, Alphabet and Facebook have crept up on us over the past few decades from mythologically humble dorm-room beginnings to becoming structurally embedded in the global economy. Like the financial industry, these high-tech companies are now of vital importance to the system.

But the other side of Silicon Valley is venture capital. Overstuffed venture capital funds, searching for the next billion dollar opportunity, are investing in any team with a half-decent pitch and the right connections. US investment recently hit its highest level since the dotcom era.

Those with a vested interest in maintaining this situation would have you believe that it’s not another bubble – this time is different, and any perceived froth is simply due to Silicon Valley’s unprecedented innovation.

This entrepreneurial hubris overlooks the role of larger economic trends. The current low-interest-rate environment post-2008, combined with general economic stagnation, has led to a situation of ‘overaccumulation’ – too much capital sloshing around, needing a place to go. At the moment, technology seems like a good bet and investors are jumping on anything remotely tech-related in the hope that it will eventually provide a return.

Is this sustainable? Unlikely. I would categorize the threats to Silicon Valley into three main areas: consumer backlash, mismanagement, and worker organization.

Right now, the strongest avenue for consumer backlash involves privacy concerns. The Cambridge Analytica debacle has spurred closer looks into Facebook’s business model. This could result in consumer boycotts or regulators intervening. Still, consumer action is inherently limited in power, especially as some platforms approach too-big-to-fail status.

Mismanagement – unethical behaviour, or merely investing in a bad idea – is rife in Silicon Valley. Theranos, once valued at $9 billion, is on the verge of liquidation, after its blood-testing technology was exposed as fraudulent. Zenefits ($4.5 billion) was fined by the government for flouting insurance laws. Snapchat lost $720 million last year and is now cutting staff. And the list of once-glorified tech start-ups that have recently failed is virtually endless. If this trend continues, there could be reverberations throughout the economy, given that venture capital typically comes from pooled sources such as pensions and university endowments.

Lastly, the possibility of worker organization in the industry is starting to threaten business models. Companies like Amazon, Deliveroo, and Uber maintain low consumer costs through exploiting underpaid, overworked and precarious workers. But these workers are starting to strike back through direct action and legal challenges. Though it’s yet unclear whether workers can extract lasting concessions before jobs are automated away, there is potential for massive disruption of existing business models.

Bottom line: Silicon Valley will not magically solve the problem of overaccumulation. Just like the financial frenzy pre-2008, it’s a temporary fix, and it will come crashing down soon enough.

Wendy Liu is a software developer and economics co-editor at the UK-based New Socialist. @Dellsystem

A global trade war – Michael Roberts

Since 2008-09, the major capitalist economies have been locked in what we could call a Long Depression, characterized by weak economic growth (a slower recovery from a slump than even in the Great Depression of the 1930s), weak investment rates and low profitability for big business.

To make things worse, President Trump and his new ‘protectionist’ advisers are threatening a series of measures to reduce the quantity of imports the US gets from other countries – particularly China.

The mainstream economics view is that free trade is good for all. And yet the historical evidence contradicts this. Over the past three decades, world capitalist economies have moved closer to ‘free trade’ with sharp reductions in tariffs, quotas, other restrictions, and by signing many international trade deals. But average annual economic growth since the 1980s has been slower than in the ‘golden age’ of the 1960s.

The mainstream economics view is that free trade is good for all. And yet the historical evidence contradicts this

Free trade ‘works’ when the profitability of capital is rising everywhere and everybody gains from a larger slice of the cake of value, even if in differing proportions. Then globalization appears attractive. The strongest capitalist economy will always be the strongest advocate of ‘free trade’, as Britain was between 1850 and 1870 and the US was between 1945 and 2000. ‘Globalization’ was the mantra of the US and its international agencies: the World Bank, the OECD and the IMF in the post-1945 period.

But if profitability starts to fall consistently, as is happening now thanks to the Long Depression, then free trade loses its glamour – especially for the weaker capitalist economies as the profit cake starts to shrink for them. ‘Populism’ and nationalism then rear their heads and mainstream economists opposed to ‘free trade’ become more prominent. 

A trade war would lower export sales for most countries and drive up prices of imports for households and companies. As a result, economic growth would slow, along with employment and investment. Real incomes would fall for the very people Trump claims his protectionism would benefit. ‘Free trade’ weakens the weak and strengthens the strong; but a trade war will weaken all.

If this happens – just at a time that the US Federal Reserve is thinking about raising the cost of borrowing to control budding inflation – it could be the final ingredient in a recipe for new economic recession, at a time when most countries are just recovering, 10 years after the last one.

Michael Roberts works as an economist in the City of London. His latest book is Marx 200 (Lulu) and he blogs at

Warning signs from Africa? – Sanjay G. Reddy

Debt crises are an ever-present risk for developing countries. In the case of sub-Saharan Africa, the post-independence build-up of debt to official creditors – be they governments, the World Bank or the IMF – led to a debt crisis in the 1980s and 1990s. This was only alleviated due to a combination of debt relief – under the Highly Indebted Poor Countries Initiative, with conditions that the recipients adopt free-market policies – and the resumption of growth in the 2000s. The latter was primarily due to a commodities boom, bolstered by robust global economic growth.

But the spectre of a debt crisis once again haunts sub-Saharan Africa. The total value of outstanding debt in the region has almost doubled between 2008 and 2016, to more than 450 billion dollars, of which more than a fifth is to private lenders. The continued accumulation of debt at the current pace, especially if accompanied by low commodity prices and higher global interest rates, may eventually cause some countries to be unable to repay their debts. This will greatly threaten economic and social investment and make it unlikely that the UN’s Sustainable Development Goals, which depend on significant gains in sub-Saharan Africa, can be achieved.

Damningly, the world has failed, despite recurrent international debt crises, to establish either principles for creditors that would diminish the accumulation of unsustainable debts, or a debt resolution mechanism that could deal with such crises effectively when they arise. Increasingly, when private creditors lend to developing countries, the arrangements contain ‘collective action’ clauses that bind both parties to accept decisions by a sufficient majority. Although this may reduce future risks, it cannot substitute for a set of background principles governing the accumulation of sovereign debt, and, in the event of crisis, bringing about its orderly restructuring (including write-offs).

Such principles should protect the most essential forms of government spending – those relevant to protecting vulnerable populations – and require a sharing of risks between debtors and creditors, much as domestic bankruptcy law ensures. There has been considerable discussion, within academic circles and international agencies, about the logical and practical basis for such principles. It is time to codify and implement them. Otherwise, in the event of a global economic downturn or other events causing debts to become unsustainable, development both in Africa and globally will be severely challenged.

Sanjay G Reddy is Associate Professor of Economics in the New School for Social Research, New York.

Shadowy banks – Grace Blakeley

When asked recently about the most significant future threat to the international financial system, Mark Carney, Governor of the Bank of England, replied: ‘Shadow banks in emerging markets.’ So what are shadow banks and what makes them so shadowy?

A bank is an institution that lends money and which uses deposits, guaranteed by central government, to finance that lending. Shadow banks, in contrast, lend money without taking deposits that are guaranteed by the state; examples include hedge funds, pension funds and private equity. So if a shadow bank defaults, its investors have to bear all the risk, whereas if a bank defaults, the government will step in to save depositors.

Many of the complex instruments that caused the financial crisis – from asset-backed securities to CDOs – were concentrated in the shadow banking sector. When the value of these assets collapsed in 2007, the shadow banking system – concentrated in the Global North – collapsed with them.

Sine then, however, the fortunes of the shadow banking system have turned. The Financial Stability Board has shown that the share of financial assets held by non-deposit taking institutions reached almost 50 per cent in 2016. This trend has been particularly evident in the Global South, hence Carney’s comments.

As soon as a modicum of stability returns to the international financial system, it’s not long before the next crash

China is the biggest cause for concern; its shadow banking industry is now worth $15 trillion, or about 130 per cent of GDP. The growth of shadow banking is linked to dramatic increases in levels of private debt in China, with non-financial sector private debt having grown from $6 trillion in 2007 to $29 trillion today, equivalent to 260 per cent of GDP. Shadow banks can provide credit with fewer restrictions and there are concerns that many shadow banks are relaxing their underwriting standards, particularly when it comes to refinancing existing debt.

It is true that the regulatory environment has moved on since the financial crisis. Ambitious proposals have been put forward for the regulation of both banks and shadow banks – from breaking up commercial and investment banking to taxing financial transactions.

Some of this has been implemented. But as the dust has settled, much of it has been forgotten. In fact, just as before the financial crisis, some fairly tough regulation has been imposed on banks while the shadow banking system has been left almost entirely untouched. The IMF, in a 2017 report on shadow banking, now has cause to worry that ‘risk has… shifted towards corners of the financial system where we have less visibility and fewer instruments to deploy’.

As economist Hyman Minsky, the great theorist of crashes, predicted, as soon as a modicum of stability returns to the international financial system, it’s not long before the next crash. There is no shortage of potential solutions – from extending capital requirements to shadow banks, to regulating their relationships with traditional banks, to limiting the amount they can borrow. But unless democratic governments are able to tame the power of financial systems, financial institutions – shadow and traditional – will undermine their best attempts to bring the sector under control.

Grace Blakeley is a researcher on the Commission for Economic Justice at the Institute for Public Policy Research, a progressive thinktank in London. @Grace_Blakeley

A Bitcoin bubble? – Brett Scott

Although Bitcoin is called a ‘cryptocurrency’, many are sceptical about whether it can actually be considered a currency. It is not legal tender like ordinary money, and it is not a legal contract as a normal financial instrument would be. Bitcoin tokens are just movable ‘digital objects’, and this makes categorizing them very difficult. Even hardcore Bitcoin evangelists cannot seem to decide, fluctuating between calling it ‘money’ and calling it an ‘investment’.

The US dollar price of these tokens has skyrocketed over the years and many observers see Bitcoin as a speculative frenzy. Bitcoin is particularly susceptible to wild swings because it is not anchored into any real-world economy. Financial instruments like shares or mortgage-backed securities can go through prolonged speculative bubbles, but they eventually have to crash when people realize the prices do not match the underlying reality that the instrument references. Bitcoin, though, is not attached to an ‘underlying reality’ – it is like the digital equivalent of a blank piece of paper – so it is hard to tell if it is a ‘bubble’.

Would a crash in the price of Bitcoin pose a threat to financial stability? Probably not. If you were hypothetically to attempt to buy up the entire supply of Bitcoin tokens, you would need roughly $150 billion, in theory. To try do the same thing for Apple Corporation, you would need $850 billion. The market value of all Bitcoin tokens is only a sixth of the value of a single major US company. So, while individual people will lose their money if it crashes, it is unlikely to bring whole economies down.

Indeed, while many regulators are concerned by various issues that cryptocurrency poses – from its use within dark markets, to consumer protection – they are not in general concerned that it poses a systemic threat to financial stability. Europe’s central bank recently issued a statement saying Bitcoin was not their problem, but that people should be careful when speculating in it. In other words, they have bigger fish to fry.

This does not mean we shouldn’t pay attention to it. Cryptocurrency could be a useful alternative to our bank-controlled payment systems; groups like Wikileaks have used it to circumvent attempts by payments corporations to choke off their donations. On the other hand, cryptocurrency is seeing a big uptake by far-right neo-fascist users, and many are concerned about the massive energy consumption of the Bitcoin mining system.

Behind the scenes, the Bitcoin developer community is in the midst of a civil war. Some breakaway factions maintain that the original purpose of Bitcoin was to be ‘digital cash’ for small everyday transactions. Others, including the main lead developers, are characterizing it as ‘digital gold’ to be held as an investment. They believe that, in the context of another crisis, there could be a mass flight to cryptocurrency. This seems like wishful thinking. Gold is in extremely constrained supply and only the wealthiest really have access to it. If Bitcoin was to become ‘digital gold’, it would just be another elite bastion of inequality.

Brett Scott is author of The Heretic’s Guide to Global Finance: Hacking the Future of Money (Pluto). @Suitpossum

Against futurology – Chris Dillow

Where might the next crisis come from? There are several possibilities. In truth, though, speculating about the precise cause might not be productive. There’s one overwhelming fact about crises: mainstream economists do not see them coming. Prakash Loungani, an IMF economist, has shown that forecasters typically ‘miss the magnitude of the recession by a wide margin’. He shows that for 63 countries between 1992 and 2014 the average forecast made in the April before a recession year (a year in which real GDP fell) was for growth of three per cent.

There’s a good reason for this. Crises occur when the values of assets fall unexpectedly – be they share prices, bond prices, the value of bank loans or factories, credit derivatives or whatever. Such falls are always possible for a reason pointed out by Keynes in 1936. All asset prices depend upon expectations of the income they’ll yield in future. And, said Keynes, our knowledge of that future income ‘is usually very slight and often negligible’. This means asset prices are prone to fall – sometimes sharply – as expectations or sentiment change.

But the very same lack of knowledge of the future, which causes asset prices to be so fragile, also means that people are unable to predict such falls. Crises and economists’ inability to predict them are two manifestations of the same fact – our lack of knowledge of the future. Because this lack is an inherent feature of the human condition, crises are inevitable.

There’s one overwhelming fact about crises: mainstream economists do not see them coming

Instead, of asking when or why the next crisis will happen, we should ask: is the economic system resilient to sudden changes in expectations?

Sometimes it is. In the early 2000s share prices fell sharply. Between 2000 and 2003, $6.3 trillion was wiped off the price of US shares – a far greater loss than banks incurred in the 2008 crisis. And yet the early 2000s saw only a mild recession while the 2008 losses triggered the worst recession since the 1930s.

Why the difference? It’s because losses on shares were spread across millions of people and so were bearable; whereas banks’ losses were concentrated in a handful of highly indebted organizations which could not bear big losses and upon which the rest of the economy was dependent.

Instead of just trying to predict and prevent crises, policymakers should also ensure that economies can cope with them when they happen. This requires strong welfare states, a financial system that ensures that good projects can acquire financing even in bad times, and a willingness and ability of policymakers to take strong counter-cyclical policy actions via expansionary government spending, tax and interest rate policies. Rather than engage in futurology, we should ask whether such institutions are in place now. I fear the answer is: not sufficiently so.

Chris Dillow is economics editor at Investors Chronicle. He blogs at Stumbling and Mumbling. @CFJDillow