Déjà vu is in my bones, I feel it like the cold chill of winter.
It relates to interest rates. History tells us that periods that saw unusually low interest rates followed by a period of rapidly rising rates, don't end well. The longer the previous period of low rates, and the lower they fell, the worse the eventual crisis.
In the mid 1990s, the US Federal Reserve increased rates after a period when they were abnormally low. This sparked a chain of events that led to the Asian and Russian crises of 1997 and 1998 and the collapse of Long Term Capital Management. Only a bailout orchestrated by the Fed and IMF stopped the crises spreading to the West.
Arguably, the Fed, and its famous chairperson, Alan Greenspan, avoided a global crisis by creating a new bubble. This bubble developed in the early years of the 21st Century, interest rates were cut to levels that were even lower than those enjoyed in the 1990s; subprime mortgage securitisation led the way, debt surged and it all came spectacularly to a halt in 2008.
The crisis of 2008 was the worst crisis to rock the West since 1929. The solution: banks were bailed out, interest rates were cut to an all-time low, and stayed there for the best part of a decade, and to make sure we got the point, central banks also tried to stimulate the economy by buying short-term government bonds in a process called quantitative easing, or QE.
It worked, sort of !
Lower interest rates and QE meant higher asset prices. Higher asset prices encouraged higher levels of borrowing, putting an end to the credit crunch and stimulating economic growth.
But there are dangers:
- Record low interest rates led to an explosion in debt.
- Rising asset prices exacerbated inequality.
- The banking bailout created a sense of popular unease.
- In parallel, technology has begun to hollow out the labour market, replacing well paid jobs in manufacturing with minimum wage or insecure jobs in warehouses or in the so-called gig economy.
- We forgot the lessons of 1929.
Earlier this year, the IMF said:
"Global debt is at historic highs, reaching the record peak of US$164 trillion in 2016, equivalent to 225 per cent of global GDP. The world is now 12 per cent of GDP deeper in debt than the previous peak in 2009, with China as a driving force."
Recently the Harvard economic professor, Carmen Reinhart, warned that Argentina, Turkey and Peru have the worse combination of current account vulnerability and poor government effectiveness, but she also suggested that Brazil, Indonesia, Mexico, the Philippines and India were not far behind.
The lessons of 1929
One of the self-defeating actions, following the 1929 crash, was the Hawley–Smoot Tariff, which slapped tariffs on 20,000 goods imported into the US, part of a wider, global, protectionist trend. Most economists agree that this helped prolong the 1930's Great Depression.
We also saw the rejection of an international framework, such as the League of Nations.
Popular discontent fuelled by weak economic performance led to the rise of fascism, creating global political instability, culminating in World War II.
Risk of a bursting debt bubble
Debt levels may be sustainable if interest rates remain low. Although rates have been rising in the US and to a smaller extent in the UK, so far rises are modest. If factors over which central banks have little control create a greater inflationary risk, central banks may have no choice but to step up the pace at which they increase interest rates, creating the risk that global debt becomes unsustainable.
Factors that might force the need to increase interest rates include:
- US fiscal stimulus at a time when the US economy appears to be near full employment
- Protectionism (reversal of globalisation).
Mark Carney and Gordon Brown have both warned of the risks of another 2008 style crash.
Mr Carney says that the four big risks to the global/UK economy are "those areas that have taken on a lot more debt ... risks around Brexit ... risks related to cyber security ... but one of the bigger risks for the global economy are developments in China", namely the surge in its debts.
The fact is, in the UK, household debt to GDP is lower than in 2008. Although some emerging markets such as China, Turkey and Argentina are haunted by massive debts, the Asian tiger economies are not as indebted as they were in 1997. Besides, China is complex, and its debts are largely internal – although its debt levels are high, so are its savings.
Technologies, including AI, robotics, The Internet of Things, nanotechnology, genome sequencing, CRISPR, stem cell technology, additive manufacturing, virtual and augmented reality and new renewable energies, may yet prompt a period of rapid growth, nullifying many of the factors described here.