The Next Financial Crisis

Being one of the world’s leading economic historians, Niall Ferguson has occasionally tried his hand at prognostication. It’s not a bad business. People tend to remember when you get it right. They forget when you get it wrong.

Anyway, Ferguson does remember that he got the Great Recession and the 2007-8 mortgage meltdown right. It feels slightly immodest, but he has every right to remind us of his prescience. Especially when he adds modestly that if he had really believed what he was saying he would have invested accordingly and retired to Tahiti:

  

The thing about which I have been most right in my career is the thing for which I have received the least credit. Beginning in June 2006, I wrote a series of articles and gave numerous speeches that predicted, with considerable precision, the global financial crisis that would emanate from subprime mortgage defaults.

Looking back, I now realize I should have kept that prediction to myself, set up a hedge fund and short-sold everything in sight, beginning with US mortgage lenders. Instead, like the fool of an academic that I am, I wrote a book, “The Ascent of Money,” that was published just as my predictions were coming true.

What saved the economy n 2008? Most people believe that it was the Obama administration. In truth, most of the legislation that helped was passed during the Bush administration. Savvy observers tend, like Ferguson, to credit the Federal Reserve bank. Lowering interest rates and buying up bonds and mortgages (keeping interest rates unnaturally low) produced an economic resurgence.

Ferguson wrote:

For it is a truth universally acknowledged that it was the Federal Reserve, with its bold policies of zero interest rates and “quantitative easing” (large-scale purchases of financial assets) that saved the world from deflation and a second Great Depression.

Now, the cheap money party is about to end—or, as Shakespeare said: “Our revels now are ended”-- and rising interest rates will surely, Ferguson says, slow down the economic expansion:

First, the monetary policy party is drawing to a close. The Fed and now the Bank of England are raising rates. The combined assets of the big four central banks — Fed, European Central Bank, Bank of Japan, and Bank of England — will peak in December 2018, but the rate of expansion has already started to slow. Moreover, global credit growth in aggregate is slowing.

History shows that monetary tightening acts with long and variable lags. But it does act, often on stock markets.

Perhaps it is too early to lock in stock market gains, but, as the saying goes, no one ever went broke taking a profit.

And then there is the demographic factor. Population growth seems destined to decline over the next decades… though, to be fair, China might institute a two or three child policy and, kaboom, will solve this problem.

Anyway, Ferguson says that the contracting labor market will cause wages and inflation to increase:

Globally, the ratio of workers to consumers has peaked. Between now and 2100, China’s working age population is projected to shrink from 1 billion to below 600 million. Already many labor markets look tight, with unemployment rates and other measures of slack leading economists to expect a surge in wages and inflation.

For ages now we have read that human jobs were going to become obsolete and that we would all be blessed with an abundance of leisure. As of now the predictions have not come true, so we have reason to doubt them.

In Germany, however, some people believe that the new influx of immigrants will take up the slack and fill in for a declining working age population.

Ferguson remarks that this is a pipe dream. And he wrote this before Angela Merkel’s attempt at building a governing coalition collapse:

Countries such as Germany that think immigration will help matters will be disappointed, as many newcomers lack the skills to be easily absorbed into a modern workforce — hence the big discrepancy between native-born and foreign-born employment rates in northern Europe. What is more, the rising dependency ratio as populations age doesn’t translate into higher saving but into higher consumption, especially on health care. Welfare safety nets have encouraged many retirees not to provide completely for the costs of a prolonged old age.

All of those refugees, Ferguson says, will consume more in health care and government benefits than they contribute to their economies: but you knew that already.

And then, he continues, the end of the bond bull market will produce higher interest rates… especially for highly indebted nations. Ferguson mentions Canada and China, but America’s debt is nothing to feel optimistic about. If interest rates rise to 5%, interest on the national debt will amount to $1 trillion a year… thus eating up most government spending.

Ferguson explains:

This leads to the conclusion that the end of the 35-year bond bull market is nigh. Bonds will sell off; long-term rates will rise. The question is whether or not inflation will rise as much or more. If not, then real (inflation-adjusted) interest rates will rise, with serious implications for highly indebted entities. The Bank for International Settlements recently published “early-warning indicators for stress in domestic banking systems.” Two big economies with flashing red lights are China and Canada.

And then there is structural deflation. Hmmm… By that he seems to mean that what with the arrival of Amazon and online shopping prices are destined to go down. One thing we do know, in a deflationary environment debt is not your friend. Which would mean that the Federal Reserve would feel constrained to inflate the currency…

In Ferguson’s words:

regardless of monetary policy, a networked world — whose biggest companies are dedicated to reducing the cost of everything from shopping to searching to social networking — is a structurally deflationary world.

Ferguson foresees a new financial crisis. The only question is what it will look like—it will not look like the last one—and when it will come:

No two financial crises are the same. The next one will not be like the last one. But there will be a next one and, as the monetary medication begins to be withdrawn, it draws nearer. This time, mark my words.